Moody's: Sustained overcapacity, low oil prices will pressure global offshore drillers through 2017

A persistent oversupply of rigs combined with low oil prices will prolong the downturn in the offshore contract drilling industry, weakening the credit quality of offshore drillers through 2017, says Moody's Investors Service.

Overcapacity has already eaten into day rates for offshore drillers, which is the amount an oil company pays drillers per day to operate an oil rig. But if crude oil prices remain near today's $40-$50/barrel range, then day rates will fall further, approaching the cash break-even cost levels in some markets. With fewer available drilling opportunities in the marketplace, drillers are growing desperate to win contracts and minimize operating costs.

"The rig industry's overcapacity problem could last for several years," says Sajjad Alam, a Moody's Assistant Vice President and Analyst. "Older rigs will not retire easily and new rigs will keep coming with any positive development in the market."

Deepwater/ultra-deep water rig markets will have challenges on both the supply and demand fronts. Low oil prices will restrain drilling activities in those higher-cost markets, while the supply of new rigs will continue at a high level through 2017. Shallow water markets, on the other hand, will not experience as much demand erosion, but will face similar supply pressures. "We could see a 10%-15% increase in global jack-up supply even if only 50% of the current mostly un-contracted new builds are ultimately delivered to the market," says Alam.

Moody's expects oil prices to remain low through 2017 because of global factors such as greater production efficiency, the strategic need for certain nations to maximize oil production, slowing growth in China, a strong US dollar, and the possibility of new supply coming online from Iran, according to the report "The Worst Is Yet To Come For Offshore Drillers." Day rates for offshore drillers will remain under pressure as upstream companies look to trim costs and continue to drill conservatively in a low oil price environment.

Most offshore drillers are likely to have weaker credit metrics by 2017 as earnings and rig values decline substantially without any material improvements to debt levels. Large drillers with investment-grade ratings have greater financial and operational flexibility, but even their credit metrics will erode if industry conditions remain weak for an extended period of time.

"Companies that can reduce debt, minimize capital spending and maintain conservative financial policies are more likely to avoid ratings downgrades during this down-cycle," says Alam. Moody's expects credit quality to decline more significantly for companies with high leverage, smaller revenue backlogs, lower-quality rigs, substantial funding needs and exposure to high-risk customers.

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