Of all the various industry groups within the broader energy sector, there is perhaps no group getting punished more severely by low oil prices than the offshore oil drillers. These are the companies that manufacture and sell the use of oil rigs to the oil and gas producers. In the past two years, the entire offshore oil drilling complex has been brought to the brink.

Low commodity prices have compelled the major oil and gas producers like Exxon Mobil (NYSE: XOM) and Chevron Corporation (NYSE: CVX) to significantly cut back on capital expenditures. In an effort to remain profitable during a period of falling commodity prices, these oil majors have trimmed spending on new projects. As a result, oil drillers like Transocean (NYSE: RIG) and Diamond Offshore (NYSE: DO) have had to accept lower day rates for their rigs, and in some cases, have suffered outright cancellations of oil drilling contracts.

In a time when deep-water oil is becoming harder to find and more expensive to drill for, and renewable energy like wind and solar is booming, offshore oil drilling is in real danger.

Global oil majors tighten their belts

During the oil boom, when WTI and Brent crude prices averaged over $100 per barrel, the oil drillers could charge oil and gas producers higher rates, which boosted their revenue and earnings. Oil producers like Exxon and Chevron were entirely willing and able to pay higher rates for oil rigs, as that spending was justified by high returns on oil drilling projects. But as profits collapse around the oil industry—Exxon and Chevron each suffered roughly 50 percent declines in earnings last year—the oil drillers have been squeezed. In response, major exploration and production firms have cut back on spending. In 2015, E&P companies collectively reduced capital expenditures by more than 20 percent, for the second consecutive year.

The downturn in oil prices has led to a significant reduction in contracting opportunities, particularly for new ultra-deep water drill ships, which has had a devastating effect on the oil drillers. Transocean’s operating profit fell 37 percent last year, due to a 19 percent decline in revenue. Impairments of deep-water and mid-water floater assets resulted in $1.71 billion of charges in 2015. Revenue fell another 28 percent in the first quarter, as demand for offshore oil rigs continued to sink. Transocean’s rig utilization fell to 51 percent last quarter, down from 60 percent in the previous quarter.

Diamond Offshore suffered a 14 percent decline in revenue last year and another 24 percent decline in the first quarter. The company lost $274 million in 2015. Due to the continued deterioration of oil drilling, Diamond Offshore had to reduce the value of 17 rigs, which resulted in an $860 million impairment charge last year. In the past two years, Diamond had to scrap or sell 13 rigs. And, the company has 11 rigs that are currently cold-stacked. Management has warned investors that additional rigs may be idled before the market recovers.

The trend is not likely to reverse any time soon. Even though the price of oil has recovered to $50 per barrel in the United States, nearly doubling since February, offshore oil drilling has not benefited. While oil rigs are beginning to be put back online—U.S. rigs in operation rose by 2.4 percent last week, compared with the previous week—deep water drilling continues to deteriorate. Rigs in operation in the Gulf of Mexico dropped by 10 percent, week-over-week. Year-over-year, the Gulf of Mexico has seen 38 percent of its rigs taken offline. Meanwhile, offshore rigs declined another 9.5 percent last week and are now 34 percent below where they were one year ago. Onshore rigs are benefiting from the recovery in oil prices. Land rigs in operation rose 2.7 percent last week.

Onshore drilling continues to outperform this year, driven by stronger economics in some of the premier U.S. oil fields like the Permian Basin. Oil producers are incentivized to add land rigs back into operation, as the costs are low enough to justify higher drilling. But deep-water drilling remains uneconomical, which is why many offshore rigs continue to sit idle.

The bottom line

Oil is a highly cyclical industry, and investors could be looking at the offshore drillers as compelling turnaround opportunities, as their share prices have fallen significantly over the past year. But the turnaround might not come, even if oil prices do not revisit the 2016 low. The reason is that the economics of deep water production are not likely to improve any time soon—as a finite resource, oil will eventually become more difficult to find and produce in deep waters.

It seems that the only environment in which offshore drilling could boom once again is if demand for oil soared from here. But that is an unlikely scenario. Demand for oil is projected to grow only slightly this year. Most of the growth will be seen in renewables such as wind and solar. Plus, the more advantageous cost structure of the strongest onshore fields has shifted focus to drilling on land in the U.S., perhaps permanently. The takeaway is that even if oil prices rise, there will be winners and losers within the energy sector.

Companies to watch

Other offshore drillers that have been severely impacted by the drop in oil prices are Ensco plc (NYSE: ESV), Seadrill (NYSE: SDRL), and Atwood Oceanics (NYSE: ATW). All three stocks have lost 50 percent or more of their value in the past year. The collapse in commodity prices along with the rise in renewable energy has weighed on the entire offshore drilling industry. Ensco and Seadrill both reported losses in the trailing 12 months. In addition, Ensco cut its dividend to stay afloat, while Seadrill and Atwood eliminated their shareholder payouts to conserve cash.

Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance.