Size doesn't matter: small pureplay offshore drillers competing with the big players

A quick overview of the offshore drilling sector and some opportunities in less known drilling companies

Oct 22, 2023

The offshore segment has been receiving a lot of attention in the last few months. Offshore Supply Vessels (OSVs) have been the darling of many investors, mostly due to the fantastic work of ~~Aristotle Onassis~~ Ed Finley-Richardson. If you are interested in shipping in general, his substack is a must: edfin.substack.com.

Another segment of the offshore service market, drillers, seem to receive less attention now than it used to not that long ago. The sector got very hot before summer, but it seems this steam is now gone. Drillers have kept a low profile and most stocks have performed well in the year but poorly in the last months. There are theories that after a high cycle in 2023, a low cycle is coming, with lessened rates due to lower demand. If you are interested in this segment, you should follow Tommy Deepwater, Ed and Ultradeep on Twitter.

The companies have a limited stock of stacked vessels ready to be activated, with longer contracts and rising day rates (at a slower pace than before), the sector seems to have tailwinds. Also, the reactivation cost of a cold stacked driller is in the range of $50-150M, depending on the type of vessel, which reduces the ability of the owners to offer them. Also, oil companies avoid signing drillers that have been stacked for a long time.

As an example of how tight the market has been, Transocean announced on 18/10/2023 a 3 year contract with a rate of $448,000 in Brazil for its Deepwater Aquila, which is not yet delivered and will begin the contract in June 2024. Backlogs are increasing and the fleet doesn’t seem to grow in the coming years. The number of orders to shipyards is at the lowest level in decades, due to the previous years when virtually all companies were losing money and went bankrupt. This led to the cancellation of contracts, and shipyards ended with unfinished vessels that had to sell in the market or scrap them. Some of these unfinished drillships have been sitting in the shipyards for almost a decade, which has made that several shipyards discontinue their lines for drillers.

For those that are not familiar with drillers, one aspect to consider is that there are different types of drillers and the day rates reflect this. It is very important to bear in mind that each company owns or operates a particular fleet covering shallow water, harsh environments or ultra/deepwater. For example, a jackup can only operate in shallow water, thus its rate is the lowest of the market, contrary to an Ultra DeepWater Drillship (UDW) that typically receives the highest rates. Also, the day rate depends on different services that are included, for example, the use of Remotely Operated underwater Vehicles (ROVs) for inspections during the process or the specific equipment for running production tests aboard. Last, but not least, the location of the driller is very important, because moving them to a new location at thousands of miles of distance is expensive and can take weeks, a mobilization cost that most clients are not always willing to cover. We are not going to go into deep about the different aspects to consider when analysing a driller and how the specifications affect the type of contracts they can assume. If you are interested in such content, let us know in the comments, please.

How will the sector perform?

After a steep rise of day rates, it shouldn’t be a surprise that demands start to weaken, at least momentarily. I found out this thanks to another superb contribution by Ultradeep, which touts the possibility that day rates could lower in the next quarter. He explicitly mentions Valaris (NYSE:VAL), which owns and operates a very particular fleet with many low tier assets:

The evolution of this sector will always depend on the appetite of IOCs to invest in offshore exploration and development, particularly in frontier exploration, and there are many areas in the world where deepwater prospects and leads haven’t been fully studied. There are well-known cases such as Guyana and Namibia, but there are others in Vietnam (we wrote about Pharos’ exploration plans), Angola, East Mediterranean or Malaysia. Many wildcat wells can be drilled in the next few years and most modern drillers (7th or 8th generation drillships or some types of harsh environment semi-submersible drillers) are the only options for this type of job.

But high-spec drillers aren’t the only ones that can benefit from a long high cycle. Other less capable drillers like jackups will see an increase of demand driven by the oil price curve. In the case that the oil price curve stays well above the $70 level, they can be used for extending the life of existing mature fields by drilling infill wells. Should the oil price fall below 70$, many companies will shut down their older and less productive fields and begin the abandonment process. Brynne Kelly on Twitter tracks the long-term oil future curve (see the last update below), which is a very interesting input to understand some swings in the stock prices beyond the changes in the next future contract.

