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Danger ahead for offshore services sector

Unmanageable debt and a shortage of work is wreaking havoc on company finances. Bruising maturities starting from next year could signal even more pain

Bankruptcies are starting to surge across the offshore oil services sector, with many high-profile names defaulting on their debt. London-based Valaris, the world’s largest offshore drilling contractor by fleet size, became the latest big-name casualty when it filed for bankruptcy on 19 August, joining UK rival Noble Corporation and US-based Diamond Offshore Drilling, which have both already succumbed to the economic downturn.

And more bankruptcies are likely to follow. Offshore drilling contractors Transocean, Pacific Drilling and Seadrill are all in precarious positions and have highlighted either bankruptcy risk or the need for financial restructuring. “The offshore rig market is structurally damaged,” says Nicholas Green, senior research analyst at US asset management firm AllianceBernstein. “If all your competitors are entering Chapter 11, is one not competitively disadvantaged by electing to not enter yourself?”

Racking up debts

The offshore drilling sector was struggling even before the Covid-19 pandemic sent oil prices tumbling and forced producers to radically cut capex. Technology improvements over the past decade drove efficiency and production gains for drillers. But robust financial profits for service providers failed to materialise, with Ebitda sinking annually and many firms racking up sizeable debts. 

AllianceBernstein research shows that the top 50 most indebted services companies have total debts of $66bn, with offshore drilling accounting for $19.5bn and onshore $9.1bn. Transocean tops the list with the most debt, at $7.15bn, with Seadrill in second place with $3.4bn.

“The offshore rig market is structurally damaged” Green, AllianceBernstein

And while many services firms have already capitulated from lack of business and falling margins in 2020, the survivors face increasing pressure going into next year. Around 40pc of debt is set to mature by 2022, with the largest share in Q2 2021.  

Without a substantial oil price recovery, many firms face sluggish growth and significant difficulty meeting debt obligations. “Offshore drilling activity has fallen about 15-20pc year-to-date,” says James West, fundamental research analyst at US bank Evercore.

Turning the taps off

Falling oil prices have also destroyed access to credit, with the AllianceBernstein research showing high-yield issuance has dropped to $30bn so far in 2020 compared with $105bn for 2019 as a whole. US law firm Haynes and Boones surveyed reserve-based lending from banks and showed that, before this year’s economic crash, they had an average post-2020 oil price assumption of $50/bl. Since then, banks have revised this down to $45/bl to 2025 and just over $45/bl through to 2030.

Cash flows for loan underwriting previously assumed much high oil prices. In current conditions, banks are much more likely to tighten their credit standards, issue higher loan pricing and avoid riskier refinancing on high levels of maturing debt.

Adding to this, investors’ increasing preference for investing according to environmental, social and corporate governance (ESG) criteria is a long-term headwind limiting the oil sector’s access to credit and refinancing. Banks increasingly say they will comply with shareholders’ concerns about exposure to fossil fuel producers.

Efforts to fund decarbonisation and meet Paris Agreement goals could also impact the long-term debt of offshore oil services companies. US presidential candidate Joe Biden has pledged to return the country to the accord if he wins the November election and has an ambitious net-zero manifesto. The knock-on effect would likely increase ESG priorities for banks and could permanently affect the lending landscape.

Feeling the pinch

Barring an oil price recovery to above $50/bl, offshore drilling will be driven largely by basins with the most competitive pricing. “We will likely see drilling focused on lower cost, higher margin areas such as the Middle East,” says West. Frontier exploration will feel the brunt of the cutbacks and capex restrictions.

Latin America will also likely be a core focus for businesses. In Brazil, state oil firm Petrobras has approved a tender for three new floating, production, storage and offloading (FPSO) platforms at its Buzios pre-salt field, which will eventually ramp up to 12 platforms by the end of the decade. Petrobras already has four FPSO vessels in the Santos basin. Further drilling is also planned offshore Suriname and Guyana, with ExxonMobil’s Liza oil project in the basin among the industry’s most competitively priced breakevens.

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