The Emporers New Clothes… Seadrill Redux…

As a quick update to my last post on Seadrill (in which I was making a semi-serious point). I had a quick flick through the Seadrill 6k so you don’t have to… But first a little background… this post I wrote in April last year “Seadrill restructuring… secular or cyclical industry change?” seems to have aged well. In particular I noted:

[According to their restructuring plan in] 2019 Seadrill needs to grow revenue 65% to lose $415m of cash after turning over $2bn. In 2020 Seadrill then needs to grow 40% again, and only then do they generate $25m after meeting all their obligations. A rounding error. A few thousand short on day rates or a few percentage points in utilisation adrift and they will lose some real money.

Have another look at their business plan they had released in April last year:

Seadrill forecast P&L 2018.png

How is that “forecast” on revenue going? Seadrill did $302m in Q1 2019, which if they keep at that level is a rounding error above 2018. But it is more than 30% less where they thought they would be only a year ago. It’s not that long ago to be like $600m (of only $1.9bn) out… just saying… it’s more than a minor forecasting error… (go back and look at my post they were already downgraded and had been based on numbers supplied by a reputable IB with an analyst who currently has a Buy rating on SDRL).

Now just be to clear Seadrill was also forecasting they would generate $721m in EBITDA (a proxy for cash flow and an ability to service their debt). We have now passed the Q1, where they generated $72m, and guided $60m for Q2. So if we annualise that (which is generous as they got an unexpected $12m in Q1) they are on target for (max) $250m; around 1/3 of what they thought.

The $7.2bn of debt remains of course and was the (only?) accurate part of the forecast. Immovable and a testament to the willingness of humans to believe something that cannot possibly be true.

The numbers are clearly a disaster. The business plan above is a fantasy and Seadrill is heading for Chapter 22. Relatively quickly.

If you’re interested here’s how bad it is:

Seadrill actually did less revenue last quarter than the one the year before:

Seadrill Revenues Q1 2019.png

But had the same number of rigs working:

SDRL rigs working Q1 2019.png

And therefore the obvious… day rates have dropped…

SDRL Day Rates Q1 2019.png

And that is your microcosm for the whole industry offshore and subsea. Excess capacity means that even if you can find new work it is at lower rates.

Also, and I keep banging on about this, what are they going to do when Petrobras starts handing back the PLSVs this year? DOF’s are in lay-up, and there is no spot market for PLSVs. The equity in that JV is likely zero. Even if Petrobras does start re-tendering for PLSVs (unlikely given the drop in the number of floaters working) all that beckons is a price war with DOF to get them working. Anything above running costs will be a victory if the vessel market is a guide.

It goes without saying that in a price deflationary environment it is only a question of how long the banks can pretend they will be made whole here. SDRL isn’t going to get to $1.9bn in revenue this year and it certainly isn’t getting to $2.6bn the year after unless they change their reporting figures to the Argentinian Peso.

When I have more time I will explain my point on this more… but in the meantime be reassured the 23% drop the other day was  not an anomoly. The real question is why it took so long (and yes I do have a theory:). The investment bankers dream of someone buying Seadrill almost as much as Seadrill’s lending banks, but I find it highly unlikely (but not impossible) someone will make good $7bn in debt, and putting to stones together doesn’t mean they will float.

But the core point is that this is part of a deep structural change in the oil production market where offshore is not the marginal producer of choice any more. Previously that meant short-term oil price effects had a large (extremely pro-cyclical) effects on an industry with a very long-run supply curve, and this was combined with a credit bubble between 2009-2014. If my theory is right, and it has held up well for the past few years, then the much predicted,  but never appearing, demand-side boom will remain the Unicorn it has been for the past few years: a chimera that only appears in investment bank and shipbroker slide-decks.

That marginal producer is the now that shale industry a point Spencer Dale made a very long time ago now:

An important consequence of these characteristics is that the short-run responsiveness of shale oil to price changes will be far greater than that for conventional oil. As prices fall, investment and drilling activity will decline and production will soon follow. But as prices recover, investment and production can be increased relatively quickly. The US shale revolution has, in effect, introduced a kink in the (short-run) oil supply curve, which should act to dampen price volatility. As prices fall, the supply of shale oil will decline, mitigating the fall in oil prices. Likewise, as prices recover, shale oil will increase, limiting any spike in oil prices. Shale oil acts as a form of shock absorber for the global oil market.

Ignoring this fact lets you produce a “Key Financials” slide that bears no obvious relationship to how the market is really going to evolve. There is a lot of pain to come for the offshore industry as the need for banks to make painful writeoffs starts to permeate through the system and finally even more painfully capacity will be permanently removed from the market. This is an industry that needs significantly less capital and capacity to generate economic profits. And as I say: this is the recovery.

