On Wednesday, Diamond Offshore Drilling (NYSE:DO) announced sparkling results thanks to rising dayrates across all categories of drilling rigs. Worldwide, the market for drilling rigs is tight, and it appears that investors can look forward to positive results for some time to come. First, let's do the numbers.

Quarterly profit was $0.60 per share, compared with just $0.02 per share a year ago. This quarter's number was somewhat inflated, though, because the company received $0.16 per share from insurance proceeds on the Ocean Warwick rig, which was destroyed by Hurricane Katrina. Conversely, hurricanes depressed results by way of causing more expenses and downtime. Backing out the $0.16 and adding the lost income, management provided a "non-hurricane" number of $0.49 per share, which still handily beat estimates of $0.41 per share.

As I mentioned before, two metrics drive this business: dayrates and utilization. The dayrate is daily drilling payment, and utilization is the percentage of the rig fleet in service. Both metrics are improving at Diamond, particularly dayrates. Take a look at the gains compared with the year-ago quarter.

Class
of Rig

Dayrate
Q3 2005

Dayrate
Q3 2004

% Gain

High-Specification Floaters

$148,000

$92,000

61%

Semi-Submersible Floaters

$77,000

$55,000

40%

Jack-Ups

$58,000

$40,000

45%


High-specification floaters are the deepwater rigs, with the most advanced capability of drilling; they can drill in water depths of up to 10,000 feet. Jack-ups operate in shallow water, and semi-submersible floaters operate in between the extremes.

During the conference call, management substantially reinforced my belief that the tight market, rising dayrates, and high utilization will continue driving profits. This tight market bodes well for Diamond Offshore, along with its larger competitor, Transocean (NYSE:RIG), going forward. It's pretty basic supply and demand. Drilling rigs are not exactly flexible on the supply side. New construction of a deepwater rig takes several years and hundreds of millions of dollars, so there will not be a glut in the market anytime soon. For example, Diamond is in the process of upgrading its rig, the Garden Banks, for service in deeper water. The shipyard in Singapore will not even begin work until the second half of 2006 because of a full schedule of other projects.

On the demand side, deepwater oil fields are relatively undeveloped and therefore offer some of the most attractive new drilling sites. The deep waters of the Gulf of Mexico, offshore Africa, and offshore South America are three of the most active areas right now.

Meanwhile, dayrates for jack-up rigs are rising as well. Hurricanes reduced an already tight supply in the Gulf of Mexico, and dayrates in the Gulf of Mexico have lagged other parts of the world, causing a migration of jack-ups in places outside the Gulf. Strong gains on this end of the market are expected to continue, thereby increasing revenue from Diamond's 13 remaining jack-up rigs. Investors may also want to look at TODCO (NYSE:THE), which has heavy exposure to the Gulf of Mexico jack-up market.

Diamond Offshore can hardly be called cheap at current prices, but earnings growth is quickly bringing the ratios down to earth. The stock is volatile, with every drop in oil prices causing gyrations. I guess traders think that oil at $55 a barrel will reduce dayrates and cause contract cancellations. In reality, many of the high-specification rigs are under contract for two years or more, with customers seeking even longer terms because of increasing rates. In short, oil companies don't make long-term drilling plans based on a $5 swing in oil prices. Therefore, I am happy to buy on the dips whenever they occur.

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Robert Aronen own shares of Diamond Offshore and Transocean but of no other company mentioned in this article. Please feel free to share your comments with him at [email protected].