Offshore drillers are facing a softening market with credit implications linked to asset quality and financial flexibility, according to Fitch Ratings.
The market expects floater rig day rates to exhibit weaker trends in the near-term mainly due to the timing of newbuild deliveries and contract rollovers. Jackup rigs, on the other hand, are reportedly experiencing more day rate resiliency.
However, Fitch points to the large delivery backlog of speculative jackups as a cause for concern. Near-term demand has moderated as IOCs focus on cash flows and shareholder returns and NOCs, particularly Petrobras, delay drilling programs further depressing market conditions.
The breadth and depth of the oversupply cycle remains uncertain. The market’s day rate outlook is varied due to the limited number of recent contract announcements. For example, ultra-deepwater day rate estimates are generally in the $400,000-$500,000/day range. This is substantially below the nearly $600,000/day rates observed over the past couple years. The rate of absorption could introduce downmarket competition leading to some lower specification rig displacement and, potentially, stacking.
New builds equal to roughly one-third of the working worldwide rig fleet are scheduled to be delivered over the next few years. This will materially increase the supply of offshore rigs and raise the average worldwide fleet quality. As a result, utilization and day rates for existing, lower specification rigs will come under pressure. Fitch believes that drillers with higher quality assets during the oversupply cycle are likely to experience better market utilization and day rates than lower quality peers.
Fitch expects the most capable and efficient rigs, as well as those that employ the latest safety advancements, to realize more favorable contract terms and lower idle times. However, consistent with the general market outlook, Fitch anticipates that near-term uncontracted newbuild and higher specification renewal day rates will be considerably below rates realized over the past few years.
Fitch believes drillers’ ability to retain financial flexibility will be integral to maintaining credit profiles. This may be particularly challenging for drillers that have large, near-term capital requirements, weaker contract coverage, higher leverage profiles, and heightened dividend programs. Fitch understands there is precedence for drillers to defer capital spending, divest assets, and/or suspend dividends in periods of sustained weakness to support operations and protect their balance sheet. However, these actions may be tough to execute for legal, economic, and policy reasons during a prolonged market dislocation.
The ability to defer capital spending on the delivery of previously ordered newbuilds is limited given the contractual obligation, as well as reputational risk. Divestitures are being pursued by several drillers with material actions being undertaken via IPOs and/or MLPs, but these strategies are subject to heightened economic execution risk in the present market environment. Dividend cuts are a possibility and equity markets seem to have priced in this risk with large, established drillers yielding 5%-11%. However, there may be little willingness to do so, since many dividend programs were recently initiated or upsized.