Is the Tide Rising for Offshore Energy Stocks?

There's no question that green energy has become very popular within the U.S. With companies like SolarCity (SCTY.DL) owning most of the market, the oil companies are trying to throw their hats in the ring to see if they can cash in on this highly sought-after space.

With the stock price of Golar LNG (GLNG 0.35%) skyrocketing, why would an oil company want to attempt something they know so little about? Should investors cash in on this opportunity, or stick with the companies that know what they're doing?

Fool analysts Sean O'Reilly, Taylor Muckerman, and Tyler Crowe have the dos and don'ts for this captivating market, on today's Energy edition of Industry Focus.

A full transcript follows the video.

Sean O'Reilly: The biggest investors in green energy are oil companies? On this energy edition of Industry Focus.

[INTRO]

Greetings, Fools! I am Sean O'Reilly joining you here from Fool headquarters in Alexandria, Virginia. To my left, our Fool analyst Taylor Muckerman, and Tyler Crowe. How are you today, gentlemen?

Taylor Muckerman: Doing pretty well.

Tyler Crowe: They have to trust you that we're to your left.

O'Reilly: They're actually to my right. Dun-dun-dun! So, nice day out today, guys. Talking a little oil, talking a little energy. First we wanted to talk about the big event in Golar last week. Stock popped, what, 24%?

Muckerman: 24% in one day. For a lot of...

O'Reilly: For doing what they said they were going to do.

Muckerman: Exactly. Doing exactly what they were planning on doing.

Crowe: Because that's what happens when you don't do what you're planning on doing for a while.

O'Reilly: Yeah.

Muckerman: That is true.

O'Reilly: Is that true? Has it been a while?

Muckerman: It's taken them a little while.

Crowe: LNG's been a long time coming.

Muckerman: So, a lot of people may not necessarily know who Golar LNG are. They are a company that, for many years, have been liquefied natural gas shippers. They own tankers, moving natural gas around the world to various -- from port to port.

In the past couple of years what they have done is decided to go on a new venture where they're going to build floating liquefied natural gas ships, which are going to be used in remote locations that may be a little more difficult to build a regular LNG export facility where you have all that liquefaction equipment and whatnot. What they're saying is, there will be an opportunity for this over several years.

Not to a whole lot of surprises, yesterday there were two big announcements. The first was that they secured a 20 year contract to use one of these new floating liquefied natural gas vessels. It will be off the coast of Equatorial Guinea, one of the large oil and gas hubs of today.

Crowe: Booming LNG economy.

Muckerman: Booming LNG economy.

O'Reilly: Don't forget their awesome tourism industry.

Muckerman: Oh, it's huge.

Crowe: Booming.

Muckerman: So, what it's going to end up doing is, it's going to be about 2.2 million tons per year at LNG, which will basically -- according to Golar -- will add up to about $350 million in EBITDA to its general partner which it owns. Just to give a perspective to that, last year the partnership of Golar LNG, its entire EBITDA was $325 million.

So, basically what they're saying is...

O'Reilly: Hence the stock pop.

Muckerman: Hence the stock pop. Basically what they're saying is, "We're going to more than double our EBITDA in the next couple of years when this thing actually comes online."

O'Reilly: So, I've been reading a lot about natural gas and I understand it's a cleaner fuel, it's a better fuel -- all that. Is this actually going to be the future? Are we going to be a civilization increasingly using liquefied natural gas? We just can't today because of the lack of infrastructure?

Crowe: Don't tell that to United States.

O'Reilly: I would never.

Crowe: Because there's tons of infrastructure here -- in fact, I think Kinder Morgan has more pipeline than the whole country of China. Eventually, once they get the infrastructure running -- yes. Natural gas could be the cleaner fuel of the future until solar or wind can power the world. But that seems to be a far-off notion. Some countries that need power that have no natural resources, like Korea and Japan, are clamoring for natural gas.

Europe relies heavily on Russia. They're trying to wean themselves off of that dependence.

O'Reilly: So, Japan's really, you think, the real market for natural gas?

