The oil industry has been a hotbed of merger and acquisitions-M&A, activity over the last couple of years. I discussed this frenzy in an OilPrice article last fall as oil giants jockeyed for prime positions in U.S. shale plays to ensure their long-term survival. Up to now industry consolidation of this type has largely skipped over the oil service industry, but the recent announcement by Noble Corporation, (NYSE:NE) of the acquisition of Diamond Offshore, (NYSE: DO) brings momentum to the offshore drilling segment.
Recent stock price movement has been bullish with shares of Noble Corporation, gaining about 6% in recent trading. This is directionally a little hard to unpack given the sag in underlying commodity prices for the same period. Most oil-related equities have suffered as a result. Fears about Chinese oil demand have reared their heads for the last few days, raining doubt and frustration on investors in upstream-focused equities, and denting their portfolios. More quickly than most, the offshore drillers seem to be gaining back recent losses.
The Street remains bullish with 12 of 14 analysts rating it a buy. Price targets range from $47 to $67 and the median is $59, largely splitting the difference. NE missed EPS targets last quarter, coming in at $0.45 vs the $0.53 that had been expected. For Q-2 the magic number is $0.59, lowered over the prior three months from $0.73.
In this article we will revisit the overall thesis for a resurgence in offshore drilling and specifically what that might mean for NE.
Let's begin by stating the thesis for an uptick in offshore activity looming for 2025 and beyond. Quite simply, for the most part, 150 years or so into the oil age, and particularly in North America, most of the big onshore fields have been found. To replenish reserves companies like Chevron, (NYSE:CVX) and ExxonMobil, (NYSE:XOM), and a handful of other Super Major drillers, have had to go offshore to find fields that move the needle for them. A company like XOM, producing ~4 mm BOEPD is depleting their reserve base by ~1.2 bn BOE annually. They will have to find new supplies or find a new line of work. The consolidation phase of shale drillers is in its latter stages and companies that have been throwing money at shale-focused upstream operators are going to have to go back to drilling, or begin the long slide to oblivion. Offshore exploration is their best option.
It didn't take geologists long, once some initial suppositions had been confirmed about drilling the Gulf of Mexico in the late 1940s, to figure out that if you went into the bays, and the near shore deltas formed by the outflow waters of big rivers over the eons, and sank a bit a few thousand feet down, you had a reasonable chance of striking oil or gas. Or both. Flash forward to the modern day and imaging technology has advanced to the point where much of the guesswork has been taken out of the equation and offshore wells have a much higher success probability than they used to, and penetrate much deeper into the earth to tap much older geological sediments. Much of the current GoM activity, for example, is tapping Paleogene sediments that are as much as 65 million years old and occur at depths of ~35K feet below the mud line.
Finally offshore reservoirs, by the nature of their deposition often yield highly permeable (permeability is the mother's milk of oil production) structures with relatively low decline rates. This can cause often prolific flows of high quality crude, enabling quick payouts and long term cash flow. A compelling proposition for many. Big finds along the west side of the Atlantic margin-Guyana and Suriname in recent years, down in Brazil over the last few decades, and in an imaginative leap a few years back on the eastern margin of Atlantic-offshore West Africa have largely confirmed this notion.
Conveniently for NE, the only way to test theories about the existence and location of offshore oil deposits, is to rent a jackup, semi, or drillship and start turning to the right.
Present day Noble is the sum of several legacy drilling companies-Pacific Drilling in 2021, Maersk Drilling in 2022, and now Diamond Offshore-June, 2024 (subject to regulatory review). All in all, NE has an offshore fleet of 13 Jackups, 15 mostly 7g Drillships, and 3 semi-submersibles. Diamond Offshore will bring another 10 Deepwater rigs in a mix of 4 7g drillships and 6 semis. The slide below shows the company's post-acquisition footprint. One immediate advantage NE has over competitors is a lack of stacked iron. Most of their assets are turning to the right somewhere in the world, as opposed to rusting away in the oilfield boneyards of Singapore or the Canary Islands. As I've discussed in the past, it is very unlikely Gen 5 rigs will be reactivated, and the hurdles are getting higher for Gen 6 rigs that are cold-stacked.
With relatively little debt to service, thanks to wiping a bunch out in bankruptcy a few years ago, NE has positive cash flow. The DO deal will bring $2.1 bn in new backlog and brings new clients with relatively little overlap.
EverCore ISI analyst, James West was bullish on the deal, valued at $1.6 bn, cash-$600 mm, and stock-0.2316 shares of NE for each share of DO.
"We believe Noble's acquisition is highly strategic, and the addition of 12 offshore floaters is expected to strengthen the company's revenue and cash flow visibility through the long-duration offshore upcycle," Evercore ISI analyst James West writes.
I've pointed out XOM's problem already. The Law of Large numbers is just relentless. To goose their short-term production up a bit, they just spent ~$60 bn to buy ~715K BOEPD of daily output in the Pioneer Natural Resources acquisition. That's almost $84K per flowing barrel!! There are other ways of looking at that deal, and I was and am supportive of it. But, that's a lot of money on a unit basis! By comparison, the company just sanctioned the Whiptail subsea development, offshore Guyana for $12.7 bn. With 250k BOEPD expected daily output, that's a less heart-stopping $50K per flowing barrel.