The sector is complex and following it requires a high-level of expertise and dedication, because the number of data points is massive. Follow all accounts mentioned here and the online version of Upstream is also recommended. However, the sector right now seems to experience more tailwinds than headwinds, despite some short-term doubts about specific sectors. In general, the future of the oil sector goes through frontier exploration, which requires the most advanced drillships (e.g. Guyana or Namibia) or the high-spec harsh environment semi-submersibles (e.g. North of the NCS). Another play is to position in companies that will benefit the most from the decommissioning and abandonment in the North Sea, which will require the use of jackups. In this article we will focus on the former, 3 ideas of world-class vessels that will compete for the most complex jobs in the following years.

A quick overview of main stocks

There are many companies in the sector that are public in either Oslo or NY. There are a handful of pure players and other companies that own and operate drillers like Saipem, but they are diversified into other markets and activities, and we have only included pure players. Below we compare the stock behavior of a selection of pure players, comparing their market capitalisation, debt, fleet size and last reported backlog (some may include the options, but most only consist of the firm backlog). Each company has a very different fleet, so don’t jump into conclusions by looking at these raw numbers, a detailed analysis has to be completed before reaching an opinion:

Below we make a quick comparison between all companies (debt is just last quarter short- & long-term debt less unrestricted cash, excluding WC adjustments):

Noble Corporation: $6,430M Mcap, $330M debt, 32 drillers (4 stacked, 1 in repair), $5B backlog
Valaris: $5,250M Mcap, ($116M) debt, 51 drillers (10 stacked) + 2 options + 2 managed, $3.0B backlog
Transocean: $6,210M Mcap, $6,626M debt, 42 drillers (11 stacked) + 1 construction - 2 sold pending closing, $9.2B backlog
Seadrill: $3,276 Mcap, ($184M) debt, 19 drillers (3 stacked) + 2 managed, $2.6B backlog
Borr Drilling: $1,786M Mcap, $1,524M debt, 22 drillers + 2 construction, $1.65B backlog
Odfjell Drilling: $828M Mcap, $645M debt, 4 drillers + 4 managed, $2.2B backlog
Shelf Drilling: $624M Mcap, $1,300M debt, 36 drillers (all jackups), $2.6B backlog
Dolphin Drilling: $211M Mcap, $7M debt, 3 drillers (2 stacked) + 2 acquired pending closing, $377M backlog - closed a placement of c. $65M for the acquisition
Northern Ocean: $231M Mcap, $415M debt, 2 drillers, $209M backlog
Deep Value Driller: $197M Mcap, $41M debt, 1 driller, $160M backlog

Note: these companies don’t own 100% of all vessels, some are shared with other companies (for example, Transocean owns 33% of the Norge driller)

Many of them are well known and there are many write-ups and discussions about the largest companies like Noble, Valaris, Transocean, Shelf, Odfjell or Borr. Hence, we don’t want to comment on them in detail and we will present the less known companies, which are interesting for 2 reasons: they will receive the same day rates as the larger companies and they could be acquired at any given moment.

There are some companies that we haven’t included like Vantage Drilling International, due to its OTC listing, or Northern Drilling (OSL:NODL), which is a very special situation. NODL doesn’t currently own or operate any driller at the moment. It is involved in an arbitration process with Daewoo Shipbuilding & Marine Engineering (DSME) for the claims against West Aquila Inc. and West Libra Inc. NODL received the outcome of an arbitration process in September, and the award is in favor of DSME. NODL acquired these 2 drillers from Seadrill, which were originally ordered in 2013, after signing a resale contract with DSME. In 2021, NODL canceled it due to the delays and supposedly breaches of contract (which was coincidental with a severe drop of drilling rates). This week it announced that it plans to prepare an appeal, but it is an expensive process. Hence, the company will require external funds, starting with a first $3-3.5M placing that will be followed by more. NODL is the parent company of Northern Ocean and has been backed by John Fredriksen, an important Norwegian investor who is behind many Norwegian oil service and shipping companies. He may see something in challenging the award that we don’t.