Seadrill restructuring… secular or cyclical industry change?

There is a cheeky 879 page document that outlines the Seadrill restructuring, agreed this week, if anyone is interested. My only real point of interest is that the business plan that was agreed finally in December 17 contained a significant reduction in day rates and forecast utilisation levels from the previously agreed plan of June 2017.

Seadrill VA Dec 17.png

It seems to sum up something I have said here before that the general consensus  said 2017 would be better than 20 16, and actually as the numbers come in it was not, and therefore 2018 will be another year with only weak growth for offshore. The longer this keeps up the harder it gets to mark the drop in demand in the offshore industry as a purely cyclical change that will reverse. The longer the rigs and jackups keep quiet the longer the boats will be under-utilised as well. Part of this I think is the realisation that the industry has relied in the past on very high levels of utilisation to remain profitable: fixed costs are so high that profit often wasn’t reached on any unit until it has worked 270-300+ days a year, so a future where these levels might not be reached permanently again is almost too much for many banks to accept or even contemplate.

A quick look at the forecast P&L for Seadrill shows that this is a business that requires a rapid recovery for this complex restructuring to work:

Seadrill forecast P&L 2018.png

In 2019 Seadrill needs to grow revenue 65% to lose $415m of cash after turning over $2bn. In 2020 Seadrill then needs to grow 40% again, and only then do they generate $25m after meeting all their obligations. A rounding error. A few thousand short on day rates or a few percentage points in utilisation adrift and they will lose some real money. Sure they start with a big cash pile, but they are still paying off .5 billion debt per annum and it goes up quickly. You don’t need to be a financial wizard to see that there is very little margin for error here. But the real dynamic here is the banks who would have to look at writing off billions if a plan along these lines cannot be agreed. And this is exactly the dynamic that drove the SolstadFarstad restructuring.

Here is a graphic example of “extend and pretend” or “delay and pray” that the Seadrill restructuring has come up with:

Seadrill extend and pretend.png

The banks are hoping that a collection of 32 assets, many  in lay-up, will recover in economic value enough to keep them whole in the next six years. I guess if you are in for this much it is a risk you have to take but is it really realistic?

McKinsey noted in their latest OFS outlook that:

[t]he offshore Baker Hughes rig count managed a tentative rise to 215 in January from a record low of 209 in September – barely reflecting the beginning of what many expect to be a more broad-based recovery in oil and gas project development in 2018 and 2019. Our data show that after showing signs of recovery in Q1–Q2 2017, rig demand actually decreased in the second half of the year (–3 percent for jack-ups, –13 percent for floaters since July 2017). Demand has now stabilized, although it remains more than 30 percent below levels seen in mid-2014. In the next bid round, we anticipate some improvement in rates as a result. [Emphasis added].

It doesn’t feel like a deep recovery that will lead to increased day rates. Certainly not on the scale that would lead to huge increases in day rates and utilisation. Borr Drilling recently used this data point:

Borr Activity Levels.png

Tender volumes might be rising… but surely if the price goes up some tenders will be withdrawn because the work will come in above budget? The longer oil stays rangebound at $70 surely the less likely, and longer, and these high utilisation and day rate scenarios become? Borr also have a whole presentation that essentially argues for a degree of mean reversion in day rates which is really just an argument that this is a cyclical downturn. For large portfolio investors Borr might make a sensible hedge in case it is true, but I don’t think it reflects the profound nature of the change going on in the industry at the moment.

The second Borr chart simply ignores the fact that in every other upturn mentioned shale was a non-existent market force, not the marginal producer of choice it is now. And look at the most recent 2011 recovery cycle: a very shallow recovery, and the fleet increased significantly since then. But the Borr presentation does highlight the scale of the upside if this is purely a cyclical downturn. My doubts are well known here.

The other unresolved issue in the restructuring is the fate of Seadrill/ Sapura JV flexlay vessels. In Europe everyone concentrates on the DOF/Technip and Subsea 7 vessels but the Sapura/Seadrill JV also own six PLSVs operating on long term contract. The huge drop in Brazilian floater and jack-up work directly imperils the long term demand for all the PLSVs in Brazil, and it is impossible to see Petrobras renewing such long-term and rich contracts for all these vessels.

Seadrill is going to be a very public bellwether of what an industry recovery looks like in the rig market and whether this is a cyclical or structural change in industry demand. The restructured Seadrill will have to hit the run rate very quickly this year or it will rapidly become apparent that, not for the first time in this downturn, projections of a broad industry recovery have been far too optimistic.