Will this Offshore Oil & Gas Driller Sink or Swim?

Ensco has a near-term challenge in the form of an aging fleet, but strong demand for its ultra-deepwater rigs should provide plenty of profits down the road.

Feb 7, 2014 at 11:20AM

Recently, there are serious concerns over the state of the offshore oil drillers. Investors may be understandably concerned that Ensco PLC (NYSE:ESV) is in the wrong place at the wrong time when it comes to its rig fleet.

It seems the market is extremely negative on Ensco because it has some significant capital expenditure needs in the near future, due to its aging fleet. While those are indeed valid concerns, investors overly bearish on Ensco are missing the bigger picture. Offshore oil demand is strong, and Ensco has an industry-leading reputation which has attracted repeat customers. Here are the important considerations when it comes to the state of Ensco's rigs.

Ensco's aging fleet is a key issue going forward
Importantly, investors should be aware that Ensco has an aging fleet a key product area. According to its most recent rig fleet report, 64% of Ensco's jackups are older than 30 years. These jack-ups however, comprise the largest premium jackup fleet in the business thanks to frequent upgrades. Not surprisingly, its aging fleet will require significant capital expenditures in the upcoming years. Ensco will have to allocate significant resources to upgrading its fleet. That being said, it has the second youngest ultra-deepwater fleet in the business. 

That's why the company has a sizable amount of rigs under construction. In all, Ensco plans for approximately 30 new floaters and 35 new jackups to be delivered industry-wide through the end 2014. The company will be challenged to keep expenses at moderate levels, since it's already noting rising construction costs for its jackup rigs.In all, Ensco is targeting nearly $2 billion in newbuild expenses through 2015, on top of an additional $380 million in enhancements this year.

It's clear that Ensco's aging floaters and jackups are a significant concern, one that Transocean (NYSE:RIG) is navigating better. To be sure, Transocean is investing in high-specification jackups and floaters. For example, it's building 12 high-specification rigs, seven of which are contracted. But, it's also selling off non-critical rigs to raise cash. Since 2011, Transocean has divested 62 non-core rigs for total proceeds exceeding $2 billion. This will help offset some of the cost of upgrading its fleet later on.

And, Transocean is also pursuing other initiatives to produce margin improvements including cost savings and operational efficiencies. The company targets a total of $800 million in margin improvements by 2015.

Despite the potential headwind presented by rising construction costs, Ensco is confident it will see more than enough demand to make its capital expenditure plans worthwhile. Its customer demand is becoming more diversified, and it sees positive developments in key markets worldwide. For example, energy prices are proving to be very supportive, and Ensco is seeing strong demand in Brazil, as well as expansion of the floater market in Mexico.

Demand for Ensco's rigs looks strong
Investors should feel confident in Ensco's future because it's seeing strong demand for its deepwater rigs. In particular, the ENSCO 8500 Series ultra-deepwater rigs, which are capable of drilling for oil in up to 8,500 feet of water, utilize Ensco's highly successful proprietary design. The 8500 series has a history of strong performance and has attracted repeat customers.

For example, Anadarko Petroleum (NYSE:APC) has used several of the ENSCO 8500 series, including the ENSCO 8500, the ENSCO 8505, and the ENSCO 8506. Anadarko's deepwater results have been impressive over the past couple of years. In 2012, it announced two of the world's largest offshore discoveries in Mozambique. Last year, Anadarko successfully drilled two appraisal wells there in the third quarter. Plus, Anadarko made significant progress in a sizable Gulf of Mexico project, which will result in first oil production during the second half of 2014.

Look past Ensco's short-term hiccups
Ensco has an aging fleet which will require significant expenditures. Its jackups are quite old, which need to be replaced. These costs will likely weigh on Ensco's near-term profits.

However, the long-term fundamentals of offshore oil drilling remain sound, and Ensco has a distinct track record for attracting repeat customers. Ensco's sterling industry reputation and strong demand for its 8500 series ultra-deepwater rigs means its future outlook is bright.

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Bob Ciura owns shares of Ensco. The Motley Fool owns shares of Transocean. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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