Outlook 2015: Offshore oil drillers face wave of restructurings amid declining prices, oversupply

By Stephanie N. Rotondo

Phoenix, Jan. 2 – A decline in oil prices has put the offshore oil drilling sector in peril, according to Mark Pibl, head of high-yield strategy at Canaccord Genuity.

“We’ve seen a whole bunch of these guys trade down dramatically,” he said in an interview with Prospect News.

It all started toward the end of summer, when oil prices started to see significant declines. From mid-July to mid-August, the price of West Texas Intermediate crude dropped to $96.54 per barrel from $103.59 per barrel. By mid-November, prices had fallen to $66.15.

Prices continued to decline into December, with the WTI benchmark seemingly hitting fresh five-year lows every week.

On Dec. 15, the price was $55.21 per barrel, a five-and-a-half year low.

However, Pibl explained the most deepwater contracts were renewed in late summer, when prices were still well over $100 per barrel and there was a “significantly lower day-rate environment.”

That kicked off “the downward spiral,” he said.

As the day-rate started to weaken, “equities [of offshore drillers] really took it on the chin in September,” Pibl said. Debt linked to offshore drillers then followed by late September.

“It happened very fast,” he said, as corporate bonds began trading with yields as high as 24%.

But falling prices and lower day-rates weren’t the only problem the sector was facing. Many drillers, Pibl said, have more fleet capacity than they need – “some vessels are still being built,” he said.

With investors jockeying around in names such as Hercules Offshore Inc. and Transocean Inc. – among others – everyone is wondering how things will shake out.

Moves to restructure

So far, analysts are still mixed on when oil prices will hit a floor and what that floor might look like: some are predicting that oil will stabilize in the $50 range, while others are predicting in the range of $40 per barrel.

One analyst, Pibl notes, is forecasting a three- to five-year downside cycle for the oil industry and “we’re in the beginning of that cycle.”

“There’s only so many projections to go around,” he said. “Ultimately, you can’t model it right now. Some of the deterioration won’t be known [until toward the end of 2015].

“On an equity basis, forward multiples are 50% lower than the trailing 12 multiples.”

But without any signals toward the upside – for instance, an increase in demand or a production cut from OPEC – it is likely that some offshore drillers will need some form of restructuring “both in and out of bankruptcy.

“A few are way over-levered and need to seek bankruptcy,” he said.

That becomes clearer when comparing enterprise value with EBITDA, he said.

“Some of these are at all-time lows or even two-decade lows in some cases,” he added.

Even offshore names that are deemed investment grade – like Transocean – are not necessarily safe.

In the case of Transocean and its ratings peers, “they are falling out of investment grade – bonds have really widened.”

Pibl feels that no matter how Transocean moves to weather the storm, it will likely lose its investment-grade status. “There are implications that the bonds will continue to widen. They will start talking a dividend cut, which needs to happen for them to live within cash flows.”

There are some companies, however, that might be able to take advantage of the current turmoil in the market.

“Ones with less debt will be in a position to acquire vessels,” Pibl said, resulting in single asset sales from companies really under pressure to those managing a bit better.

In fact, Pibl speculates that there will be more single asset sales than full-on mergers.

“The irony is, you don’t see a lot of mergers when stock valuations are low, even though that is the best time,” he said.

Looking for strength

In order for the sector to right itself, a few things need to happen, Pibl said.

First of all, prices need to firm up. With prices well below $80 per barrel, “a lot of the deepwater projects get put on the backburner,” he said.

Secondly, many companies should start looking at decommissioning vessels. Pibl notes that some working vessels “might not be worth book value,” which further depresses the bottom line.

With that, he said that “the amount of debt against those vessels is going to need a haircut.”

In a broader view, OPEC needs to cut production targets – something it failed to do in November and something the Saudi Arabian government in particular has been fighting against.

If all of these things happen, “some names will bounce back quickly,” Pibl opined. “If we don’t [see these things occur], some of these names will continue to decline rapidly.”

Your move, investors

With yields averaging in a 10% to 15% area, Pibl believes that offshore drilling has potential for high-yield and investment-grade investors alike.

“We like some of the opco bonds that have strong coverage and are closest to the assets,” he said.

Take, for instance, Ocean Rig UDW Inc.’s 6½% senior secured notes due Oct. 1, 2017, linked to Drill Rig Holdings Inc. In early December, that paper was trading in the low-90s, with a 9.3% yield.

Also a good pick is Pacific Drilling V Ltd.’s 7¼% notes due 2017, a first-lien piece of paper “tied to one special purpose vessel.” According to Pibl, “it’s the only debt at that entity,” which is a unit of Pacific Drilling SA.

Pibl concedes that those pieces “are not as yieldy” as some, but they might have better chances at recovery. For those looking for yield, however, Hercules Offshore might be a good option.

That company’s debt, Pibl said, has seen several issues hit 15% yield, though “at this point it is starting to get overdone.” He also noted that Hercules in not facing an illiquidity crisis – at least, not yet.

With no clear idea of where oil prices are going, it does appear clear that offshore drillers are going to have an uphill climb in 2015. The market must now try to figure out just how deep the damage will go.

© 2015 Prospect News.
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