I Love Deepwater Drillers

There's one sector of the oil patch I really love -- the deepwater drillers. These companies operate some of the most sophisticated equipment on Earth -- oil-drilling rigs that can operate in up to 12,000 feet of water depth and drill to total depths of 40,000 feet. With high oil prices and limited untapped areas for the major exploration and production companies to drill, demand for these rigs has skyrocketed, sending dayrates (the industry term for pricing) and earnings to record levels.

Limited supply
If you know only one rule of economics, it's probably that prices are set by a balance of supply and demand. If you have limited supply and high demand, prices will rise.

In the deepwater-drilling industry, there are only a few companies with the capabilities to operate in the tough deepwater environment. The limited supply becomes clear when we add up the deepwater rigs from five of the largest drilling companies in the world: Transocean (NYSE: RIG  ) , Noble (NYSE: NE  ) , Diamond Offshore (NYSE: DO  ) , Global Santa Fe (NYSE: GSF  ) , and Ensco International (NYSE: ESV  ) . Adding all five fleets together, I find 51 active rigs capable of drilling in water depths of 3,000 to 9,999 feet and only 11 active rigs capable of drilling in 10,000 feet or more.

Increasing demand
Deepwater drilling services are in demand for a combination of reasons, but probably the biggest driving factor is that deepwater exploration areas are a relatively new frontier in the oil patch. The chances of finding a giant oil field in Oklahoma, West Texas, or anywhere else that has been explored for the past 100 years is highly unlikely. In contrast, in water depths greater than 7,500 feet, exploration and production has only been possible for the past 20 years, and production in water depths greater than 10,000 feet has been possible in only the past four years.

World Record Drilling Depths

Year

Max. Water Depth

1977

3,937 feet

1988

7,467 feet

1996

7,612 feet

2003

10,011 feet

Source: Transocean

Furthermore, deepwater oil fields are being explored around the globe. Transocean alone has deepwater rigs active in the Gulf of Mexico, West Africa, Brazil, East Asia, Egypt, Australia, India, and the North Sea. These new frontiers have been responsible for some of the largest new discoveries in recent years.

The result
As basic economics would suggest, limited supply and strong demand has caused prices to increase. Maximum dayrates for the latest-generation rigs have soared from about $250,000 in 2003 to over $500,000 today.

As one would expect, the increase in dayrates has triggered an increase in supply of rigs. Over the next few years, there will be 10 new built rigs and upgrades capable of 10,000-12,000 feet of water depth entering service. However, even with 10 new rigs, the total supply of ultra-deepwater capable rigs will be very small. Furthermore, the new rigs are being built in conjunction with long-term contracts, not on speculation.

Perhaps, like so many loves before, this one will eventually fade. Oil prices will someday fall; limited supply will become surplus. But from where I sit, that day is several years into the future, maybe even not until 2017. ... Until the love is lost, I'll craft sonnets for this sector.

Fool contributor Robert Aronen owns shares of Diamond Offshore and Transocean. He thinks it's no small coincidence that Transocean is reporting 2006 results on Valentine's Day. The Fool has a disclosure policy to fall for.


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