Jindal Drilling: Drilling profits

Disc: Invested

Jindal Drilling is an offshore drilling and allied company with five rigs under its portfolio, which it rents out to ONGC to drill oil out of the earth's surface. With the rise of oil prices and rig price revisions, Jindal drilling is set to double its profits in the next quarter. Let's understand how viable it is and what will aid them in achieving it,

What exactly is offshore drilling, rigs etc?

An Oil Rig is a structure that can drill oil from the earth's surface. These rigs can be located onshore (on land) or offshore (in water). Jindal Drilling has a fleet dedicated to offshore drilling. Finding oil from the Ocean bed.

There are multiple types of rigs.

1. Land Rig

Land rigs are built exclusively for onshore drilling, designed to operate on dry land. These rigs come in various sizes and are categorized by their drilling depth capabilities. The most powerful land rigs can drill over 30,000 feet, penetrating deep into the Earth’s crust to access oil and gas reservoirs. These rigs are relatively simple in design compared to offshore rigs, making them cost-effective and easier to maintain. Land rigs can be either stationary or mobile, depending on the specific operational needs. They are commonly found in deserts, plains, and oil-rich regions like Texas and the Middle East, where large onshore reservoirs exist. However, their use is limited to land-based resources and cannot handle the complexities of offshore environments.

2. Submersible Rig

Submersible rigs are offshore rigs that combine floating and stationary properties. These rigs float on water when being moved, but their lower structure submerges to rest on the seafloor during drilling. Designed to operate in wetlands, swamps, and shallow offshore areas, submersible rigs are ideal for water depths up to 85 feet. They are capable of drilling over 30,000 feet below the seabed (not that deep in water, but that deep in the seabed), making them suitable for deep reservoir extraction in shallow water environments. Submersible rigs offer stability due to their contact with the seabed, but they are not practical for deeper waters or rough seas. These rigs are a common choice for operations in coastal regions and other areas where shallow water drilling is required.

3. Jack-Up Rig

Jack-up rigs are versatile offshore rigs designed for shallow water drilling. They have extendable steel legs (sometimes three, sometimes four) that anchor to the seabed, allowing the rig’s hull to be raised above the water's surface, safely above the highest anticipated waves. This unique design ensures stability during operations in shallow waters up to 400 feet deep. Jack-up rigs are capable of drilling over 30,000 feet into the seabed and are widely used in calm offshore waters, such as the North Sea and Persian Gulf. They are mobile and can be towed to different locations, making them cost-effective for exploratory drilling in shallow water. However, jack-up rigs are unsuitable for deepwater projects or regions prone to rough sea conditions.

4. Semi-Submersible Rig

Semi-submersible rigs are advanced offshore drilling platforms partially submerged below the water's surface. These rigs rely on air-filled steel pontoons for buoyancy and are stabilized either by anchoring to the seabed or using dynamic positioning systems. This design allows semi-submersibles to remain steady in rough seas, making them suitable for moderate to deepwater drilling. They can operate in water depths up to 10,000 feet and drill over 30,000 feet below the seabed. Semi-submersibles are commonly used in regions like the Gulf of Mexico and offshore Brazil, where intermediate and deepwater operations are frequent. Although they are more expensive to operate than jack-up rigs, their superior stability and adaptability make them essential for challenging offshore environments.

5. Drill Ship

Drill ships are highly mobile offshore rigs designed to drill in ultra-deepwater environments. These ships are equipped with drilling equipment, including a derrick, on their decks. They use dynamic positioning systems, which employ thrusters to maintain the ship's position above the drilling site without needing anchors. Drill ships can operate in water depths up to 10,000 feet or more and are capable of drilling over 30,000 feet below the seabed. Their high mobility allows them to quickly relocate to different drilling locations, making them ideal for exploration in remote ocean areas such as the Atlantic Ocean and the Indian Ocean. However, drill ships are among the most expensive rigs to operate due to their advanced technology and significant energy requirements.

Summary:

Industry landscape

I am going to take some time to explain this, as the biggest threat is the supply-demand cyclicality, but trust me, I will try to keep you as engaged as possible by explaining it through a very popular story. 

The industry has suffered multiple shocks in supply and demand, which can be traced to macro events such as the 2008 crisis and 2020 COVID-19. However, we also noticed a big drop in oil prices in 2-14, and the reason that led to this has changed the whole industry (for good). Let's understand it by a very popular story.

