Modern Fleets Win In Deepwater Drilling

| About: Pacific Drilling (PACD)

On Friday, Pacific Drilling (NYSE:PACD) announced a 5-year contract for the Pacific Sharav that amounts to over $1B in revenue. According to the presentation at Global Hunter Securities, the dayrate amounts to $555,000 for the term. The deal was hinted at during the Q112 earnings report so possibly the terms shouldn't be used to read too much into the current strength of the deepwater markets. Worth noting though is that the rig won't be delivered until the fourth quarter of 2013.

With its best-in-class drillships and highly experienced team, Pacific Drilling is a fast growing company that is committed to becoming the industry's preferred ultra-deepwater drilling contractor. Pacific Drilling's fleet of seven ultra-deepwater drillships will represent one of the youngest and most technologically advanced fleets in the world. The company currently operates four recently delivered drillships, has two additional drillships under construction and one on order at Samsung.

Naturally with oil sliding the last month, stock prices for deepwater drilling companies such as Pacific Drilling, Atwoods Oceanics (NYSE:ATW), Ocean Rig (NASDAQ:ORIG) and Seadrill (NYSE:SDRL) have gotten drilled. Though with Brent oil prices still topping $90 one has to wonder if this doesn't provide a buying opportunity. The above contract suggests demand remains strong.

These companies operate drillships typically on 2-6 year terms with demand typically remaining strong in all but the leanest years. The long term contracts provide steady cash flows as well. Also, the bifurcation in the pricing and utilization, as noted in Figure 1 below, favor the new rigs suggesting the above companies should see less impact from the volatile markets.

Figure 1 - Floater Utilization Rates By Build Cycle

As the above Figure highlights, the age of the fleet is highly predictive of utilization rates. Basically, new rigs immediately replace old rigs placing long term established companies with old fleets at a huge disadvantage. The companies mentioned above can virtually build at will and replace the older rigs of competitors.

Below Figure 2 highlights the modern Ultra Deepwater advantage of the new firms versus the established companies. One has to wonder why some of the larger players haven't been more aggressive in selling off old rigs and building new ones.

Figure 2 - UDW Fleet Age

This Motley Fool blog has some great data on the larger competitors in the industry though new entrants Ocean Rig and Pacific Drilling weren't included in the analysis. Back in January, this article analyzed the different stocks back then highlighting the concerning fleet age of the more established companies.

This industry is even more complex to analyze as the younger and smaller companies have taken on substantial debt to finance the newbuild programs. Even previously mostly debt free Atwoods Oceanics has taken on some debt to build out its fleet.

Naturally any bet on the industry has to be broken out into two decisions. The first decision is whether oil will hold at these levels or plunge further. In the later scenario, all sector stocks will fall regardless of fleet age and should be avoided for now. The second decision is to determine the best play assuming the bullish outcome on the first decision.

The move to deeper and deeper drilling will benefit the companies with the newest fleets. Not to mention the larger companies like Transocean (NYSE:RIG) have fleets of older rigs and jackups that dilute the benefit from building newer rigs.

Investors looking for the company focused solely on deepwater drilling with modern fleets should look no further than Pacific Drilling. Though don't be confused as the company mostly works in the Atlantic and Gulf of Mexico.

Disclosure: I am long ATW.

Additional disclosure: Please consult your financial advisor before making any investment decisions.