Ending the zero-sum game in offshore drilling

Stormy waters are nothing new for offshore drilling. Boom and bust cycles figure regularly in its long and volatile history. But the convergence of the global pandemic with the acceleration of the energy transition presents a unique challenge to an industry with unwieldy economics. Many drillers are considering restructuring their organizations or redeploying capital elsewhere, but another, more radical, option is worth considering: transforming offshore drilling into a more attractive business.

The industry has evolved to meet customers’ technical and operational demands while navigating the highs and lows of the oil price.

However, its inherent volatility, together with its cyclicality, has led investors to question its potential for long-term value creation. While offshore drillers have delivered value for brief periods, they have destroyed value in excess of $85 billion since the 2007 peak, through speculative rig investments and a lack of commercial discipline

This unattractive industry structure has been materially worsened by the events of 2020 and is likely to remain very challenged in the business-as usual-scenario. Today’s industry is plagued with chronic oversupply and poor economics in all categories. Leaders in offshore drilling have responded to the downturn by incrementally reducing costs, delaying capital expenditures, and canceling orders for new rigs. The resulting savings have allowed them to sustain positive operating cash flows for a while longer, but significant challenges remain

Positive Operating cash flowa have been sustained through cost reduction, but significant challegers remain.

As part of their cost-reduction efforts, many drillers are retiring non-competitive older assets . However, yet rig supply continues to exceed demand, pushing down rig rates. Further action is needed: many offshore drillers are approaching bankruptcy, their operating cash flows unable to support debt-ridden balance sheets or the traditional industry business model. New shareholders need to realize this is a zero-sum game: extinguishing debt allows companies to continue without addressing the structural oversupply of active rigs.

This Time, Recovery calls for a different approach

Some observers may claim that the downturn is merely part of the oil cycle, and will be resolved by underinvesting in new projects. But this view ignores the new forces that are transforming the dynamics of supply and demand for offshore oil. On the demand side, the transition to renewable energy sources and the impact of the COVID-19 pandemic have brought about a structural shift in oil demand (Exhibit 4). These shifts could potentially eliminate almost $130 billion in near-term capital spending. In addition, an estimated 6 to 7 MMb/d of yet to be sanctioned offshore projects between now and 2035 will be at risk if the energy transition accelerates.