If I may, allow me to reuse an analogy about the energy markets. Imagine the energy market as a big merry-go-round. The major international companies like ExxonMobil (NYSE:XOM) and BP (NYSE:BP) are in the middle, smaller producers like Apache (NYSE:APA) are a little further out, drillers like Transocean (NYSE:RIG) still further out, and jack-up rig companies like TODCO (NYSE:THE) are closer to the rim.
Assuming you've been on a spinning merry-go-round, I think you get the idea. Those sitting in the middle can experience a pretty dull ride, while those on the outer edges simultaneously have a white-knuckle experience. That's the jack-up market in a nutshell -- lucrative as all heck when times are good, but pretty wild over the course of a cycle.
For now, TODCO is enjoying the ride. Revenue was up 73% this quarter, as companywide utilization improved a bit and dayrates improved a lot (more than doubling in the Gulf of Mexico segment). EBITDA rose 86% and operating income was up a couple of multiples from last year, whether you use adjusted numbers or not. Remember, too, that the company shelled out a lot more in rig reactivation expenses this quarter.
The issue in front of TODCO shareholders isn't whether TODCO is a good operator. It is. Nor is the issue whether or not rig supply in the Gulf of Mexico is presently shrinking as rigs move to overseas destinations. It is. The issue is how long this balance will stay in favor of the drillers and continue to push up rates.
There are more rigs coming onto the market in the coming years, and even TODCO is now starting to reactivate rigs (one, in this case) without a contract in place. That's speculative activity, and it's pretty normal. The question, though, is what rates will look like beyond next year and whether there will be an ongoing trend away from the Gulf of Mexico because of hurricane fears.
While the number of producers in the Gulf may shrink, I don't think overall activity is going to decline much -- there's still a lot of oil and gas there, and companies like Apache will buy assets if other people don't want to stay. The real trouble, though, is that jack-up pricing has never been particularly stable, and what has shot up in recent times is likely to fall back down in the coming years.
But how fast and how far? Those are the key questions that all current and potential TODCO shareholders must wrestle with at some point.
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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
