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William Hoffman

Soaring commodity prices have boosted demand for oil and gas production in recent months, creating strong conditions for offshore drilling companies Transocean and W&T Offshore to tap the high yield bond market.

For years, investors have been wary of offshore drillers, which carry high operational risks on top of their exposure to commodity price cyclicality. The broader push for renewable energy adds extra uncertainty to the outlook for these credits.

But as fossil fuel demand bounces back after the pandemic and Russia’s invasion of Ukraine upends energy markets, offshore drillers are better positioned than they have been for quite some time.

“Relative to the rest of the market, energy is a decent place to be,” said a banker. “That was the theme of 2022 and there’s no reason to think 2023 will be any different. The market is more open to energy now. It’s recession-resistant, compared to tech, for example.”

This positive momentum for energy credits in general may help investors get comfortable with the higher risks associated with offshore drillers. Thanks partly to disasters like the Deepwater Horizon explosion in 2010, investors can demand a greater risk premium for offshore producers.

“Offshore drilling was a little bit left for dead a few years ago during the last oil price crash, and during Covid,” said a portfolio manager. “But it appears that ideas around the demise of the industry were a little bit premature.”

As one of the bigger players in the offshore drilling space, Transocean set a strong precedent with its deal.

In a one-day syndication yesterday, Morgan Stanley priced $525m of 8.375% SSNs due 2028 for the company. The deal was upsized from an initial target of $500m, and final pricing came tight of the 8.5% area talk.

Proceeds will fund final payments and related costs for its latest offshore drilling ship, which goes by the name of Deepwater Titan. The ship itself is collateral for the notes, helped investors get more comfortable with the name, sources noted.

Even in a worst-case scenario — such as oil prices going negative like they did in 2020 — ships like Deepwater Titan could still retain significant value given the specialized nature of such equipment, one investor said.

Deepwater Titan was first ordered all the way back in 2013; however, it was only delivered late last year after various delays due to Covid and related supply-chain issues. That should make the ship valuable to any offshore driller, even if it’s not Transocean.

“I'd like to think in five years this ship is still worth a decent amount of money,” the investor said.

“Even if you don’t necessarily like Transocean, you can still like this deal. There are theoretical scenarios where this transaction is in trouble, but this rig is still getting contracted out and throwing off cash flow.”

W&T Offshore has operated in the Gulf of Mexico for nearly four decades, but its operations are much smaller than Transocean’s and the name is unfamiliar to many high yield buysiders. It last tapped the high yield market back in 2018.

That lack of familiarity is one reason why W&T’s new $275m senior secured second lien notes due 2026 may end up pricing significantly wider than where Transocean’s deal priced. The deal is being whispered at 12%, according to 9fin sources.

The notes are rated Caa1/B and are secured against the company’s oil and gas properties. Proceeds, along with cash on hand, will be used to fully redeem W&T’s existing $625m 9.75% second lien notes due in November 2023.

The company will use $350m of its roughly $477m balance sheet cash to pay down the remainder of the existing 2023 notes (check out our Credit QuickTake and Legals QuickTake for more detail on the transaction).

Following the announced redemption plan, those 2023 notes quickly rallied to above par from 98 cents on the dollar previously. That earlier price implies a yield to maturity of 11.74%, providing the basis for the 12% whispers on the new deal.

Both Moody’s and S&P said they would upgrade their corporate family ratings for W&T by one notch upon completion of the deal. The agencies currently rate the company Caa1/CCC+.

Still, while debt reduction and ratings upgrades provide some credit positives, investors noted there were still significant risks associated with the deal.

Some risks stem from the fact that W&T is smaller than many of its competitors, including Transocean. This smaller size could magnify the downside impact of adverse events, and also reduce negotiating leverage with customers relative to larger peers.

Morgan Stanley declined to comment. Transocean and W&T Offshore did not respond to requests for comment.

Offshore drillers ride wave of positive energy

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