In almost every sector -- but particularly in those that show a pronounced cyclical volatility -- there are companies that try to hedge and manage risk throughout the cycle. And then there are those who are more willing to let it ride and thus take more of the good (and the bad) of whatever the cycle has to offer. I'd suggest Diamond Offshore (NYSE:DO) fits into that latter category, which is both good and bad news for investors. Diamond should outperform if rates keep rising, but the company is arguably all the more vulnerable to new capacity additions and a weaker rate environment.

Certainly the "now" is quite good for the world's second-largest deepwater driller. Revenue was up 81% this quarter as drilling revenue rose 83% on seemingly ever-higher dayrates for its floaters, submersibles, and jackups. Operating profits also continue to spike as the company leverages this higher revenue through the income statement, to the tune of 267% growth in operating income and over 300% growth in net income this quarter.

There's no question that the market today is hot. Dayrates were strong across the board, up 80%, 63%, and 98% year over year for high-specs, intermediates, and jack-ups, respectively. What's more, the company got a commitment for its Ocean Worker, beginning in March of 2008, that will increase the dayrate by more than sixfold from today's rates.

But how long will this all last? And how sensitive is Diamond? For starters, Diamond has only two-thirds of its fleet committed through 2007, lower than the likes of Transocean (NYSE:RIG), ENSCO (NYSE:ESV), and GlobalSantaFe (NYSE:GSF), to name three. If rates continue to rise (a pretty likely scenario in the Gulf of Mexico), it'll reap the rewards. If rates soften, it'll suffer.

While rates overall are very strong today, more capacity will become available in 2007 and 2008, and a fair bit of that is presently uncontracted. Plus you have companies like Petrobras (NYSE:PBR) that are increasingly willing to run an end-around the big drilling companies and contract with local companies who lack experience but charge a fair bit less. All in all, then, pricing could get iffy going into 2009, and that'll obviously hurt results -- just like strong pricing has helped them.

Diamond Offshore could certainly see impressive growth over the next couple of years. What it seems like to me, though, is a game of chicken -- investors want to stay in as long as possible to benefit from the hot energy market, but are scared of holding the bag when rates back off. Fools should stay mindful of those risks and invest accordingly.

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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).