Offshore Drilling Provides a Safe Haven As Oil Tumbles

We're starting to see exactly why I've been higher on offshore drill rig owners over the past two years than companies more directly tied to oil or natural gas. Rig owners lease rigs to oil explorers in contracts that last months or even years, particularly in ultra-deepwater, so the day-to-day price movement of oil means very little to these companies. When Chevron (NYSE: CVX  ) and ExxonMobil (NYSE: XOM  ) tumble because oil falls, rig owners barely react.

SDRL Total Return Price Chart

SDRL Total Return Price data by YCharts

Combine that insulation with the fact that drilling rates are improving in shallow water and demand remains high in deepwater, and we're in for a solid earnings season.

Shallow water momentum
Since the Deepwater Horizon oil spill in the Gulf of Mexico, it has actually been shallow-water drilling that has been negatively affected, not the deepwater, where the spill took place. Rates have been anemic and utilization rates have been terrible. But recent earnings reports show some strength in this market. Not enough for companies to turn a profit on these rigs, but progress nonetheless.

Hercules Offshore's (Nasdaq: HERO  ) fleet of shallow-water rigs is starting to benefit from a pickup in demand domestically. This part of the business saw revenue increase 53.2% in the third quarter, helping drive overall revenue 13.4% higher to $184.9 million.

Transocean's (NYSE: RIG  ) recently announced third quarter shows similar improvement, driven by higher utilization rates and higher dayrates in the high-spec business it is not selling. The company utilized 66% of standard jackup days, up from 49% a year ago, and 84% of high-specification jackup days, up from 66% a year ago.

The trend for the jackup market is higher over the past year, which will benefit companies still holding on to shallow-water fleets.

Company

Q3 2011

Q2 2012

Q3 2012

Hercules Domestic 

$49,060

$60,734 

$63,203

Hercules International

$96,388

$91,404

$94,377

Noble

$89,352

$97,612

$97,857 

Transocean -- Standard Jackups

$101,000

$90,800

$92,800

Transocean -- High-Spec Jackups

$115,000

$141,500

$156,700

Diamond Offshore 

$84,000

$94,000

$98,000

Source: Company filings.

Deepwater maintaining strength
As I pointed out after Noble (NYSE: NE  ) and Diamond Offshore (NYSE: DO  ) reported earnings, the momentum toward higher dayrates has slowed some in ultra-deepwater but the business still remains steady. The following dayrates below show a strong improvement from a year ago across the board but mixed numbers quarter over quarter.

 Company

Q3 2011

Q2 2012

Q3 2012

Noble -- Drillships

$225,669

$329,761

$267,166

Noble -- Semisubmersibles

$315,034

$349,163

$331,900

Transocean

$524,800

$537,000

$539,300

Diamond Offshore

$336,000

$354,000

$354,000

Source: Company filings.

This can mainly be attributed to an increasing supply of ultra-deepwater rigs in the market. Transocean, Noble, SeaDrill (NYSE: SDRL  ) , and Diamond Offshore are among a long list of companies adding supply to ultra-deepwater globally which keeps rates from exploding higher.

Even with that in mind, ultra-deepwater is still the place to be for drillers because utilization rates are higher, and this is where major discoveries are taking place around the world. Dayrates may not be growing, but even steady dayrates bring in massive profits, unlike shallow-water rigs today.

How to play the earnings bonanza
We have yet to hear from leveraged ultra-deepwater play SeaDrill, but I think this is still the safest bet in drilling. The stock trades at 11.7 times forward earnings and pays an 8.3% dividend, both incredible values in energy. Transocean has made efforts to eliminate the shallow-water rigs dragging on earnings and increase efficiency in ultra-deepwater, but the company simply hasn't performed as well as SeaDrill, so it has to take second on my list. It may be able to improve that standing as it puts Macondo and the loss associated with selling much of its shallow-water fleet behind it, but I'd like to see earnings performance before making an outperform call on the stock.

To learn more about the strengths and weaknesses of my top pick, Seadrill, as well as what to expect from it going forward, be sure to check out this brand-new premium report put together by one of our top Stock Advisor analysts. Click here to get started.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 06, 2012, at 11:27 AM, allanmsmith wrote:

    In November of 2011, an oil spill occurred at the Frade field offshore Brazil. This resulted in an $11 billion civil lawsuit against field operator Chevron (CVX) and drilling rig operator Transocean (RIG).

    At the end of March, the same Brazilian prosecutor that brought the $11 billion civil lawsuit filed criminal charges against 17 local executives and employees of Chevron and Transocean.

    On August 1, 2012, a Brazilian judge issued an injunction barring Transocean and Chevron from operating in Brazilian territory. The companies were given thirty days to cease all operations in the nation.

    Unfortunately for Transocean and Chevron, their appeal failed. On Tuesday, August 28, a panel of three Brazilian federal judges upheld the injunction in a unanimous verdict. Obviously there are serious consequences for Transocean but I am not aware of the current status of this dispute.

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