Other major oil companies are worse. Javier Blas, an opinion columnist for Bloomberg just wrote a fairly scathing rebuke of BP.
"For now, investors don't have much clarity of what exactly the Auchincloss wants to do beyond the next few months. Will he continue letting oil production decline, or is he prepared to reverse course and greenlight multibillion-dollar investments in oil projects that would be controversial not only outside BP, but perhaps even among its board of directors?"
Recent news suggests that perhaps BP is altering course. The announcement on July 30th that they had taken an FID on the Kaskida Paleogene project puts another 80K BOEPD on track for 2029.
Donald Rumsfeld, Secretary of Defense under Reagan and Bush, once famously said, "You go to war with the Army you have, not the Army you might want or wish to have at a later time." I am reaching out a bit to tie this quote into our theme regarding oil companies needing to hire a bunch of rigs and start exploring for new reserves. But not hugely. The fact remains, that BP and others are not replacing their daily output with new discoveries by and large. And, that is an untenable situation for their long-term future.
Rystad published a note recently that pulls this scenario into sharp focus, taking down recoverable reserves estimates 52 bn barrels YoY, and a striking decline of 700 bn barrels since 2019. With their new estimate of 1,500 bn bbls of recoverable reserves at present, if nothing changes...we are in a bind 32 years from now.
The upshot of this section is that for self-preservation and the sake of global energy supplies in the not too distant future oil companies had better rent some rigs and drill baby, drill.
Contract drilling services revenue for the first quarter of 2024 totaled $612 million compared to $609 million in the fourth quarter of 2023, with the sequential increase driven by utilization. Marketed fleet utilization was 72% in the three months ended March 31, 2024, compared to 68% in the previous quarter. Contract drilling services costs for the first quarter of 2024 were $390 million, up from $374 million in the fourth quarter of 2023, with elevated contract preparation and mobilization expenses preceding several pending contract commencements. Net income decreased to $95 million in the first quarter of 2024, down from $150 million in the fourth quarter of 2023, and Adjusted EBITDA decreased to $183 million in the first quarter of 2024, down from $201 million in the fourth quarter of 2023. Net cash provided by operating activities in the first quarter of 2024 was $129 million, capital expenditures were $167 million, and free cash flow (non-GAAP) was $(38) million.
Outlook for 2024
For the full year 2024, Noble is maintaining guidance as follows: Total revenue in a range of $2,550 to $2,700 million, Adjusted EBITDA in a range of $925 to $1,025 million, and capital additions (net of reimbursements) in a range of $400 to $440 million.
Company filings
Long term-an undefined quantity for the purpose of this article, oil companies must pick up the pace. That's a given. The question remains when that will happen. Contracting hasn't been hitting the numbers that the industry thought it would a year or so ago. Noble CEO Robert Eifler reiterated a bullish outlook for the company in their Q-1 conference call, that if correct, diminishes this risk-
"Offshore drilling fundamentals, especially for high-spec floaters, remain supportive of a continuing multi-year uptrend in both day rates and average term duration, while near-term white space for lower-spec units persists as a 2024 headwind. Our outlook for an earnings and cash flow inflection in the second half of this year is well supported by several meaningful contract startups that are on schedule to commence over the next several months. As Noble progresses into this next stage of earnings growth, we will remain committed to returning the significant majority of free cash flow to shareholders via dividends and share repurchases."
It goes almost without saying that continued near-term recovery in the OSD sector is certainly dependent on Brent prices above $75.
Many things are starting to go right in this sector. Day rates for 7g rigs are moving toward the $500K per day rate-ex ancillary services like Managed Pressure Drilling-MPD. Transocean, (NYSE:RIG) moved its stock the other day with the announcement of a new contract for the 8g Deepwater Atlas for two 20K psi wells at $580K per day and contingencies for two 20K psi completions at $650K per day. This is getting to be serious money and puts the 8g rigs on a path to generate serious revenue for RIG in the coming years. Thus far NE doesn't have any 8g rigs-and there is no business case for them to build any, the 20K market is pretty limited, but the new contracts for the two now floating around in the GoM, will put upward pressure on the 7g rigs, of which NE now has plenty.
NE is trading at a little over 8X EV/EBITDA and leads other competitors in this metric except for smaller competitor, Seadrill, (NYSE:SDRL).
Where does the stock go from here?
Q-3 EPS estimates are for $0.93 per share. That would imply an NTM EBITDA of $1.6-1.8 bn. To keep their multiple at 8X-ish, which as noted above is pretty reasonable in this cohort, the shares would have to rerate toward $100 per share well ahead of the analyst's upper range. Risk-tolerant investors may find the company attractive at current levels.
By David Messler for Oilprice.com
More Top Reads From Oilprice.com
Mr. Messler is an oilfield veteran, recently retired from a major service company. During his thirty-eight year career he worked on six-continents in field and… More