Deep Value Driller

Deep Value Driller is listed in the Oslo Stock Exchange (OSL:DVD). This company only owns a modern 7th generation UDW drillship that it acquired in 2021 from Dolphin Drilling, called Bolette Dolphin, which was built in 2014 at Hyunday's Ulsan shipyard in South Korea. The acquisition cost was just $65 million. There are estimations of the cost of a similar drillship that sit in the range of $800-1000 million with an upfront payment of $400 million, this show how incredible this acquisition was. The Deep Value Driller is a high-spec drillship able to drill up to 10,000 feet water depth and drill up to 40,000 feet depth, and the low acquisition cost was due to conditions of the creditors of Dolphin Drilling and the low day rates at that time.

The vessel was stacked for several years while DVD was trying to secure a contract during 2022. In February 2023, DVD reported the signature of a bareboat contract with Saipem, which will operate the vessel, for a drilling campaign in West Africa. The contract has a duration of 3 years and a value of ca. $160 million, excluding extensions. The company had to cover the reactivation and mobilization expenses. DVD signed a 9.75% senior loan facility of $75 million, which had an original issue discount of 3.875%, to pay these expenses and cancel previous debt. The company used $50 million for the reactivation and cancellation of debts, creating a $25 million surplus for other purposes.

The vessel left the Westcon Yard in Norway in August, and it was delivered to Saipem in early September. The driller is now working in the Baleine oilfield in Ivory Coast’s waters. The contract signed with ENI has a total value of $400 million and includes 11 wells for a total of 985 days. Since the delivery, Saipem is responsible for the daily operational and maintenance responsibility for the vessel.

The cost of the vessel for the company including the acquisition + other equipment + reactivation has been ca. $112 million. Now, the company is earning $146,118/day of bareboat revenue, without having to assume the operational expenses. Hence, the company has only to repay its debt and pay the administrative expenses and fees. At the finalization of the current contract signed with Saipem, DVD will be in a very strong position. In just 3 years, it will have recovered all the acquisition and reactivation costs, leaving the company with a clean balance, a net cash position and a 7th generation drillship ready to participate in the bids for the largest drilling contracts.

Now, the company has no other activity than to collect the rates and negotiate any potential extension of the contract with Saipem or a future contract with another customer. Additionally, management can try to seize another vessel(s), which is very unlikely as the market is really tight at the moment, or could seek other options to materialize the value of the company (i.e. selling it).

Due to the minuscule size of the company and the high value of the vessel, DVD is a perfect target for any company looking to add a 7th gen UDW drillship to its fleet. On the other hand, we see very unlikely that the company dares to make an offer for other drillers. The only ones that could be available are older jack-ups for shallow waters, which is the opposite of what its current vessel represents and we doubt it is of the interest of management. The acquisition of the Bolette Dolphin was extremely opportunistic and demonstrated the long-term vision of the founders. Hence, we think that they could profit from the current high day rates above $500,000 in some cases, and sell a world-class drillship under contract, generating a return of several multiples of their initial investment in a few years (it was founded in January 2021).

Maybe management decides to keep the company as independent, cashing the fees and distributing dividends to shareholders. At the current share price of NOK 25, an annual dividend yield of 10% could be reasonable (and it should grow to ca. 15% or more once the debt is paid out). The ‘easy’ money has already been done, but DVD can be an important position in a risk-taking portfolio due to the de-risk provided by the contract with Saipem.

Northern Ocean

Northern Ocean is listed in the Oslo Stock Exchange (OSL:NOL). Its fleet is currently composed of 2 high specification offshore drilling units designed for harsh environments. NOL is a spin-off of Northern Drilling. The company is supported by John Fredriksen, who remains as the largest shareholder with 39% of the shares through Hemen Holding Ltd.