Crowe: Well, if you look at a lot of the contracts from the export facilities proposed in the U.S., Korea and Japan are heavy buyers.

O'Reilly: Yeah.

Muckerman: One of the things with natural gas is, for so long it's been a regional product. It's a gas. It's so much harder to transport it economically versus something like crude oil where you can put it into a relatively innocuous tanker and send it all around the world. Hence you've got global prices.

With natural gas you've got these large, regional disparities of prices and liquefied natural gas is starting to combine those two -- those regions -- with a much more reasonable price disparity. What we're saying is, like, here in the United States it's a little under $3, I think, for a unit. What they call 1000 cubic feet of natural gas. Once that's fully processed, liquefied, transported and regasified over in the Asia-Pacific region, China -- it's about $10 per that same unit.

But because of the lack of natural gas in China the economics actually work out. So, we can basically produce it $3 here, take that $5-$6 that it takes to transport, liquefy, regasify, and it still becomes economical. Everybody wins.

O'Reilly: What does liquefied natural gas look like? Just paint the picture. Does it look like...?

Muckerman: It's very cold.

Crowe: Subzero temperatures.

Muckerman: Yeah. It has to be stored in refrigeration and you can't actually have an open pit of liquefied natural gas.

Crowe: If you look at a ship of liquefied natural gas it looks like a giant cargo ship with essentially the domes of basketball arenas on top of it.

O'Reilly: Oh, wow!

Crowe: Yeah. It's pretty sweet. Maybe two or three of them. At least that's the one's I've seen. Now, increasingly they're trying to power these ships with LNG...

O'Reilly: With the gas.

Crowe: Yeah. So, they'll be cleaner to ship it, it will be cleaner to use it once it gets to where it's going, and it will be cheaper for these ships to operate on the fuel that they're actually carrying.

O'Reilly: Very good. So, moving on. Lots of big changes going on in the energy industry. Tyler, you were just telling me about a lot of big events in the last month in the offshore industry. A little offshore drilling.

Muckerman: Yeah. Everybody's -- well, not everybody, because we're talking about energy here and it's not exactly the most popular of investing topics sometimes. But if you were to look at one month's charts on a lot of offshore drilling companies -- your Seadrills (SDRL), your Transoceans -- they would look like they are going absolutely gangbusters.

Last month...

O'Reilly: They are tech stocks now.

Crowe: Yeah, they really are. It's like a dang GoDaddy IPO.

Muckerman: Seadrill's up 50% over the past month, Transocean's up 28%, Ensco (VAL) is up 25%. These numbers look huge, and one of the biggest reasons that we've seen that is that the price of Brent crude is up 15% over the month, and is somewhere around $68 today.

Basically what's going on is -- I would love to come up with some fancy, fundamental reason as to why this is actually happening. It would sound really smart to investors. The real thing is, it seems that the downtrodden oil market that we had over the last few months have been a little overzealous. Maybe it went a little too far and people started to realize that the supply glut that we had was not as great as everybody was projecting.

So, we're seeing a slight uptick in oil prices as a reflection of that. Physically, there hasn't been a whole of changes. U.S. production has gone down a little bit. So, the worries of oversupply aren't...

O'Reilly: We did just get our first drawdown in supplies today, as I heard though.

Muckerman: So, we're seeing a little bit of production reduction. We could see a little bit of that supply glut start to relax a little bit and make oil prices, obviously, better. But before anybody sees those "up 50%, up 28%" and goes "Oh my God! This must be the next great thing," let's keep this in perspective.

Crowe: Look at where they came from first.

Muckerman: Let's put this in perspective. Over a one-year period, those exact same companies: Seadrill's down 59%, Transocean's down 55%, and Ensco's down 46%.

O'Reilly: Oof.

Crowe: Yeah. I'm personally an Ensco shareholder.

Muckerman: And I'm a Seadrill holder.

