Diamond Offshore Drilling Continues to Cut Costs and Squeeze Profits From Its Rig Fleet

By Markets Fool.com

While rig companies continued to see revenues and profits decline precipitously in recent quarters, Diamond Offshore Drilling (NYSE: DO) generated a surprisingly resilient third-quarter earnings result. What's even more impressive, though, is that management had some very optimistic things to say about the outlook for the rig market. Here's a quick look at Diamond's earnings, what management thinks it sees in the future, and whether it's a signal of good times ahead.

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Image source: Getty Images.

By the numbers

Results* Q3 2016 Q2 2016 Q3 2015
Revenue $349.2 $388.7 $609.7
Operating Income $54.1 ($626.7) $181.4
Net Income $13.9 ($589.9) $136.4
Earnings per share $0.10 ($4.30) $0.99

*in millions, except per share data. Source: Diamond offshore earnings release

Overall, Diamond's results were quite good. Sure, we saw the expected declines in revenue from rigs coming off contract, but it didn't have as much of an impact on the bottom line as it had on other rig companies in recent quarters.

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One of the most surprising things in these earnings results is that the company posted quarter over quarter gains in operational income for its ultra-deepwater and midwater floater rigs. Midwater rigs have been falling out of fashion in the rig industry as of late because they are less technologically advanced and can't handle some of the more complex drilling jobs that the ultra-deepwater rigs can handle. On top of that, there hasn't been much new work in general. A closer look at those results will reveal that those gains in operational income all came on the cost control side of the business as revenues for these two rig classes remained pretty much flat and drilling expenses declined.

Source: Diamond offshore earnings releases. Chart by author

What management had to say

On top of CEO Marc Edwards comments on Diamond's rather commendable work this past quarter, he wanted to share the company's thoughts on what it sees in store for the industry in the coming years.

Our belief in the viability of deepwater drilling is driven by a number of factors. Firstly, annual oil demand is expected to continue to grow at slightly more than 1 million barrels per day, which stacked against a conservative production decline, means that over the next decade, we, as an industry, have to find an additional 33 million barrels per day of new production. Onshore, including unconventional shale, cannot fill this gap alone.

Of the shortfall, we estimate that the deepwater segment will have to find an additional 6 million barrels of production over and above that which has already been sanctioned and approved. This alone is equivalent to 70% of all the deepwater production that is available today. And to meet this production requirement, our customers will need to return to very active drilling programs in the coming years.

During the month of October, I visited with the senior management of deepwater producers in Asia, Europe and Latin America and can advise that deepwater drilling remains at the forefront of the minds of our clients. Secondly, and despite the recent uptick in oil pricing, we are witnessing what will become 3 years of consecutive cuts in our clients' capital expenditures, something which has not previously occurred in the history of the hydrocarbon industry. This dramatic cut in spending will impact future oil production, which should bring the oil markets back into balance from a supply and-demand perspective with obvious consequences for pricing.

And finally, the full life cycle project NPV of an offshore project is becoming more competitive when compared against an onshore unconventional project as costs and efficiency gains are realized in offshore developments. Over the life of a deepwater development, offshore wells have proven to deliver high returns and cash flow to our clients. Today's challenge, however, is the timing of the cash flows of an offshore project. Lower commodity prices have forced our customers to preserve cash in the near term, and this has postponed drilling of the more economic deepwater wells.

What a Fool Believes

Edwards' statement on the future of offshore oil aren't that revelatory. Shale drilling globally is likely going to play a larger role that just about everyone anticipated a few years ago, but its total production contribution won't be enough to meet new demand and declining production from other places.

Eventually, offshore sources will need to be utilized, and when that day comes Diamond says its fleet will be ready because the company has done a commendable job of maintaining both fleet and balance sheet discipline. The biggest question for these companies is not if the market picks back up, but when. With so many producers needing to improve their balance sheets and a muted oil price recovery, chances are we are still a long ways off.

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Tyler Crowe has no position in any stocks mentioned.You can follow him at Fool.comor on Twitter@TylerCroweFool.

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