Gulf of Mexico Drillers: Bargains in the Aftermath?

by: Osiso
I wrote an article back on March 28, 2010 on long / short drillers, with an emphasis on players in the Gulf of Mexico. I chose Noble Corp. (NYSE:NE) and Rowan Companies (NYSE:RDC) as the top buys and Hercules Offshore (NASDAQ:HERO) and Seahawk Drilling (NASDAQ:HAWK) as the best short candidates.

After the recent announcement of closing exploratory drilling off the Gulf of Mexico [GoM] I figured it might be a good time to see if this thesis still holds, my guess is that it does not based on the way the market has reacted but I’ll try to go through the information I know as of right now. I encourage the Seeking Alpha community to add their input as to catalysts that could help find bargains at these prices (or value traps).
The question is, are there any bargains in the aftermath? Transocean (NYSE:RIG) and BP have been written about over and over, so I will look at other alternatives.
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Update on my long/short candidates
I did short HAWK and buy NE calls after I wrote the previous article, and largely ignored RDC and HERO. I did not invest in those two only because I was looking at some Russell plays as well and wanted to have exposure to the upcoming Russell rebalance.
The calls expired out-of-the-money and I covered my short soon after, not realizing the 44% gain (I didn’t have a bottom price on the stock….need to work on a salvage value model).
Equal Wt
Table 1: Returns since initial article
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Had I held onto the portfolio I would be up +7.6% in little over 95 days, instead I am up 2% for these two securities. Now looking at the latest environment I am looking at getting back into this space....but first I need to see if there are any screaming buys or not.

Regulatory Issues announced:
A number of issues have impacted the Gulf of Mexico since the Deepwater Horizon accident.
  • Six-month ban on drilling exploratory oil and gas wells in deep water off the Gulf of Mexico.
  • Deep water in this sense is depth greater than 500 ft. (Dow Jones Newswires)
  • Cancel the August lease sale in the Gulf of Mexico of Block 215
  • 18.8 million acres of offshore Western Gulf for lease
  • 9 -250 miles offshore
  • 16ft – 10,975 ft depth
  • 242-430 mBOE probable
  • 1.64-2.65 tcfe probable natural gas
  • Deepwater rigs currently in production will not stop.

Shallow water leases will still go on to the dismay of environmental groups but appease calls from industry groups such as the International Association of Drilling Contractors [IADC], which state 200-300 jobs depend on each working rig.

  • As of 5.28.2010 Marathon (NYSE:MRO) and Exxon Mobil (NYSE:XOM) have started halting exploratory drilling in deepwater (ref: Dow Jones Newswire)
  • S. Elizabeth Birnbaum, director of the Minerals Management Service resigned hours before President Obama was to speak about the oil spill in the Gulf of Mexico.
  • Insurance rates have risen 15% to 25% for rigs operating in shallow water and price increases for as high as 50% may be coming, according to a recent Wall St. Journal article.
  • Swiss-Re has estimated that insurers would have $1.5B- $3.5B in claims… that was when the oil spill was day 16 of the oil spill. We are in day 41+.
Clearly there will be many casualties of this spill, sea turtles, Tony Hayward, drillers, etc. Drillers and every energy company move with the price of oil. Will this moratorium affect the price of oil? I don’t think so, production will not be impacted, so it will be mostly drillers, E&P, and some ancillary players who will feel the brunt of the new environment.

Some of the facts according to the EIA:
  • About 30% of the total crude oil produced in the U.S. comes from the Gulf Coast
  • 12% of total natural gas comes from the Gulf Coast
  • Half of the refining capacity in the U.S. is there
  • 2/3 of the crude oil processed in the Gulf Coast is imported by tanker
  • To date, only two natural gas production platforms (6.2 mcfe/day less than 0.1% of GoM production) have been shut down.

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Figure 4: Current levels of inventory in the U.S.

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Figure 5: Current levels of Natural Gas in the U.S.

28% of total crude oil is a significant number, but when you look at current stock piles, we are running at the higher end of inventory. We currently are producing about 5.3 million barrels of oil equivalent/day in the Gulf of Mexico of 15.1 mboe in the U.S. So long term I don’t see this moratorium affecting demand in any way. Since production rigs are exempt, there should not be a big change to the GoM oil production in the next six months.

