The oil-drilling market is hot -- but that's not news in the slightest. Whether it's large drillers like Transocean (NYSE:RIG) or smaller drillers like Pioneer (AMEX:PDC), day rates have been steadily rising, and contract terms are becoming increasingly favorable for the drillers.
On Friday morning, offshore driller Noble (NYSE:NE) announced a long-term agreement with Petrobras (NYSE:PBR). While these two companies have worked together for some time already, the terms of the deal are interesting.
The contracts involved locking up five semi-submersible rigs for five years -- a long stretch in the drilling business. While four of the rigs are already operating under contract, each deal includes an escalator for when the present operating agreement ends. These escalators range from 33% for a rig deal that was set to expire next summer to nearly 50% for a rig whose current deal ends in early 2007.
Obviously, these deals mark a variety of risk/reward trade-offs. For Noble, it is an exchange of the possibility that day rates will continue to soar even higher for the security of long-term agreements that guarantee some solid profitability. For Petrobras, the agreement guarantees access to the rigs and protects the company from out-of-control rate increases in the future.
Of course, this agreement covers just five of the 60 or so rigs that Noble has in operation, so it's not as though it's going to have a massive impact upon the business. What interests me about it is what it could mean for the rest of the contract drilling space. Although customers have seen steadily rising day rates, most have not been too eager to enter into long-term deals. Perhaps that attitude is starting to change as producers continue to face higher costs from those rising rates.
Drillers are usually a later-cycle play in energy, and this is no exception. What that means, then, is that drillers tend to start moving after the big oil companies have had their days in the sun. Given that long-term dynamics in oil and gas continue to favor higher prices (for producers, drillers, and customers), this could end up being a longer cycle than average.
With 2006 earnings expected to be more than triple the level of 2004 earnings, it's clear that analysts are already on board for the boom. While investors need to be careful about stock selection (and remember that these are cyclical companies), so long as day rates keep rising, the stocks should follow.
Don't get drilled; learn what you need to know here:
- Life in the Fast Layne
- Pioneer Drills Down, Strikes Money
- Petrobras Plans to Pump Up
- Transocean's Rig Gig
Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
