In this overheated stock market (now in its sixth year of a bull run), value investors are struggling to find places to invest new money. Luckily, the energy sector is one that still has many good values to choose from, and right now the offshore drilling space is one of the most undervalued. This is largely because of recent negative press from Barron's magazine (predicting a long-term decline in oil prices of 25%), as well as negative reports from Barclay's (predicting potential share price declines of 40%), Citigroup, and Morgan Stanley.
The reasons for these concerns? Short-term weakness in offshore drilling day rates for industry leaders such as Transocean (NYSE:RIG). This weakness is a result of two things: a slew of new UDW (ultra-deepwater) rigs being delivered in the next two years and energy companies announcing a pullback on their E&P (exploration and production) budgets over the next few years.
However, the long-term outlook for the offshore industry is stronger than ever, due to several key factors:
- Global oil demand is expected to increase by 13%-26% through 2035.
- Oil prices are expected to gradually increase to $125-$150/barrel during this time.
- Conventional, land-based oil production is expected to grow by just 1% CAGR through 2030.
- UDW offshore production is expected to increase by 19% CAGR.
- Global E&P budgets total $650 billion annually and have grown at 15% CAGR over the last 11 years.
- By 2020 a total of 165 more UDW rigs will be needed to meet demand than exist now or are scheduled to be built.
During its latest earnings call management revealed that its turnaround plan was working, albeit slowly (utilization rate up 3% to 78% and cost cutting of 13%), but Transocean is facing a gigantic obstacle in the coming two years. Twenty of its UDW contracts are expiring, and its UDW fleet, at 23-years-old, is the second oldest in the industry.