StatoilHydro Move Signals Lower Driller Earnings

StatoilHydro (STO-NYSE) announced it is ending a rig procurement effort that began this summer. The reason for the termination signals lower rig day rates in the future along with reduced earnings for offshore drilling contractors such as Transocean (RIG-NYSE), Noble Corp. (NE-NYSE), ENSCO International (ESV-NYSE), Diamond Offshore (DO-NYSE) and Atwood Oceanics (ATW-NYSE)to name a few.

The company commenced the rig procurement process last summer with a request to tender for both jackup and semisubmersible drilling rigs that would be available for a contract starting in 2012. On August 25, StatoilHydro received bids for 28 rigs from 15 offshore drillers. On Dec. 1, the company asked for the tendering companies to update their rig bids. After receiving updated tenders and reviewing them, on Dec. 23, StatoilHydro announced it was shutting down the rig procurement process because all the rig dayrates were too high,

Anders Opedal, StatoilHydro's head of procurement said, "there is still a considerable gap between the tenders and the expectations we have concerning the rates." It is important to understand that the rig contracts were to commence in 2012, four years from now. StatoilHydro's action suggests it expects rig dayrates to either not go higher for the next four years or possibly that rig rates should be trending lower.

The important consideration is that there is a divide between operator and contractor pricing expectations. This is the first stage in an industry downturn. At some point contractors will lower prices sufficiently to entice operators to sign up rigs. Eventually the rest of the contractors will focus their bidding activity around these newly contracted day rates. That is usually the bottom of the industry cycle at which point the stocks are likely to begin to rise in price - well ahead of the trough in earnings.

Company earnings are always a trailing indicator, and in this case oil service and drilling contractor earnings are still strong making current price to earnings ratios look extremely attractive based on historic valuations. Don't fall for that misleading valuation. It's too early to by buying the stocks, but also too late to be selling them.