OREANDA-NEWS. Fitch Ratings says lower day and utilisation rates will continue to negatively affect offshore and onshore drilling companies throughout 2015. We expect a longer, slower rig recovery profile, based on higher global supply - driven by U.S. shale - tepid global demand, and a perceived lack of OPEC price support leading to our U-shaped price forecast assumption.

In response, oil and gas exploration and production (E&P) companies have cut capital spending sharply. Cutbacks have been weighted toward onshore, where possible, given U.S. shale's higher capex flexibility. However, offshore may increasingly share in the cutbacks if prices remain depressed. Fitch believes that older, lower quality rigs are subject to heightened obsolescence risk. The current downcycle has forced drillers to revaluate their historical aversion to scrap rigs to lower operating and maintenance costs to support near-term cash flows and help rebalance the rig market.

Offshore drilling day rates continue to come under considerable pressure, but a limited number of rig tenders provide poor visibility of spot market terms. However, recent announcements from Seadrill Ltd and Diamond Offshore Drilling Inc., among others, regarding contract renewal concerns and contract cancellation suggest E&P companies, in certain cases, are seeking contract relief. Offshore drilling day rates for ultra-deepwater rigs are broadly estimated to be down roughly 40% from pre-cycle levels with similar day rate declines across other rig classes.

Offshore rig utilisation has also decreased over the past year as the oil price downcycle has compounded the effects of the offshore rig oversupply cycle. Worldwide supply of offshore rigs increased by 8% while the number of working rigs declined by 2%, resulting in a decline of the utilisation rate to 74% from 81% over the past year. Fitch believes that offshore drillers face tough decisions regarding their existing fleets to help rebalance the market, which may now be accelerated as drilling volumes have fallen and are likely to continue doing so as considerable newbuilds are scheduled to be delivered. Fitch views the announcement of over 30 rig scrapings - led by Transocean's (BBB-/Negative) plan to scrap 18 rigs - as an encouraging rationalisation signal that should support day and utilisation rates as oil and gas prices improve.

Onshore drilling markets tend to exhibit more volatility as contracts are normally shorter-term and provide E&P companies with the most near-term capital spending flexibility. Onshore rig fleet are also regionally stratified and, as a result, are generally more exposed to regional supply-demand imbalances. The characteristics of U.S. shale have contributed to the U.S. rig counts' outsized weighting of drilling cutbacks with total and oil directed rig counts down over 45% and nearly 50%, respectively, from recent peaks. International markets are expected to show more resilience, but will also be challenged. The benefit of global diversification for onshore drillers is evidenced by Nabors Industries Ltd. (BBB/Stable), which, with nearly 35% of its working rigs in international markets as of end-2014 has seen its rig count decline less than 25%, or roughly half the U.S. decline rate.

In Russia, drilling volumes and rates will be affected not only by falling oil prices but also by western sanctions and blocked access to international financial markets. Lukoil has indicated that it may reduce drilling in western Siberia, the country's largest producing province, by 20%. Day rates, already affected by the rouble depreciation if assessed in dollar terms, may further decline by up to 10% on lower demand. Fitch has recently revised Eurasia Drilling Company's (BB/Stable) Outlook, Russia's largest independent driller, to Stable from Positive. Further negative rating actions may occur if unfavourable market conditions persist.

Fitch continues to believe that medium-term demand for offshore and onshore drilling will rebound to offset declines in existing production and reserve bases. Fitch's U-shaped price forecast assumption implies that pricing support for a larger scale ramp-up in drilling activity is a couple of years away. However, Fitch's estimate could be pushed back with day and utilisation rate improvement expectations moderated to the extent the market's fleet rationalisation process is prolonged and/or the depressed oil price/demand environment is sustained. We believe drillers with favourable asset quality characteristics, mutually beneficial, long-term E&P company relationships, and, particularly onshore drillers with a global footprint will be best positioned to mitigate the operational and financial impact of the downcycle.