What happened
Crude oil continued its bull run this week, finishing up slightly more than 1%, putting it up double digits for the quarter and more than 20% above its low point in June. The positive finish helped propel several oil stocks to big gains this week. That said, the bulk of the largest moves were from offshore-drilling stocks, according to data from S&P Global Market Intelligence, thanks to some industry-specific catalysts.
So what
A boatload of offshore-drilling contractors finished the week up double digits, led by Atwood Oceanics (ATW), Transocean (RIG 2.16%), Ensco (VAL), Rowan Companies (RDC), and Noble Corp (NEBLQ). While the rise in oil certainly helped, the primary driver of this move offshore was a bullish report from UBS, which upgraded Transocean, Rowan, Noble, and Ensco from neutral to buy, while raising its price targets on those stocks. Meanwhile, Ensco's move higher pulled Atwood Oceanics up with it since the two are in the process of merging in an all-stock deal.
Image source: Getty Images.
The driver of the near industrywide upgrade is that there are signs that demand for oil rigs is improving, which should help stabilize the sector. Because of this, the bank expects vessel utilization to improve slightly next year before demand accelerates in 2019 and 2020. That should drive up earnings for offshore drillers, with UBS anticipating that profits will be 25% higher next year across the sector than it initially expected.
In addition to this bullish stance, there was a report by Bloomberg on Monday that Rowan was in talks to acquire the drilling assets of shipping giant A.P. Moeller-Maersk. The deal could be worth as much as $4 billion and would help improve Rowan's scale so it could better compete with larger rivals. That's becoming increasingly important since most of its competitors have bulked up during the downturn.
As noted earlier, Ensco and Atwood are merging, while Transocean recently signed a deal to buy Songa Offshore. A key driver of those deals is that they'll enable the combined entity to reduce costs.
In Ensco's case, it expects to save $65 million per year in expense synergies by combining with Atwood. Meanwhile, Transocean believes that it can save $40 million per year due to cost and operational synergies by bringing Songa into the fold. These costs savings will enable those drillers to make more money in a lower-oil-price environment, which lines up with UBS' view.
Now what
Despite this week's rally, these offshore drillers are still down more than 20% this year and 50% over the past three years. The still-depressed stock prices suggest that they could have ample upside ahead as the market starts to return to normal, especially as they start signing more contracts that increase earnings visibility and capture the anticipated merger synergies. That said, investors will need an iron stomach to invest offshore since it could still be a wild ride given that crude might remain volatile as it tries to find its footing.