Crowe: That's fun. But I have been looking to buy more because I still believe in it. It's a multiyear investment, obviously, because it's the most expensive oil to drill for when you're talking about several thousand feet of water to get through before you get to several thousand feet of earth, before you get to several hundred thousand gallons of oil. You haven't seen any bankruptcies.

So, these companies have been able to survive. Some of them are on the brink of it more than others, but Ensco is one company that I still feel safe with. Best credit rating of the bunch when you look at big offshore oil drillers. They have lost a couple contracts, one with BP in particular, but BP has to pony up some cash in order to break that contract. Not as much as they would have over the period of what that contract would have given Ensco. But still, it's not a compete loss.

If you continue to see that, you're going to have to suffer a little bit longer as a shareholder of any of these companies. Look at companies that are exposed to -- state-owned oil companies you might want to be a little more nervous than companies that are exposed to privately or publicly owned oil drillers -- oil producers -- just because they typically have more flexible contract terms. They can negotiate prices where they can outright cancel it without having those much larger fees like BP did with Ensco.

I think they canceled one with Seadrill and they canceled a few earlier. It cost them about $350 million in payments that they had to dole out, but I don't think anybody's been hurt as much as Diamond Offshore (DO) because they've been exposed to Petrobras and Pemex. Those two companies run by Brazil and Mexico, respectively have been slicing and dicing offshore.

Muckerman: Yeah, and when you also have -- in the case of Diamond Offshore -- when you have one of the oldest and least technologically advanced...

Crowe: Yeah, that's a good point.

Muckerman: ...fleets in the business, it's going to be much harder for somebody like that to get contacts in the future because we are seeing -- with offshore drilling -- they're having to go deeper. They're having to go to more advanced drilling techniques, looking at what are called "high-pressure reservoirs." It takes higher-specification rigs to do that. Going in to the Arctic, you need to be harsh-environment-ready.

Companies like Diamond don't necessarily have the fleet to do that. If you look at the companies that do, you have Seadrill, you have Ensco -- they're the ones that actually have the fleets that are going to be capable to do this. And on the really, really long term those are going to be the companies that are probably going to have the most success.

Crowe: You're putting these companies in a strainer right now and you're really going to see who the strongest ones are. Much like OPEC thinks, "We can go ahead and eliminate some of the higher-cost shale producers in the U.S." If this lasts longe, you're going to eliminate some of the higher costs and older fleets of offshore drillers that just can't compete.

Everyone can compete when oil is over $100 a barrel, and obviously it's not anymore. So, it's going to really expose those that were just taking advantage of lofty prices for oil.

Muckerman: That's an important takeaway for any investor out there. Just remember: Any bonehead can make money at $100 oil. It's the ones at $50 oil that you want to look for.

O'Reilly: So, just an investing takeaway. You guys are talking about all these stocks around 50% to 60%, Brent crude's sitting at, I don't know, 66, 68... WTI hanging out at about 60. I don't want to say "Are these undervalued," because that kind of depends on what oil prices do, and we might as well flip a coin there. But do they -- they've obviously had a little bit of a relief rally here -- do they price in all reasonable risks going forward, or are they a little too optimistic now?

Crowe: I could see some of the run-up a little overly optimistic. At least in the short term. I would still feel comfortable adding shares if I'm holding for five years or more, but if I'm only going to hold this for the next year or so, offshore after a run-up might not be the best place to look.

Muckerman: How's the best way to explain this? I would like to say they've priced in any foreseeable risks, but when it comes to the oil industry...

O'Reilly: Obviously, last year we saw unforeseeable risks.

Muckerman: In the great words of Donald Rumsfeld, "There are known unknowns, and there are unknown unknowns." You got to watch out for those unknown unknowns.

O'Reilly: You'd make a great defense secretary, Tyler. So, before we wrap it up here, real quick: You just shot an article over to me before we went on, Tyler. It was how the biggest green energy investors are actually oil companies like Total (TTE 0.14%). What's going on here? Are they seeing the writing on the wall?

