ROUGH WATERS? (IMAGE SOURCE: ATWOOD OCEANICS COMPANY PRESENTATION

It looks like the persistence of low oil prices caught Atwood Oceanics (NYSE: ATW) by surprise. After sticking with its $0.25 quarterly dividend throughout 2015, it finally slashed its payout last quarter to just $0.08 a share. On February 18th, only months after the previous cut, it decided to completely eliminate its quarterly dividend to provide "greater flexibility to weather the current downturn." Management cited "extremely challenging market conditions" during its announcement. 

Atwood is hardly the first offshore drilling company to face liquidity issues. Last year, industry behemoth Transocean (NYSE: RIG) suspended its dividend “in light of the deterioration of the offshore drilling market and concerns regarding the timing of the market’s recovery”. In recent weeks, Diamond Offshore (NYSE: DO) also completed suspended its dividend.

While dividend cuts will undoubtedly help struggling operators preserve cash, how much can it really stem the tide of collapsing global demand for offshore drilling services?

There's no escaping falling demand

In January, the CEO of offshore drilling company SeaDrill Limited said that market conditions will likely remain dismal until at least 2017. Low oil prices present very little incentive for companies to continue drilling a significant portion of the cost curve. For example, Rystad Energy estimates that while "oil sands and the Arctic are the most expensive supply segments with an average breakeven of $80 a barrel", offshore production is a close second, at an "average break-even price at $60 a barrel. With oil around $30, demand for additional offshore drilling services is scant.

IMAGE SOURCE: RYSTAD ENERGY 

Taking a look at Atwood's backlog, it's clear that crumbling demand is more than theoretical. In 2016, only 64% of its rigs are contracted. By 2017, that drops to under 20%. Even if capacity utilization can be salvaged, it will likely be at much lower prices. Industry capacity utilization is at just 75%, prompting an analyst at Raymond James to describe the market as one of “unrelenting oversupply.” Because these are high fixed-cost assets, it may take years of scrapping and decommissioning to balance the market, even if oil prices do rebound. 

IMAGE SOURCE: ATWOOD OCEANICS INVESTOR PRESENTATION 

How long can Atwood last?

Investors outside the offshore drilling space are getting ready for some massive insolvencies, raising funds to capitalize on what could be a buyers market. Several ventures are specifically targeting offshore companies and their assets, featuring big-name buyers like Blackstone partner Clarion Offshore Partners and John Fredriksen-backed Sandbox. Will Atwood's assets eventually end up in liquidation?

When you do the math, Atwood likely has at least two years before things start getting tricky. As of the latest quarter, Atwood has $115 million in cash plus a $600 million credit facility. For its current backlog, management anticipates generating $605 million in after-tax cash flow. On the liability side, Atwood has about $200 million in capital expenditure needs through 2017, plus roughly $220 million in corporate costs and debt servicing. Put together, even with a weak market, Atwood should have about $890 million in liquidity by the end of 2017. 

Some big risks remain however. Capital expenditures are so low because the company is idling two newbuilds. Not including interest accumulation, Atwood is on the hook for $70,000 a day being paid to the shipyard. At some point, it will need to pony up $400 million for the remaining installments.

The real issue however is that many other major competitors have idled or delayed orders that have already been built. Around 299 rigs were ordered over 2011-2014, with many more waiting to enter the market if demand starts to pick up, likely keeping dayrates and profitability continually low for some time. If you're investing in offshore drillers like Atwood, Transocean, or Diamond Offshore, a conviction that these operators can stay solvent for years to come may be more important than simply believing in higher oil prices.