Deepsea Mira and Deepsea Bollsta can drill in water depths of up to 10,000 feet, NCS compliant and fully winterized. These features make them capable of drilling in all harsh environment areas globally. Both drillers have been contracted to operate in Namibia, thanks to its ability to work in deep waters and in harsh environments. The Namibian waters are challenging and it is not uncommon that drillers suffer delays due to bad weather and high currents, which require high-spec vessels as these drillers. The 2 vessels are currently managed by Odfjell Drilling, hence, NOL receives a bareboat rate and not the full day rates shown below.

Deepsea Bollsta is under contract with Shell Plc for continued work in Namibia. NOL signed a contract with a firm duration of twelve months plus one six-month option with a firm revenue of $124 million ($339,726/day). The contract was recently extended from December 2023 for six months into June 2024 and an additional option for six months was added to it, bringing the potential duration of the contract to the end of 2024. The extension provides $88.6 million of backlog ($489,502/day) and with the six-month option potentially adding a further $81.0 million ($442,622/day). These day rates represent an important increase with respect to the initial one, reflecting the higher demand for this type of driller. The initial day rate could also reflect Shell’s contribution to the reactivation costs. Bollsta is working for Shell, which discovered oil in its Jonker-1X well, and will be used to complete the whole drilling campaign.

Deepsea Mira is under contract with TotalEnergies in Namibia. NOL signed the Mira for a firm duration of 300 days plus one 180-day option plus one 90-day option with a firm revenue of $135 million ($450,000/day). The contract began on the 28th of June and its 2 options would extend the operation through 2024. The vessel suffered several delays while sourcing key components since it left Norway, but all the components and supplies were secured. Deepsea Mira is working for TotalEnergies and is currently performing an appraisal of the massive Venus field that was discovered last year. According to Upstream, TotalEnergies is preparing a bid process to secure a rig for a 5-year drilling campaign from end of 2024 to 2029 for the development of Venus. Deepsea Mira is an obvious contender for this contract.

Bollsta completed its last job in March 2022, so it spent just 5 months in warm stack before signing a new contract. However, Mira had been without any contract for 21 months after an incident occurred in March 2021 while being operated by Seadrill for Wintershall DEA Norge. This shows how important it is for any vessel to reduce the idle or stacked time, as oil companies will always prioritize vessels that have been working until recently or are still under contract.

During the first 2 quarters of 2023, the company only received revenue from the Bollsta, totalling $30.7 million and $34.7 million in the first and second quarters, respectively. The situation has changed in Q3 with the 2 units working simultaneously until the end of 2024 (hopefully if the options are exercised). The company received $286,666/day and $293,406/day of day rate drilling revenue from the Bollsta in Q1 and Q2, respectively. The Mira was delivered to Odfjell Drilling in the last 3 days of Q2, hence it barely contributed to the Q2 day rate revenue. However, it is expected that during H2 2023 and the whole 2024 the company will receive between $500,000 and $550,000 per day from the contracts of the 2 vessels.

Since the award of the contracts in H2 2022, NOL has assumed most of the costs related to mobilization, reactivation, and pre-commencement of the drillers, which has stressed both the P&L and balance sheet. However, these costs are not included in the P&L as the company has included them in the balance sheet and will be amortized during the duration of the contract. To be able to cover the reactivation expenses, NOL raised $40 million in August 2022 for Bollsta and $45.9 in February 2023 for Mira. Additionally, the company has acquired debt before the signing of the contracts to cover the operational costs of the two drillers, particularly when they were warm stacked. In June, a new tranche in the amount of $50 million was added to its credit facility with just a three-month tenor to adjust the working capital. In July it amended its term loan facilities bank debt agreement, deferring the next three amortization payments totaling $30.0 million and adding the balance to the balloon payment at maturity.

It is important to look at the administrative expenses, which have declined from $2.7 million in Q1 2022 to $1.8 million in Q2 2023, despite the increased activity of the company. This demonstrates that NOL is working to improve the profitability of the business for its shareholders.

