The offshore drilling sector’s path to recovery

The narrative that has been unfolding in the offshore drilling industry since the price crash of oil in 2014 is rapidly approaching a climax. To an already toxic mix—composed of stubbornly low crude prices, a chronic oversupply of drilling rigs, unsustainable capital structures, and furious operational cash burn—has been added the global COVID-19 pandemic, which has further weakened demand and day rates while imposing tight constraints on offshore drilling operations. The harsh market environment has driven drilling operators and their creditors to finally bite the bullet and undertake major restructurings, including, in some cases, Chapter 11 bankruptcy protection. More operators could follow suit.

After operators and investors perform the necessary financial surgery, the offshore drilling sector could look very different than it does today, but it will likely still labor under the burdens that have weighed on it since 2014. Although most if not all of the sector’s more than $45 billion in cumulative debt could be converted to equity, operators will still have to retire a significant portion of their drilling assets—and the sector will have to consolidate. Absent such drastic measures, operators may never regain pricing power or generate returns that exceed their (very high) cost of capital. As potential new shareholders, current creditors—especially bondholders—could be key facilitators of a consolidation wave.

Paradoxically, the operators that currently enjoy the largest contract backlogs and soundest balance sheets could soon find themselves at a competitive disadvantage to their more-troubled peers. If the stronger players do not restructure, retire assets, and aggressively lower their cash breakeven points, they could wind up losing business to rivals that have already slimmed down and could be left on the sidelines of any consolidation wave. But no matter how the competitive reshuffle shakes out, the offshore drilling sector as we have long known it could be approaching its end. The sector that emerges to replace it will likely be shaped by the critical moves that operators, creditors, and investors make—or don’t make—today.