Why Offshore Oil Producers Will Likely Be the First to Cut Output

There has been plenty of concern recently that the drop in oil prices would cause many domestic E&P names in the U.S. to curtail their activities at marginal plays. This in turn would have a knock-on effect on oil servicers and the MLPs that manage and build energy infrastructure needed to exploit America’s shale boom. Several MLPs recently commented that they felt current oil prices wouldn’t have much impact on U.S. production. For example, Enterprise Products’ (EPD) CEO Michael Creel said, “Our analysis shows that most if not all of the core drilling area in key oil plays such as the Eagle Ford, Permian and Bakken are profitable at numbers below where we are today and U.S. drilling is certainly not grinding to a hault.”

In fact, the marginal producer of crude oil looks very much like an offshore producer.

Transocean (RIG) is an industry leader in the ownership and operation of offshore drilling rigs. In their quarterly earnings call this morning, CEO Steve Newman said,

“The market pause we began discussing with you more than a year ago has evolved into a cyclical downturn. Although our customers take a decidedly long-term view in making investment decisions, the approximately 27% decline in oil prices observed over the last three months is likely to increase their challenge to improve short-term returns to their shareholders.

In turn, this may temporarily exacerbate the offshore rig supply and balance that has already resulted in dayrate and utilization pressures and an increase in the inter-contract idle time in stacking of rigs and potentially delay the cynical recovery.”

In addition, their just filed 10Q included the following:

GoodwillSubsequent to September 30, 2014, market conditions have continued to deteriorate, and we identified additional adverse trends, including continued declines of the market value of our stock and that of other industry participants, declines in oil and natural gas prices, the cancellation or suspension of drilling contracts, the permanent retirement of certain drilling units in the industry and increasingly unfavorable changes to actual and anticipated market conditions.  On that basis, in the three months ending December 31, 2014, we expect to reevaluate whether the fair value of our reporting unit has again fallen below its carrying amount, which could result in us recognizing additional, potentially significant, losses on impairment of goodwill.

So while lower oil prices may well hurt providers of services and infrastructure globally, it looks as if the most immediate pain is being felt in areas away from U.S. shale plays.


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