For drillers, the key will be to see which-- if any-- rigs will go idle in the next six months and how much of a revenue hit will that be for the firm. I will focus on the 500 ft + rigs since those will be the ones that will be affected.

Noble Corp (NE)
According to Reuters and Bloomberg the exploratory ban will affect two rigs for Noble. Recently Shell (NYSE:RDS.A) contracted the Danny Adkins which I am guessing is one of the two rigs. I have yet to come up with the list of rigs that are affected but based on the second highest dayrate rig from NE I will propose that it would be also cold stacked hence this would be the worst case scenario. Furthermore, I would assume that Shell declares a force majeure and NE doesn't get paid for its contract.
Dayrate ($k/day)
Days till EOY
Total Revenue loss
Danny Adkins
(2) 15,000psi
(2) 10,000psi
Jim Thompson
(2)15,000 psi, (1) 10,000 psi Spherical
(1) 5,000 psi Spherical

Given this scenario, I came up with a -12% top-line revenue drop and I went out till the end of the year, instead of just six months since it could take a bit of time to get a new contract. I also put in the BOPs as well, because there was some talk that these would be upgraded via a sell side report. I haven’t looked into this too much but the Danny Adkins was recently revamped, so these two may not be affected by an upgrade to the BOPs, rather the fleet of rigs would have to be analyzed.
Without looking at upgrading the BOPs for the fleet (could happen if there is further regulation) and looking at a couple of coldstacked deepwater rigs and the drop in crude oil (21%), I have a bottom price of NE at $28.1. The big assumption is that the two rigs affected by this moratorium will get a force majeure and the contracts will be nullified.
Ensco (NYSE:ESV)
According to its fleet status report as of May 14, 2010 ESV has no deepwater rigs in the Gulf of Mexico.
The stock should have moved down roughly with the price of oil, and it has moved down 26% as oil moved down 21%, it has not been hit as hard as NE and as seen on the chart below, after President Obama’s announcement (1pm on Thursday May 27,2010), NE started to fall as ESV climbed. I don’t have a model on ESV so I don’t have a price target for it, but maybe worth looking into moving forward.
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Figure 6: ESV vs. NE
Rowan (RDC)
Rowan has a fleet of Jack Ups no semi-submersibles in the Gulf of Mexico. RDC’s Gorilla lineup is Jack Ups that can withstand harsh environments, which may become an attractive option going further.
RDC does have one Jackup (Bob Palmer) which is in the Gulf of Mexico and goes to a water depth of 550ft. This one is licensed to Apache (NYSE:APA) at a dayrate in the ‘low 110s’. I don’t have a finalized model on RDC but looking at a 6 month ban on the Bob Palmer would reduce Net Income by 5%, resulting in $2.27 EPS vs. consensus of $2.55 EPS (yahoo) or an 11% drop. RDC has dropped 18% since the accident as crude has dropped by 21%. More downside could be possible for RDC.
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Figure 7: RDC vs. NE
Seahawk (HAWK)
Seahawk just presented (5/26/2010) at the UBS Global Oil & Gas Conference and in the company's presentation did not mention the Transocean accident. The stock has fallen 44% since I went short. I don't think it can fall much further under $10, but I need to calculate its salvage value to really come up with a firm number.

Hercules (HERO)
HERO does not have any deepwater rigs and with the largest fleet of Jackups in the Gulf of Mexico, some think they could benefit from a push towards shallow water. My only concern with that assumption is that shallow water production has been on the decline for years and, according to the EIA production in the Gulf of Mexico, has been on a slow decline for quite some time now.
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Of the candidates that I looked into here, it looks as if NE could be near its bottom (the caveat is that crude oil stays above $70); I’ll do a sensitivity analysis to see how much lower NE could go if crude goes to $60.

RDC looks as if may have a bit more to go down and I may get puts on it, HAWK, and HERO still don’t look attractive to me, there could be more plays in the shallow water segment, but I think land drillers may become a better alternative moving forward.

Disclosure: Will go long NE @ $28