Total's Elgin Gas Field Leak Could Present Buying Opportunity In Offshore Drillers

Includes: ESV, RIG, SDRL, TOT
by: Power Hedge

On April 20, 2010, an explosion occurred on the Deepwater Horizon oil rig located in the U.S. Gulf of Mexico. This explosion resulted in the largest accidental marine oil spill in history, releasing an estimated 4.5 million barrels of oil into the Gulf of Mexico over a period of nearly three months. The leak was successfully stopped on July 15, 2010 by capping the wellhead and through the relief well drilling process which was completed on September 19, 2010. This resulted in the federal government declaring the well officially dead.

The accident resulted in a sell-off of offshore drilling companies. This sell-off affected more than just Transocean (RIG), owner of the Deepwater Horizon and the only offshore driller that was connected to the disaster. This sell-off even impacted companies that have, or had, minimal exposure to the Gulf of Mexico and the drilling moratorium that followed the disaster such as SeaDrill (SDRL). This sell-off proved to be a good buying opportunity for investors who realized that this disaster was not the end of the world for the offshore drilling industry.

I acquired my initial position in SeaDrill in the aftermath of the disaster for $19 to $25 per share. Since that time, I have seen my investment appreciate significantly in value and have collected a very large and increasing dividend every quarter since I made my initial purchase. Other investors who purchased their shares around the same time that I did will have similar stories to tell.

We could be seeing a similar opportunity today. On March 25, French oil major Total S.A. (TOT) reported that a gas leak following a wellhead operation occurred at the Elgin field in the North Sea. Shares of Total fell approximately 8% in the days following the news. However, it is unlikely that this is another Macondo.

This incident has one thing in common with the Macondo spill: it sparked a sell-off in offshore drilling companies. Ensco (ESV), SeaDrill, and Transocean all fell significantly following the news of the gas leak. Furthermore, all three companies closed out the week with a loss.

SDRL 5-Day Chart

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Click to enlarge
Source: Fidelity Investments

ESV 5-Day Chart
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Source: Fidelity Investments

RIG 5-Day Chart
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Source: Fidelity Investments

As the three charts above show, all three drillers fell in the days immediately following the announcement of the gas leak. Although all three companies rallied late in the day on Thursday and into Friday, they remained negative at the end of the week.

This sell-off appears to be completely unwarranted and may even offer a buying opportunity. I have written numerous times over the past few months about why I think that offshore drilling companies offer compelling fundamentals. Here are just a few examples of those articles:

The gas leak at the Elgin field has not changed any of the fundamentals that I highlighted in these articles. In fact, all signs point to the industry being in the early stages of a powerful upcycle. This gas leak is unlikely to change this, particularly when the demand for offshore rigs to bring fields to production is so strong. Thus, any sell-off in offshore drilling stocks due to this gas leak appears to be unwarranted. We may have a buying opportunity here.

As of Sunday, Total was awaiting permission from U.K. authorities to return to the leaking platform and evaluate the situation. There are a few ways that this situation could play out depending on how long it takes Total to stop the leak. The company said that it is moving two platforms into place to drill relief wells and stop the leak. The situation does not appear to be another Macondo but the full extent of the damage is not completely known. If there is any more bad news out of the area, it could trigger another sell-off of shares. That would present a good buying opportunity for these stocks.

Disclosure: I am long SDRL.