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The BP (BP) accident is far and away the worst disaster to ever befall drilling companies, from both an economic and environmental perspective. Entire industries in the Gulf are on extended hiatus. It goes without saying that after oil leaking continuously into the Gulf for more than two months, natural habitats for fish and other marine life have been ruined. BP, which, prior to the incident was a giant of industry and enjoyed $7 billion revenue streams per quarter, is now on the verge of bankruptcy. Clearly, the circumstances are special. Never before in the history of the deep sea drilling industry have we seen such a fiasco. But as investors, we need to recognize that special circumstances create special opportunities.

Now, before you label me a greedy, uncaring self-beneficiary, I must say that I do have extreme sympathy for this environmental disaster. I have sympathies for the locals living near the gulf, their businesses, the animals, even BP to some extent. The reality of it is that investors everywhere recognize that situations like this do not happen every year (or even every 20). Everyone is wondering where we go from here.

The most obvious aspect of this situation is that investors believe that if BP manages to cap the spill and stay afloat financially, their shares would be extremely undervalued (or at least at a pretty good bargain by most standards). The only problem with this thought process is an obvious one; the risk of BP filing for bankruptcy. While this may seem unlikely, any investor that has been around a while knows that anything can happen at this point given the enormous amount of claims on BP. It may not head for any of the bankruptcy chapters, but at this point it’s too hard to call, and a long position in BP seems like a constant headache.

Dave and I were looking around at other drilling companies last week to see what their charts looked like. Initially, we were looking at Transocean (RIG) and Diamond Offshore (DO), which do the same thing: deep sea drilling. Much like BP, both companies’ shares had been run into the ground. Transocean’s more so since it was their drilling rig that blew up. Though legally Transocean is deemed not liable, sentiment tends to be negative when your company name is associated with a disaster of this magnitude.

We did a quick fundamentals check on RIG and DO, and noticed that RIG was in good shape as a company, and was in a price zone that indicated it to be “severely undervalued.” DO, not so much. Still, at the time, the moratorium (a six month drilling ban in the gulf proposed by the Obama administration, which is now being hotly contested by both sides) and the fact that BP had yet to clean up the spill seemed like reason enough not to make any hasty decisions.

I recently had a very interesting conversation with a friend and former executive of Noble Energy (NBL) regarding what he thought about the whole situation. We had a long discussion on drillers, natural gas, and the BP fiasco. While a lot of the information he provided wasn’t particularly relevant, from an investing perspective, there were a few key points that we believe were important and wanted to share with our readers.

According to this former executive (who is now retired and skis nearly every day of the season here in Colorado) the key points for investors to consider include:

  • Though it was RIG’s physical drilling rig that exploded, RIG will “skate away” with no blame or liabilities against them.
  • Anadarko (APC) (who owned 25% of the oil flowing through the burst line) will likely “skate away” as well. BP pointed the finger at APC, and APC replied by saying, “We weren’t there, this is your mess.” Though it is hard to prove in court, BP will likely be hit with negligence. If this happens, APC dodges a bullet.
  • It is important to differentiate your outlook on the future of drillers, as many drilling companies are international, and drill all over the world. The domestic drillers will have a challenging ride over the next year. However, international drillers like RIG may not. RIG only does 3% of its total offshore drilling in the Gulf of Mexico. Thus, even if the moratorium hadn’t been repealed, some of these companies’ revenue streams simply won’t be affected, meaning the fundamentals of a lot of the international drillers will not change regardless of what happens in the Gulf.
  • Taking the last point into consideration, international drillers’ shares have taken a BP-esque price hit over the past two months. In short, the ones that remain fundamentally healthy are severely undervalued.
  • International drillers such as NBL and RIG have enormous revenue streams due to the majority of their drilling being deep-water, which is much more effective and profitable than coastal and mainland drilling.
  • The hedge funds appear to “play” RIG more so than they do BP, APC, NBL, and DO. If there is going to be an eventual “recovery” in the drilling industry, it would follow then that a Hedgie darling such as RIG might move the most to the upside.
  • The timeframe is not set for when driller’s share prices will return to pre-spill levels. And for many of them, it may not be a question of “when?”, but “if?”

While these points were taken from conversation and are quite general, together, they make a decent argument from an investment perspective. The bottom line is this: People are still speculating over whether BP is a steal, or whether the possibility of bankruptcy makes the risk too great. International drillers may be a better bet if you’re looking to make the long term move, as they have bore the same share price cliff dive as BP has, but with none of the mess, both literally and financially. On top of this, people around the world still need oil now more than ever, so international deep sea drillers such as NBL and RIG, who supply in large quantities, will not experience a demand fallout for their product.

While a long-term investment like RIG or NBL may seem attractive after analyzing the information available, there is always a chance that it may not be the correct assessment or that it may take longer than anticipated for our thesis to unfold. As we are all aware, “market logic” is sometimes the furthest thing from real “logic” you can possibly get.

Finally, we should add that we did buy an initial position in RIG for a personal longer-term account last Friday as we felt the argument was simply too compelling to pass up. So far, so good.

Disclosure:

Author long RIG

Source: Crisis and Opportunity: Our Take on Drillers