In 1980, biologist Paul Ehrlich and economist Julian Simon made a famous bet symbolizing their clashing views on population growth and resource scarcity. Ehrlich, author of The Population Bomb, warned that overpopulation would lead to resource depletion and environmental collapse. Simon, an optimist about human innovation, believed technology and market forces would address these challenges. The bet focused on the future prices of five metals selected by Ehrlich, who predicted their inflation-adjusted prices would rise over the next decade due to scarcity. Simon wagered they would fall, reflecting improved efficiency and abundance through innovation. By 1990, the prices of all five metals had declined, proving Simon correct. The wager became a lasting symbol of the debate between environmental pessimism and technological optimism, with Ehrlich warning of ecological limits and Simon highlighting humanity's ability to adapt and thrive.

This is precisely what happened in 2014-2015. Human ingenuity prevailed. Before 2014, shale oil and gas were considered complicated and uneconomical to extract. This belief aligned with Ehrlich's perspective on the bet, which warned of the limits of resources and technological feasibility. Critics feared that dwindling conventional oil reserves would lead to energy shortages and rising costs.

However, the development of horizontal drilling and its combination with hydraulic fracturing (fracking) marked a turning point. Horizontal drilling allowed companies to drill vertically into shale formations and then extend laterally for miles, accessing far more of the oil and gas trapped in the rock. This breakthrough, paired with improved fracking techniques, greatly enhanced the efficiency and profitability of extracting shale resources.

By 2014, these advancements had triggered a shale boom in the US, significantly increasing oil and gas production. This technological leap not only proved the skeptics wrong but also transformed the US into a leading global energy producer, with domestic oil output surging to levels not seen in decades.

Due to this, there was a significant boost in U.S. crude oil production. In 2008, production was approximately 5 million barrels per day (b/d). By December 2023, it had risen to an average of 13.3 million b/d, marking an increase of over 8 million b/d.

Naturally, there was a downcycle in the prices of the Oil between 2014-2020 and many companies went bankrupt and rigs remained abandoned (cold.) Finally, the industry is witnessing some recovery and stabilising around 70-90 dollars per barrel. A thing to note is that the breakeven of most companies is 60 dollars per barrel.

Rigs

Companies in the upstream segment responsible for drilling and exploring oil, such as ONGC, do not prefer to keep themselves balance sheet heavy, so Allied services companies like Jindal Drilling rent out these rigs to such companies at day rates. They own these types of rigs and make the upfront investments in return for getting a day rate from other upstream oil companies.

Let's focus on jack-up rigs, as that is what Jindal drilling does. As the upstream market consolidated and suffered tremendously, so did the allied services companies. The day rates plunged from $120,000-140,000/day to $40,000/day. This was a huge drop, and understandingly so, the incremental production of Jack rigs slowed down. Although the supply is expected to increase in some time (gradually ), the market is currently facing a shortage of rigs, and hence, the players are set to benefit. 

Another strong indicator of supply shortage is the rise in day rates and capacity utilisation. The utilisation stands at 94%, which is a staggering number and, of course, very impressive. The prices, too, have bottomed out and come around 80,000 to 90,000 dollars per day. So why isn't the capacity increasing to bring down the utilisation %?

Well, it takes 2.5- 3 years for jack-up rigs to be made, and the investment is 300 million dollars or so. That is why there is a supply-demand mismatch, which these allied service companies can benefit from.

Finally, lets begin with the company.

About the business

Jindal Drilling & Industries Limited (JDIL) part of the D.P. Jindal Group Drilling Division, is a leading company amongst Indian Private sector companies in offshore drilling in India’s Oil & Gas sector with operation since 1989.

JDIL has to its credit around 30 years of operational experience backed by an accomplished staff and crew. They have three business divisions

• Offshore drilling and gas: Renting out Jack up rigs, primarily to ONGC at a contractual basis.

• Horizontal & Directional Drilling: Techniques to drill wells at angles or horizontally to reach hard-to-access oil or gas reserves efficiently.

• Mud Logging Services: Monitoring drilling fluid to analyze underground rocks and detect oil, gas, or safety risks in real time.

We will focus on the first business segment as most of the earnings come from that and it is where the main thesis lies.

Jindal drilling operates five rigs under with ONGC and another one in Mexico. The one in Mexico is named Jindal Pioneer where they have a 49% share of profit. Lets now understand the triggers.

