(Article originally published in Nov/Dec 2014 edition.)
***From The Maritime Executive magazine, Nov-Dec 2014***
What a difference a year makes! Just when we thought everything was hunky-dory and the oil markets were on a roll, the bottom falls out. Twelve months ago the Red Sox had won the World Series, the U.S. had become the number one petroleum producer in the world, E&P budgets were cranking up, and crude was sitting comfortably above $100 a barrel. Twelve months ago I wrote glowingly about the “Resurgence in the Gulf.”
Now the Giants are the new champions of baseball (for the third time in five years), oil has dropped below $80 a barrel with no sign of a bottom, and E&P companies are busily cutting spending. Analysts’ estimates are being revised downward, and the stocks of drillers and boat companies have plummeted. The effects are being felt especially hard right in our own backyard, in the U.S. Gulf, where new contracts have dried up, workers are being laid off, and vessels are being cold-stacked.
Houston-based contract driller Hercules Offshore (whose ticker symbol, for those of you interested in such things, like me, is HERO), announced in early November it was laying off more than 300 workers – about 15 percent of its workforce – by year’s end due to eroding market conditions, the latest sign of a growing slowdown. The news comes on top of a flood of third-quarter earnings reports from drillers and boat companies alike, all of them showing reduced earnings and lowered outlooks for the remainder of the year and for 2015.
The aforementioned HERO, for example, reported an $88.6 million loss in the third quarter. CEO John Rynd noted that "Third quarter results reflect the slowdown in U.S. Gulf of Mexico drilling activity, idle time across various international rigs, and weak operating conditions in West Africa for our international liftboat fleet.”
Commenting specifically on the Gulf of Mexico market, he added that “We expect the overall environment to remain relatively soft at least through early 2015. Given these market conditions, we are executing on cost-saving measures, including the cold-stacking of four domestic rigs. We currently believe that this is an appropriate step to better balance the market and support utilization of our marketed rigs.”
And all of this just in time for next month’s big International WorkBoat Show in New Orleans.
What happened? In the face of so much good news (like the recent EIA report showing that U.S. production reached a 28-year high in July and shows no sign of slowing), how can things turn bad? Well, for one thing, global oil demand has stagnated and there’s simply too much crude around. The global economy is not growing fast enough to absorb the additional supply.
For another, all those new rigs that were supposed to bring new contracts and new jobs with them? They wound up replacing older rigs with a zero net gain in jobs and contracts. Last year the geniuses on Wall Street were predicting a 120-vessel shortfall in the supply of offshore workboats. Now, according to one report, there’s a 200-vessel oversupply.
But the reasons run deeper and have a lot to do with consumer attitudes and spending. Developed economies are switching more and more to green energy sources, and energy conservation is the order of the day. As my colleague Allen Brooks has pointed out on numerous occasions, gasoline consumption in the U.S. – which accounts for half of all petroleum usage – has stagnated and is even declining as automobile fuel economy improves and consumers switch to smaller, lightweight, hybrid or electric vehicles.
The Macro View
There are more than 700 active drilling rigs in the world, divided between “floaters” (deepwater platforms tethered to the ocean floor) and jackups (shallow water platforms that stand on their own legs). The Gulf of Mexico has about 100, mainly jackups, and according to ODS Petrodata 15 of those are warm-stacked and 14 more are coming off contract early next year. (“Warm-stacked,” by the way, means maintained and ready to go at a moment’s notice, whereas “cold-stacked” means mothballed and out of action for weeks or months at a time.)
So the Gulf of Mexico is hurting in large part due to the decline in the jackup market, and the four rigs mothballed by Hercules were all jackups. The deepwater Gulf is less affected because these tend to be long-term, billion-dollar projects, although it too has seen a slowdown.
On the vessel side, there are roughly 3,000 OSVs worldwide. Each rig requires anywhere from two to five boats to keep it operational. The smaller jackups can get by with two. The bigger floaters need more than two and as many as five, depending on the size of the boat. So the two markets, vessels and rigs, seem pretty evenly balanced. It’s when the rigs go off contract and fail to get new ones that problems arise, and that seems to be happening more often in the Gulf than anywhere else.
