Crude oil prices are once again above $60 a barrel and local television newscasts have returned to that old chestnut, consumers grousing about the high cost of gasoline, to fill airtime. Never mind the fact that despite the great lengths we go to extract, transport and refine it, ounce-for-ounce petrol is still far cheaper than a cup of coffee or bottled water.
It’s curious that the gains in oil (which is up approximately 75 percent from its lows) and gasoline (up more than 50 percent) have occurred amid the greatest oversupply in a generation.
The financial crisis and subsequent economic contraction has pushed peak oil—the point at which the world is unable to increase oil production—from the public’s psyche. But it will not meaningfully delay the inevitable decline in output.
Peak oil will only be clearly recognized with the benefit of hindsight. Yet a good case can be make that we’ve already past that inflection point. Our guess is that energy prices will temporarily retreat in the near term as a full economy recovery is still a ways off and investors get nervous after the big run they’ve had in recent months. Energy stocks are bound to take a hit on any such correction before heading higher.
One company that has remained largely unscathed from an earnings standpoint, and will continue to thrive come what may, is Transocean (RIG). The stock should play a prominent role in everyone’s portfolio. And we consider it a long-term buy here, even though it, too, is vulnerable to a near-term setback.
The company operates the world’s largest fleet of offshore rigs and drillships, with a particular emphasis on ultra deepwater drilling. While land-based rigs are getting knocked down these days like ten pins on league night at the bowling alley (off 55 percent since last August according to Baker Hughes), the economics of deepwater offshore drilling is such that work continues apace.
Transocean has not only the most technologically advanced fleet of rigs; it’s also more than twice the size of its nearest rival. The company holds 19 of the past 23 world records for drilling in the deepest waters. That technological edge, plus its outstanding track record of service in harsh environments, means it can command premium rental rates on those rigs. Transocean’s unique position in deepwater drilling makes it more resilient to the drop in energy prices as its rigs continue to command higher dayrates. As demand for deepwater rigs, despite lower oil prices, continues to exceed supply, rental rates for deepwater drilling rigs continue to surge.
That said, an offshore rig is a huge investment, and with demand and day rates in question, rig builders won’t take a chance on building more. The global credit crunch is also a factor that will result in a stronger competitive position for a major operator such as Transocean. The lack of credit is squeezing its smaller rivals from the business, preventing them from building new vessels. As many as one-fifth of the new deepwater rigs on order in shipyards all across the world were canceled or delayed because of capital constraints.
As a result, there’s already a scramble for the relatively few offshore rigs available, particularly for deepwater capable rigs that have a water depth capacity of at least 4,500 feet. Future demand for these rigs should continue rise to benefit from successful drilling efforts in the Gulf of Mexico, offshore Brazil and other parts of the world. Soaring day rates in this leveraged business should translate into tremendous profit gains for Transocean.
The company itself believes that deepwater rates should continue to remain strong, as demand will exceed supply in foreseeable future. Yet the stock is trading at less than 5 times the consensus estimate for the company’s 2010 profits—an estimate we think is fairly conservative. With long-term annual profit gains expected to top 15 percent, you’ll be hard pressed to find a cheaper stock and certainly not one that serves such a vital role in our society.