NOL is in the best position it has been in the last years, it has captured the high day rates and it has partnered with one of the best drilling operators. The location of the two drillships is also important, as there are many drilling campaigns expected in Namibia and West Africa in the medium-term. The financial position was complicated, but it has managed to obtain the support of institutional investors (the role of John Fredriksen is key here). The company has 15 months to earn the day rates, repay its debt and improve the balance sheet. The outlook for NOL’s high-spec harsh environment vessels is promising as they will be demanded for many jobs in frontier exploration in the following years. The company hasn’t yet published a “clean” quarter with both drillers in operation, so we can get a better understanding of the accounts and margins that it can obtain, but it is difficult to imagine that it won’t be able to renew the current contracts at lower day rates. The current EV is a bit high compared to other companies, particularly DVD, but we are sure that John Fredriksen has a plan.

As we mentioned in the case of DVD, NOL can become the target of a larger company willing to add high-spec drillers to its portfolio. Also, John Fredriksen could be willing to extend the fleet by acquiring other vessels that are either stranded (more details later) or cold stacked. Anyways, NOL is in a privileged situation and we are sure that there will be a positive return either through dividends or share appreciation.

Eldorado drilling

This year a new company was created by several high-profile Norwegian investors such as Tor Olav Troim, Petter Stordalen and Torstein Tvenge. Eldorado has raised $130m to fund its offshore rig acquisition programme, which consists of the newbuild ultra-deepwater drillships Dorado (former West Dorado) and Zonda (Pacific Zonda) from South Korea’s Samsung Heavy Industries for delivery in 2024. The value of these two vessels is estimated to be more than $400 million, each. The company remains private, but it may need additional funds, which could come from an IPO.

There has been speculation with regards to the acquisition by Eldorado of a third drillship for its fleet. There are 3 other high-capable drillships available that are currently stranded: West Draco, West Libra (the one from NODL) and Can Do (built by Keppel but currently stranded). According to Tommy Deepwater’s estimation, the acquisition cost of these vessels ranges between the $500M of Can Do and the $300-400M for the others. There are other abandoned drillships, the four Tiger drillship series, ordered by the now bankrupt Opus, but their status is unknown and all but Tiger 1 could be scrapped.

As part of this speculation, the acquisition of DVD was touted as a potential candidate to seize a high-spec drillship at a lower cost. This cannot be totally discarded, as it could happen in the future but not in the way of an acquisition but through a merger. An alternative could be that Eldorado completes a reverse takeover to list its shares in Oslo and add the Deep Value Driller to its fleet. Nonetheless, should Eldorado decide to list or IPO in the short-term, it is a company that deserves to gather the attention of investors, due to its high-profile backing and top-class assets.

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Conclusion

The offshore drilling sector offers compelling opportunities for investors who can tolerate the volatility and cycles of this industry. While the stocks have come off their recent highs, the long-term outlook remains positive due to aging offshore fleets and rising demand for complex wells in frontier basins. Smaller pure play companies like Deep Value Driller, Northern Ocean, and the newly formed private equity-backed Eldorado have secured modern, high-specification drillers capable of commanding premium day rates. These players are poised to generate substantial cash flows at a fraction of the cost of newbuilds. Additionally, their concentrated exposure and nimble corporate structures make them prime targets for acquisition by larger competitors. Savvy investors with multi-year time horizons should keep a close eye on these stocks for potential entry points. The next few quarters may present a chance to pick up shares at attractive valuations if concerns about slowing activity weigh further on the sector. While timing the inflection point is difficult, the risk-reward appears skewed positively in the medium-term.

Drillers were an obvious bet in late 2022 and early 2023, when all inputs indicated that offshore drilling was receiving the favour of many specialised investors due to the uptick in demand. Despite the rise of the stocks in the recent quarters, the current downtrend represents a good opportunity if it continues. We hope this write-up helped you to understand the sector and introduce you to some interesting companies. We’ll appreciate if you let us know what your thoughts about the sector are in the comments.

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