In fact, the slump – on a global level – seems bifurcated. While the U.S Gulf and, to a greater or less extent, the North Sea and Southeast Asia are taking it on the chin, Brazil, West Africa and particularly the Middle East (the biggest market) are holding up well – at least thus far. Tidewater pointed this out in its quarterly conference call while gloating over the fact that it has minimal exposure in the U.S. Gulf and Southeast Asia and lots of exposure in the stronger regions of the world.
Tidewater also pointed out the interesting fact that its fortunes, and presumably those of other vessel companies as well, are not tied exclusively to the global rig count. About 60 percent of TDW’s revenues come from drilling operations with the remaining 40 percent attributable to production activities, construction and subsea, decommissioning and other non-rig count-related activities. An insightful observation.
So the slump is in many ways a regional phenomenon although global rig rates have fallen across the board. In the case of the most sophisticated deepsea floaters, that drop has been precipitous – from $600,000+/day to $400,000+/day. The trickle-down effect has yet to hit vessel operators, whose day rates through the third quarter of this year have stayed steady although utilization has suffered.
As a glance at the chart on this page will show, the stocks of the four major publicly traded workboat companies in the U.S. have all – with the exception of Seacor – taken big hits. And most of the decline has come in the last five months. As a result, all four of these companies have initiated aggressive stock-buyback programs, believing their stocks are undervalued and trading substantially below nominal book value and well below net asset value (the liquidation value of the fleet minus debt).
Seacor has been the least affected because its operations are so diverse. In addition to offshore marine, it operates a large inland barge fleet and has a number of Jones Act tankers, not to mention its towing and terminal operations. Commenting specifically on the Gulf of Mexico market, the company noted that it had two vessels cold-stacked and had repositioned four others to other geographic regions as a result of “weak market conditions.” It also stated that utilization had fallen from 77 percent in the previous quarter to 69 percent, although day rates had risen slightly.
Gulfmark in its third quarter report cited soft market conditions in the U.S. Gulf that it expected to continue into 2015. In its other two major markets, the North Sea and Southeast Asia, results were mixed. The North Sea remained strong but is expected to weaken in the months ahead while Southeast Asia is among the weakest and most oversupplied global markets. “The Southeast Asia market remained challenged,” commented Quintin Kneen, President & CEO, “as national oil companies in the region have been slow to award new contracts, compounded by an increasing supply of offshore vessels in that region.”
Gulfmark is one of the two stocks in the group to pay a dividend, the other being Tidewater. But it doesn’t seem to have helped much. As for Tidewater, it remains in the opinion of many consistently undervalued and unappreciated. Rodney Dangerfield’s classic “I can’t get no respect” comes to mind when thinking of TDW. No matter what it does – how impressive its fleet is, its unique global footprint, its stellar safety record and its strong balance sheet – none of it seems to make any difference. Its latest venture is into the subsea market where it, along with many others, sees opportunity. It currently has six ROVs in its fleet and has ordered two more.
That leaves Hornbeck, everybody’s darling and the company most exposed to the Gulf of Mexico market. HOS has leading positions in the deepwater Gulf and at least one analyst, J. B. Lowe of Cowen & Company, has an Outperform rating on the stock and a price target of 46, which would be a 40 percent jump from where it currently trades.
Lowe cites the planned conversion of the HOSMAX 300-class OSV HOS Riverbend into a Jones Act-flagged flotel as one reason for his optimism, “given the continued strengthening in specialty and maintenance projects in the Gulf of Mexico” and the fact that “the need for flotel services has remained strong.” Lowe also notes with approval HOS’s planned stacking of five smaller, less capable vessels as a prudent move in the face of continued market uncertainty. And if that isn’t enough, he looks for a rebound in the floater market in the fourth quarter from 35 to 45 as eight rigs return from the yard and two newbuilds start contracts in late December.
See You in NOLA!
If all of this is too dicey for you, you can always fall back on my favorite, Kirby Corp. (KEX). The stock is up six percent on the year, about in line with the market, and a number of analysts – including Lowe’s colleague at Cowen & Company, Sam Margolin – have given it an Outperform rating. Margolin’s price target? $130 (it’s currently trading at about $106). Meanwhile, happy hunting and see you at the WorkBoat Show! – MarEx