Iraq Oil Shock? 2 Reasons Why Deepwater Is the Place to Be

Burning oilfields in Iraq during Gulf War I. Source: Allvoices.com 

With the latest turmoil in Iraq, both global and U.S. oil prices shot up to recent highs. Brent crude, which typically represents global oil prices, now sits at a lofty $113, and West Texas Intermediate is $106 per barrel. At these prices, one would think that all is well in the oil patch. Indeed, most nascent shale plays, deepwater discoveries and new Arctic operations should be very profitable here. 

However, the problems that have been plaguing supply capacity continue. Issues such as infrastructure bottlenecks and export constraints persist in the two sources of fastest-growing capacity; Canada and the U.S. This has caused wide differentials between North American and global oil prices, and those spreads could widen even more as capacity in North America continues to grow. Elsewhere, resource nationalization keeps a majority of the world's prolific oil fields off-limits to international oil companies.

So, while oil prices are indeed high, the biggest beneficiaries to the prospect of persistently high oil prices will be those connected to global oil markets but free from resource nationalization and onshore politics. That's where deepwater oil comes into play.

It is indeed uncertain whether the events in Iraq will lead to persistently high prices. But if prices stay high, deepwater oil is the clear winner in this scenario for two big reasons: First, no matter how turbulent things get in the Middle East, such instability can never make it all the way out to oil rigs which are miles off the shores of places like Brazil, Africa, and the North Sea. Second, all the crude oil pumped from deepwater rigs gets realized at Brent crude prices. In other words, deepwater oil does not get discounted due to infrastructure bottlenecks and export bans, unlike oil from North American shale. In a scenario of persistently high oil prices, deepwater is the place to be. 

Where to start 
The companies most significantly exposed to deepwater are oftentimes not the actual drillers but the lessors of the rigs which are being used. Consider a rig lessor like Ensco (NYSE: ESV  ) . Ensco has a relatively young fleet which is geared to deepwater exploration and production. Of its large-cap offshore peers, Ensco has by far the lowest leverage. A quick look at the company's balance sheet reveals that its debt is a very manageable 2.5 times operating cash flow; a ratio far lower than that of its more indebted peers such as Seadrill (NYSE: SDRL  ) . In addition, Ensco's dividend is only 53% of earnings, which is once again far lower than that of its peers.

For those who would like exposure to a more well-known producer, try Chevron (NYSE: CVX  ) , which has two 'megaprojects' under way in the Gulf of Mexico. Jack and St. Malo, the two massive Gulf drilling projects, will be very profitable undertakings if Brent crude continues to hover over $110 like it is doing today. Like Ensco, Chevron has a solid balance sheet, a well-covered dividend, and a conservative debt load. If the global oil supply situation remains tumultuous, Chevron's offshore expertise will be of great benefit. 

Bottom line
Whether the events in Iraq will turn into a full-blown production crisis remains uncertain. This is not the first time this type of situation has arisen, and it likely won't be the last. Many times, such as during the Arab Spring in Egypt a few years ago, oil prices returned to their usual level. Nevertheless, volatility spikes seem integral to the oil market. Deepwater drillers are far enough away from the turmoil but still benefit from the price spikes that often follow. 

OPEC is absolutely terrified of this game-changer
Imagine a company that rents a very specific and valuable piece of machinery for $41,000 per hour (That's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report reveals the company we're calling OPEC's Worst Nightmare. Just click HERE to uncover the name of this industry-leading stock... and join Buffett in his quest for a veritable landslide of profits!

 


Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

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.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2993944, ~/Articles/ArticleHandler.aspx, 9/3/2014 12:49:37 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement