Offshore drilling stocks have been among the hardest hit by the fall in oil prices, despite the fact that we have yet to see a big drop in revenue or earnings. Ensco (NYSE:ESV) is one of those that has been hit, falling 24% in the last three months alone.
We don't know what Ensco's stock is going to do in the future, but if it's going to rise, there are three big drivers that could fuel it. The challenge is that many of them are out of Ensco's hands.
Oil prices rise
The biggest driver of Ensco's stock, and all offshore drilling stocks, for that matter, has been the price of oil. You can see below that Ensco's stock has followed the fall of oil almost exactly, so the stock is being driven by commodity moves, not necessarily earnings.
As much as Ensco tries to improve its own position in the market, the truth is that the price of oil will drive long-term demand. If oil prices remain as low as they are today, it's likely most ultra-deepwater offshore drilling programs won't be economical, and we'll see lower demand in coming years.
But we've seen oil prices fall before, and it's usually only a matter of time before they're bumping up against $100 per barrel again.
Ultra-deepwater drilling activity picks up
One of the strengths of offshore drilling in the past few years has been ultra-deepwater, where high-specification rigs can still command around $600,000 per day. This is also where Ensco and others have made a huge investment in growth. In the next year, Ensco will receive three new drillships that are currently being constructed and will bring the number of drillships up to 10 in the 66-rig fleet.
What has investors worried currently is that these rigs won't find long-term work, and that the rig due in Q3 of 2015 won't get a contract at all. But if contracts continue to come in with strong dayrates, especially in the next six months, we should see drilling stocks improve. That's because drillships currently drive profitability at the best offshore drilling companies, and Ensco has worked hard to increase the capability of its fleet. So, when contract momentum picks up, so will the stock.
Competitors begin stacking aging fleets
One of the things Ensco and Seadrill talk about regularly is the aging supply of the drilling fleet. Of course, this plays into younger assets in their fleets, particularly in the ultra-deepwater market. But it's true that aging rigs are less competitive than new rigs, and eventually, they'll have to get major upgrades or be retired.
According to Ensco, 19% of the current floater supply is 35 years old or more, an age when we start to see rigs become uncompetitive.
If competitors with older rigs begin stacking them or scrapping them altogether, it would reduce supply in the market. That would help open up availability in the market for newbuilds that are coming online over the next three years. This supply reduction is something that needs to happen in both the jackup and floater markets, but it's a question of how long it will take. For its own sake, Ensco hopes it's sooner than later.
Of course, all of this upside would require oil prices to recover from where they are now. At the moment, that seems like a long shot.
Travis Hoium manages an account that owns shares of Ensco and Seadrill. The Motley Fool recommends and owns shares of Seadrill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.