U.S. rig activity is the highest since the mid 1980s, despite weak natural prices (UNG) driving natural gas rig activity lower. So far, oil E&P has absorbed the capacity, but, with activity at its highest in decades, investors are getting nervous about future production and crude prices (USO).
Despite a wave of deals involving domestic emerging shale and limestone plays, shares of many producers are trading well below last summer highs. The trade is arguably crowded and challenging energy investors to find stocks where growth is likely to continue rather than stagnate.
Offshore drilling is back in the Gulf and strong globally.
A few short years ago, BP's Gulf of Mexico disaster forced investors out of offshore plays. That dynamic is reversing as the Gulf enjoys a renaissance tied to post-moratorium permit approvals and December's successful block lease auction. This resurrection is good news for offshore services companies, such as Oceaneering International (OII), whose remotely operated vehicles ("ROV") and subsea products are used to connect platforms to wells.
Last fall, 33 rigs were operating in the Gulf. Today, there are 45, good for 67% year over year growth. As a result of renewed activity, Gulf fleet utilization has increased to 60%, up from 48% last year. While this is a big move in the right direction, future growth opportunity remains since global deepwater utilization is 80% or higher - depending on the region.
As the Gulf comes back online, Oceaneering finds itself in an enviable position, given 38% of its sales and 52% of its operating income come from ROVs. The number of contracted floating rigs, globally, has grown from less than 150 in 2004 to 243 currently. At the same time, OII's ROV fleet has climbed from 125 to 262 and its earnings per share have climbed from $0.40 to an estimated $2. After trending down from its 2007 peak, OII's fleet utilization turned higher again last year, reaching 80% from 73% a year ago, as day rates increased for a second consecutive year to a new high.
Future rig deployments strengthen the company's prospects. There are 74 floating rigs on order, with 37 contracted and 24 expected to enter service in 2012. All will require subsea products and services. The number of subsea completions are expected to grow from 3,000 to more than 4,500 this decade. As a result, subsea tree orders - and related products such as OII's umbilical's - are expected to grow 58% by 2015. OII's backlog of subsea products, which account for 40% of revenue, increased to $403 million exiting Q3, up nearly $100 million from the prior year and the highest in company history.
It's not just Gulf drilling offering upside for Oceaneering.
Following the Gulf moratorium, the company focused on expanding services across emerging markets including offshore Africa and Brazil. These markets are increasingly important as Europe demands energy sources outside troublesome Iran. As a result, global deepwater oil production has increased to 6% of world production, up from 2% in 2000. And it's expected to increase further this decade.
Oceaneering also has done a solid job of improving its balance sheet. Despite growing its fleet and expanding its product line, the company brought its debt down from $229 million in 2008 to zero. The company also has an active buyback program, repurchasing 500k shares in the first three quarters of 2011, and yields 1.2%.
Investors worried about future production weakening prices, and eventually demand for rigs, can take some solace in knowing deepwater projects offer much longer tails less tied to short term crude price volatility. If oil investors want to maintain energy exposure, but reduce weights to the commodity or producers including Range Resources (RRC), Chesapeake (CHK) or Devon Energy (DVN), services plays like Oceaneering make sense.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in OII over the next 72 hours.