Merrill Lynch: Offshore drilling industry is poised for a recovery

Offshore drilling sector fundamentals continue to improve driven by strong energy commodity prices and increased upstream investment in offshore markets worldwide, Merrill Lynch Global Securities Research & Economics Group said in an Aug. 31 research note.

Sept. 1, 2004

2 min read

By OGJ editors

HOUSTON, Sept. 1 -- Offshore drilling sector fundamentals continue to improve driven by strong energy commodity prices and increased upstream investment in offshore markets worldwide, Merrill Lynch Global Securities Research & Economics Group said in an Aug. 31 research note.

"After lagging the large and mid [capitalization] oil service stocks thus far in the industry recovery, we believe the relative performance of offshore drilling stocks will likely improve in 2005 as earnings begin to grow more consistently," said analyst Mark Urness.

" Worldwide offshore rig utilization is estimated to improve to the 87% level in 2005 from 83% in 2004, as average demand is expected to grow by about 6%. Oil and gas companies are expected to continue increasing capital spending to offset declining production volumes and to grow reserves," he said.

"The primary risk to our investment thesis is the future potential for global economic weakness, which would adversely impact oil and gas demand and lead to lower commodity prices," he said.

Utilization, day rates
The jack up drilling market is the strongest with a current utilization of 88%, compared with deepwater rig (semisubmersibles and drillships) utilization of 76%.

"Day rates should begin to move up more sharply as the worldwide utilization level begins to exceed 85% on a sustained basis. Beginning in 2006, we expect global utilization will exceed 90%, pushing day rates and earnings up sharply for offshore drilling companies," Urness said.

With higher utilization, day rates are expected to rise 10-20% on average during 2005 compared with relatively flat day rates during 2004.

"However, we estimate day rates next year will average less than 60% of replacement day rates, leaving substantial remaining upside in 2006-07," he said.

Merrill Lynch said the deepwater market remains a growth opportunity, although overcapacity following the late-1990's building boom persists. Rigs capable of drilling in water depth deeper than 5,000 ft particularly are in strong demand.