Crowe: I don't know if they're seeing the writing on the wall. Maybe they just want to appear green. Some of them do -- you mentioned Total. I think they're doing it right. They're an investor and a solar producer of sun power. But some of these companies that are trying to do it on their own...

O'Reilly: Well, BP quickly was branding themselves "beyond petroleum" a couple years ago.

Crowe: Yeah, they were.

Muckerman: And then sold out of all of their wind assets when they had to pony up for the deepwater Horizon spill

Crowe: I'm pretty sure Exxon (XOM 0.22%) has sold most of its biofuel operations as well. So, maybe those companies at least realize, "Stick to our bread and butter, even if it's hurting us right now." Eventually, you could understand that a company with as much money as Exxon, if oil does start to really appear to be ending as a fuel source, they could just go up and buy someone that produces renewable energy.

But those trying to get into it now on the side? I don't see it being much of an impact.

Muckerman: Yeah. This may be more of a rant than a question -- and I don't mean this in any way to belittle moving toward cleaner energy -- but big oil companies; they're filled with petroleum engineers, geologists, chemists, etc. They are really, really good at developing, producing, refining oil and gas.

They are not solar panel manufacturers. They aren't wind turbine manufacturers. They probably are lousy at evaluating the electricity market and building utility-scale solar projects. They would be...

O'Reilly: It's a question of specialization.

Muckerman: They have been for years. They've been lousy at alternative energy investments. So, in just about every other industry -- if we go into tech, or whatever -- it somebody is moving drastically in another direction, like having to completely learn expertise in something else and develop a new product and go off on a new venture, it would scare the bejeezus out of people because they're not good at it and they're trying to compete in a whole new space.

Yet there is this large movement of saying that big oil companies, because they're big, and they're oil, and they work in energy, they have to move over to the alternative energy space. I just don't see why it would make sense when they would probably be lousy at it. When there are so many other companies that are getting pretty damn good in this space right now.

If you look at SunPower, most efficient panel manufacturer in the world. They're looking to double their capacity in the next three to four years. You've got First Solar, 59% of their utility scale backlog is overseas and they're one of the leading panel manufactures, and builder of utility-scale projects.

Then you go on the residential end here in the United States and you've got SolarCity. They own close to 40% of the market. They're growing almost double annually -- 100% compounded annual growth rate. They're actually having to build -- they bought and built their own panel manufacturer just to keep up with their own demand.

Crowe: And they bought a panel installation company. So, they're totally integrated.

Muckerman: Panel installer, bringing down costs. So, you're looking at -- big oil's basically saying "We're going to have to take on these guys who are doing a really, really good job and we're probably going to stink at it for a really, really long time." It just doesn't seem to make sense. If you want to invest in energy and are bummed out by the fact that it's big oil companies, invest in one of these guys because they're doing a heck of a lot better job than any other...

O'Reilly: So, Total's making the right move there, obviously.

Muckerman: Yeah. If an oil company wants to get involved I think the move that Total made by taking an equity interest in -- maybe even in one of these companies I just mentioned -- probably your best bet. You buy on one of these, hope that it rally turns out -- with ease it's done it so far -- and if it doesn't, they've made an honest effort.

But don't try to get into a business that you, in some rights, have no expertise in.

Crowe: And you don't have to worry about transparency because I would question whether or not these companies -- I don't think Exxon really gave investors much to go on. How they're improving, or how their biomass was progressing along -- until they were like, "Well, we give up. We're going to sell it."

But if your company is investing equity-wise into another solar company or wind power producer, you can just go look at their 10-K or their quarterly filings and figure out exactly how they're doing. Translate that on a percentage basis over to how that's going to impact your big energy investment, or your big oil investment, and then figure it out that way.

So, if they are trying to change course they better be darn sure they're transparent about it from an investor standpoint.

O'Reilly: Very good. So, moral of the story: Stick with what you're good at.

Crowe: Pretty much.

Muckerman: Stick to your guns.

O'Reilly: Mr. Crowe, Mr. Muckerman: Thank you for your thoughts.

Crowe: Appreciate it, Sean.

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