Here's Why Diamond Offshore Drilling Inc.'s Stock is Sinking Today

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What happened

Shares of Diamond Offshore Drilling (NYSE: DO) were down 10% at 2:30 p.m. EDT on Thursday. Driving the decline was an SEC filing where the company detailed that Petroleo Brasileiro S.A.(NYSE: PBR), or Petrobras, terminated the contract for its Ocean Valor semisubmersible drilling rig.

So what

Petrobras initially signed the contract for this rig in 2014, and it was scheduled to run through October of 2018. However, with oil prices remaining weak, and Petrobras under pressure due to its debt situation and a corruption scandal, it is looking to cut costs. That said, Diamond Offshore Drilling does not believe that Petrobras had any "valid or lawful basis for terminating this contract," so it intends to pursue legal action against the company.

This is a big blow for Diamond Offshore Drilling because this rig had been earning a $455,000 day rate. However, it is not entirely unexpected, given Petrobras' troubles, and given that the company has been seeking support from vendors to cut costs. For example, offshore drillerEnsco (NYSE: ESV) agreed to sign a "blend-and-extend" contract encompassing the four rigs it leased to Petrobras to preserve some work with the oil giant. The net result was the termination of two rigs and the reduction of the day rates on the remaining two rigs from the mid-$340,000 range to $275,000 for one rig and $240,000 for the other. Because of this, Ensco's overall backlog dropped by $140 million.

Now what

This rig termination is another sign of just how rough conditions are in the offshore drilling sector. There's not much hope that Diamond Offshore Drilling will be able to lease this rig to another driller anytime soon, nor for anywhere close to its prior day rate. Furthermore, the outcome of any legal action against Petrobras could be years away, and might not be very favorable for Diamond.

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Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.