This is the fifth in a series of articles regarding the outlook for investments in the oil industry in 2006 and beyond.

Over the past few weeks, I've written articles examining various sectors of the oil industry, ranging from majors such as ExxonMobil (NYSE:XOM) and BP Group (NYSE:BP), to drillers like Rowan Companies (NYSE:RDC). I've even managed to take a peek at refiners such as Hidden Gems pick Valero Energy (NYSE:VLO). While I believe these companies are well-positioned to grow profits in 2006 and beyond (I wouldn't have written about them, otherwise), they are familiar big-name players in the industry and lack a certain "sex appeal."

Because of this, I thought it was time (to pilfer a quote from the immortal comedic sages of Monty Python's Flying Circus) for something completely different -- namely, a special situation that goes under the moniker of Hercules Offshore (NASDAQ:HERO), a provider of shallow-water drilling and liftboat services focused on the U.S. Gulf of Mexico market.

Before delving into Hercules' prospects, I want to make it clear that this investment is not for those lacking a healthy appetite for risk. After all, Hercules Offshore has only recently gone public (October of last year), is relatively illiquid (trading roughly 200,000 shares per day) and has two large private equity investors -- Lime Rock Management and Greenhill & Co.-- that hold a 55% stake in the company (management retains another 7%). Furthermore, the company recently filed to sell eight million shares (or 9.2 million if the issue is oversubscribed) when the 180-day lockup expires on April 24, 2006, creating a near-term overhang on the stock. This move isn't entirely without its merits; it will increase liquidity and shrink the above-mentioned 55% private equity stake to a less daunting 32% (or 27.8%, if oversubscribed).

Sounds like a recipe for underperformance, doesn't it? Well, call me "Foolish," but I believe that the stock is more likely to surprise on the upside because of a number of factors, including strong industry fundamentals, a fleet comprised of a unique blend of jackups and liftboats, the company's significant leverage to the tight Gulf of Mexico market, and an accretive consolidation strategy.

Let's take a quick (very quick, I promise) look, shall we?

Strong industry fundamentals
Since I covered this topic in a previous article about Rowan, I'll limit myself to a quick look at the main driver of activity in the Gulf of Mexico -- drilling for natural gas. While natural gas prices have come down substantially since the hurricanes, the rolling twelve-month average was $9.10 per mcf, up some 311% from the $2.11 per mcf in January 1994. This long-term trend toward higher prices is likely to continue, since in the decade between 1994 and 2004, U.S. natural gas demand grew at an annual rate of 0.7%, while supply grew at a rate of merely 0.2%. Throw in the drop in imports due to damage from the hurricanes, and President Bush's push for energy independence, and you have a potent mix for increased dayrates in the Gulf of Mexico market.

Hercules' rig fleet
The company owns a fleet of nine jackups. It had 10, but one was totaled by Hurricane Katrina (luckily, the rig was fully insured for $50 million). Seven rigs operate in the Gulf of Mexico, and two are undergoing refurbishment for deployment to the international market.

Hercules' rigs are all designed to drill in depths of less than 250 feet, ideally suited for drilling in the Gulf of Mexico. Furthermore, most of its rigs are differentiated from standard "commodity" rigs -- for example, one jackup can drill in water as shallow as nine feet, two others are the only ones that can approach a platform from all four sides, etc.) -- which explains the high level of utilization rates that it boasts (89% in the most recent quarter) compared with its competitor TODCO's (NYSE:THE) more modest 51%.

Given the situation regarding U.S. demand for natural gas outlined above, Hercules' heavy exposure to the Gulf of Mexico market has it sitting in the proverbial catbird seat, especially since its jackups generally have short-term contracts (two months to a year) and can more easily reprice its rigs to snare higher dayrates. The combination of high utilization rates and contract flexibility enabled Hercules to record average dayrates of $58,611 in the fourth quarter, up 18% sequentially, and 72% ahead of the $34k per day recorded in last year's period.

Hercules' liftboat fleet
Hercules is the largest liftboat owner in the Gulf of Mexico, with a fleet of 42 liftboats, holding approximately a 40% share of the market (the next largest player is Superior Energy (NYSE:SPN) with roughly a 25% market share). These boats are essentially self-elevating mobile work platforms, enabling the liftboats to perform numerous offshore services such as platform maintenance, inspections, repairs, etc. Since there are roughly 3,100 unmanned platforms in the Gulf of Mexico needing such services, you can imagine the potential for profit, especially when disasters like Hurricane Katrina strike (not to mention that many of these platforms were built in the 1970s and are slightly "long in the tooth").

The same factors governing the increase in Gulf of Mexico jackup utilization rates and dayrates also come into play in the liftboat market. Hercules' liftboat fleet had respective utilization and dayrates of 83.5% and $8,000 per day in the fourth quarter, compared with 69%, and $5,700 in the prior year's period.

Lest I forget, Hercules also has four liftboats operating in the small but fast-growing West African market -- an area management has targeted for further consolidation.

Consolidation strategy
I won't bore you with details here; I'll simply state that Hercules was formed in order to consolidate the fragmented markets in both shallow-water drilling and the liftboat market. Management has done an enviable job -- Credit Suisse First Boston estimates that Hercules completed nine of its key acquisitions at only 29% of the assets' replacement costs. In other words, management has been adept at buying non-core assets from other companies at a discount, fixing them up, and redeploying them.

Conclusion
Hercules Offshore currently trades at roughly 8.5 times fiscal 2007 consensus earnings estimates of $3.73 -- pretty much in line with other players in the drilling universe. But I believe its differentiated position in the red-hot Gulf of Mexico jackup market, the company's leadership in the consolidating liftboat market, and its proven ability to make accretive acquisitions at a bargain price should provide the momentum for upside earnings surprises and a higher valuation. Investors with an appetite for an energy play with a high risk/reward profile will want to take a look.

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Fool contributor Will Frankenhoff enjoys writing for The Fool even more than playing golf or taking naps. He welcomes your feedback. He does not own shares in any of the companies mentioned above. The Fool has a disclosure policy.