North Atlantic Drilling Stock Disaster - Financhill

North Atlantic Drilling Stock Disaster

North Atlantic Drilling Stock Forecast: Offshore drilling is a tempting industry for investors. After all, the world’s energy needs are growing. Those who can access oil in nature’s most inhospitable environments offer a rare and valuable service which – theoretically – means profits. Unfortunately, it’s not quite that simple. Drilling carries a long list of risks, any one of which can completely derail an organization.

North Atlantic Drilling shareholders found that out the hard way when stock became worthless during the company’s 2017 bankruptcy. This was a shock for investors who once held shares valued at more than $100 each.

North Atlantic Drilling simply couldn’t handle its enormous debt load when low oil prices decimated revenues. At the same time, sanctions on Russia disrupted a critical partnership with Moscow’s Rosneft – a petroleum refining company – and there was just no way for North Atlantic Drilling to recover.

North Atlantic Drilling’s parent company, Seadrill Limited, came out of bankruptcy intact, and some say it is stronger than ever. Of course, many investors are still a bit shy about taking another risk. Is Seadrill Limited a buy, or should smart investors explore alternative options?

Should You Invest In Offshore Drilling?

The first step in offshore drilling investing is gaining a clear understanding of how the industry works.

Its history goes back more than a hundred years, when a number of oil companies started experimenting with methods of extracting oil from undersea deposits. They began in shallow waters, building piers that stretched out to sea. The piers were made strong enough to support drilling rigs, and eventually the practice became commonplace.

Companies specializing in offshore drilling starting contracting with oil companies. They developed drilling platforms that didn’t require a connected pier, which expanded their ability to reach underwater oil deposits.

Finally, in an effort to reach oil in deeper water, they designed massive vessels that could collect resources far offshore. Today, offshore fields contribute 37 percent of the world’s total oil production.

Offshore drilling companies contract their rigs to oil companies at a negotiated rate referred to as a dayrate. As with any other product or service, dayrates fluctuate with demand. When oil prices are up, oil companies have more to invest in offshore drilling. When oil prices are down, demand for offshore drilling decreases, too – which means a drop in dayrates.

Because offshore drilling companies don’t experience a corresponding decrease in the fixed costs of operating a rig, this can mean big financial trouble if oil prices stay low for too long.

The Offshore Drilling Roller Coaster 

As offshore drilling techniques improved, offshore drilling companies grew enthusiastic about the industry’s potential. They invested huge sums in perfecting offshore drilling methods and growing offshore drilling assets, and the amount of oil extracted through this process grew.

There was plenty of cash available for such expansion from 1999 to 2008, when oil prices went from less than $25 per barrel to $160 per barrel or more. Growing demand from China and India and a simultaneous drop in production from Organization of Petroleum Exporting Countries (OPEC) prompted the spike.

The global recession in 2008 brought oil prices crashing back down, and the subsequent economic recovery sent them up again. Dayrates for offshore drillers fluctuated with oil prices, and between 2012 and 2014, ultra-deepwater drillships commanded dayrates of $600,000 or more.

In 2014, a variety of factors created another steep drop in oil prices, and investment in offshore drilling was one of the first expenses to be cut. By 2018, the same ultra-deepwater drillships that were contracted for $600,000 per day in 2014 were only worth $150,000 per day.

Some of the offshore drilling companies that had just started to regain their financial footing after the last downturn were simply unable to survive this additional loss of revenue. They took on far more debt than they could comfortably handle, in hopes of a rapid recovery. When that recovery didn’t come, they shut down.

It took a full five years for offshore drilling companies to see anything resembling recovery, and in 2019, some companies saw early signs of improving stock prices. It appears the industry could continue to grow for a least a few more years if there are no major disasters, so it could be the right time for investors to buy.

Offshore Drilling Outlook  

Industry experts are carefully examining all of the factors that contribute to offshore drilling profitability to determine whether it is possible to be profitable in this space over the next decade. Barring any dramatic changes in world economic, political, and environmental situations, it appears that spending on offshore drilling will grow at a compounded rate of nine percent through 2025.

Those that support this forecast note that OPEC and Russian oil producers have agreed to balance supply and demand for now, which has resulted in per-barrel prices going above $60 a barrel.

More importantly, the cost of offshore oil production has gone down. In early 2016, a company could not break even with oil prices below $64 per barrel. Today, the breakeven point is closer to $43 per barrel. In certain locations, the threshold is even lower. That reduces the risk of offshore drilling investment and increases the likelihood of profits.

Seadrill Stock Forecast 

Seadrill couldn’t save its subsidiary, North Atlantic Drilling, from the financial impact of an extended period of low oil prices. However, it has emerged from its own bankruptcy a stronger organization. While it is still operating at a loss, shareholders are seeing improved numbers, and business leaders are predicting further gains by the end of the year.

Seadrill’s bankruptcy – and that of North Atlantic Drilling – was triggered in part by excessive debt. Much of that debt came from the company’s investment in new, more advanced rigs.

That gives Seadrill a competitive advantage in today’s market, as its fleet is generally regarded as the industry’s youngest and most modern. As oil companies increase investment in offshore drilling, Seadrill’s rigs should be in high demand. That means good news for investors who buy at today’s rock bottom prices.

A word of caution, though. The oil drilling industry is exceptionally volatile, and the fortunes of the industry as a whole and individual companies in particular can change in a moment.

After the North Atlantic Drilling disaster, no one knows that better than Seadrill investors. Political and economic changes can impact oil prices overnight, making it impossible to operate offshore drilling rigs profitably.

Worse still, any company can have an accident or an oil spill that disrupts operations and destroys reputations. It can be years before a company recovers from such an event – if ever.

The bottom line is that things look good for Seadrill right now, but this investment is riskier than most. Those who want to buy into this industry while mitigating some of the risk would be wise to design a diversified portfolio that incorporates smaller investments in some or all of offshore drilling’s major players.

Four to consider include Seadrill, along with Diamond Offshore, Noble Corporation, and Transocean.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.