Thesis

1. Jindal Supreme: Until April 2024, the business got about 40,000 dollars per day from Jindal Supreme. Now, that ratr has 2.2x to 88800 dollars! The huge spike in revenue is already impressive, however we need to understand that this does not mean the PAT growth is that. It will be exponential as the costs remain the same and the incremental increase straight flows to the bottomline. The scale of operating leverage is huge! During the 40,000 rates, it had a EBITDA margin of 10% and now we can assume that almost all the hike flows down to the profits.

   Lets calculate the incremental PAT.

   48000 ( dollars of incremental EBITDA) * 90 (days per quarter) * 84 (dollar rate) = 36 crores of incremental EBITDA per quarter

   Since its a very old Rig, it had to go through refurbishment and hence the cost was about 130 crores. Assuming this is amortised over the 3 year contract, about 10-10.5 crores will be deducted which leaves an incremental EBITDA of 24 crores.

   

2. Acquiring Jindal Pioneer

The company seems keen on acquiring the whole stake but has faced some delays. Although it could be considered an option, I doubt that, as it looks like it is on the cards. The only question is when. Currently, the company gets ten crores from Jindal Pioneer every quarter; acquiring it would mean that the PAT from Pioneer jumps to 20 crores per quarter.

3. Optionalities

With the contract of Explorer expiring in May 2025, we can expect a good jump in the day rates on this one. Moreover a lot of cash generation would mean that the business has the option to purchase the rented rigs like Virtue and Explorer, look for new rigs at cheaper rates, pay debts and give dividends. It all comes down to the management decision, but whatever they do: all seem to be favourable to the shareholders and the company.

An Industry thesis that I would like to mention on the side is that the rates are likely to remain high, due to the lack of supply of Jack up rigs and the time and costs it takes to manufacture them. This gives me confidence that new contracts can only benefit Jindal from here.

Anti thesis

1. Reliance on ONGC: Jindal drilling relies heavily on ONGC and, hence, can be susceptible to their demands. Recently, ONGC cancelled a few contracts because they found them too expensive. This is why we must be wary of ONGC's strongarming Jindal drilling. Moreover, a drop in oil prices could mean suspension of contracts, which would be terrible. Jindal can not do much about it as it needs to maintain a good relationship with ONGC, and it is unlikely to beat a behemoth like that. However, I am not so concerned because first, all the rates will be higher than the older ones, so the PnL can only improve from here. Second and most importantly, ONGC has national interests and therefore has to do a set amount of drilling and exploration no matter what. That is why they will need the help of local rig businesses, and hence, strong-arming them for too long won't work.

2. Price shocks: It is vital that oil prices remain above the 60-dollar break-even mark. The fall could be due to black swan events like COVID-19, which we can not predict. An event like that would mean cancellation of contracts, which is, of course, detrimental. A few people are worried about Trump increasing oil production, but that can only be done by increasing the US's output. It might be possible, but it is not so easy to 'command' private sector companies to increase oil production.

   
   

   Valuations

   
   

Since its purely cyclical, I would not expect very high multiples and would maybe assume 15-17x as the exit range. With the EPS expected to double or so for the next four quarters with some additional optionalities, the forward PE comes to about 10-11 which means there is an attractive upside to it. I would urge you all to study the company deeper to gauge a better understanding at the valuations.

Technicals

The business has been in a continious uptrend and has created a lot of wealth already. Currently, it is in a sideways trend for about a year and has bounced back from its trendline (dont expect this curve to keep continuing though) and we can expect a recovery. The business has broken out as the Q3 is expected to do great. Let us see how it continues.

To conclude, I think the business thesis is very simple and the triggers are right there. Th only thing that can spoil the thesis if there are global shocks.

I hope the blog was worth your time.

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Credits

Work done by people like Tar on TheWrap and Nirvana Laha on ValuPickr was truly exceptional and made my research much easier than I thought it would be. Sectoral webinar by SOIC laid the groundwork for me to understand the whole sector and that too was just beautifully done.

• Concalls, credit reports and Annual report

• ValuePickr Forum. “Jindal Drilling: Beneficiary of a Sustained Offshore Upcycle.” ValuePickr Forum, 18 Nov. 2024, https://forum.valuepickr.com/t/jindal-drilling-beneficiary-of-a-sustained-offshore-upcycle/173914. Accessed 20 Nov. 2024.

• Tar's analysis on the Wrap

• SOIC's webiar on Oil and gas