These Three Deep Sea Drillers Look Like a Bargain

Fundamentally we know that the world thirst for oil is going up. It will continue to go up in the future because the strongly growing economies of India and China will drive that price up.

An earlier Seeking Alpha article noted that India and China both consume less than 2 barrels of oil per person per year. The U.S. consumes approximately 26. The Western European countries and other developed countries consume 13-15 barrels per person per year.

Furthermore both China and India are subsidizing the price of oil for their citizens. Increased usage by these quickly growing economies seems certain. If China's and India's use goes up by just one barrel per person, this will have a huge impact on the global supply of oil. They both have huge populations. The price will rise with the increased demand.

This all seems virtually inevitable now. In the long term, alternate forms of energy seem to be the solution. However, in the short term the world is stuck with oil as a staple. Since the world will not change quickly away from oil, what else can it do? The answer is simple, it must produce more.

How can it do this? The land based oil fields seem to have been tapped to a large extent. The new "land based" discoveries that are made do not even seem to keep pace with the "land based" fields that are expiring. The most promising fields these days seem to be the sea or ocean based fields. Prominent discoveries have been made in the Gulf of Mexico, off Brazil's coast (the Tupi and other fields), in the China Sea, off Malaysia and Indonesia, in the North Sea, etc. This means the short term solution (i.e. for the next 5-10 years at least) is deep sea drilling for oil.

Three excellent companies in this area are Transocean (RIG), Diamond Offshore Drilling (DO) and Noble (NE). They all have good numbers:

click to enlarge

As you can see while the price of oil has risen from about $100 to $130+ (or about 30%), the price of the stocks that drill for this oil has not risen. Actually the prices went down with the market. Then these stocks generally recouped their losses as the market recovered.

If you look at the chart patterns you can see these stocks have been consolidating recently. Oil prices will likely push higher over the summer. It is hurricane season. It seems that the above stocks are about to break out of their consolidation phase due to the already considerable drag of oil prices. If oil prices go up still further this summer, these stocks should skyrocket. In the past these stocks have risen as oil prices have risen. There is no reason to expect that pattern to break.

Already RIG, NE, and DO seem primed to explode (i.e. without any further increase in the price of oil). A 30% difference in the price growth of oil versus the price growth of these stocks puts me in mind of a tightly drawn rubberband. It looks like this rubberband is currently being released. It should propel these stocks much higher.

I note that RIG seems to have predicted slower growth in the near future, if you go by the FPE. However, it also has the lowest PE and the highest long term growth rate -- lowest PEG ratio (= highest 5 year growth rate). I believe some of the short term lack of growth may be due to adjustments being made to merge GSF with the former RIG. With the obvious world demand for quick deep sea oil field development, this bigger RIG may be ideally positioned to take advantage of this demand. It is a big buy.

Disclosure: Long

Comments

[800LB GORILLA]

Ill take ESV over all the rest.

[NLFEnergy]

Ensco doesn't have the same deepwater exposure as these three, they own the deepwater market. Ensco is more focused on jackups rigs and geographically is based in different areas than these three, namely southeast Asia. Noble is the real star here as they have the inside track with the Brazilians and over 73% of 2009 days booked for drilling.

[Brian Pursley]

Since petroleum comes from the mantle, deep is the place to be.

Transocean has the lowest multiples and is the leader. RIG owns 7 of the 16 ultra deepwater rigs available to market through the end of 2010. They also have 5 enhanced-Enterprise drillships coming on which will be able to drill in 12,000 feet of water and to 40,000 feet TVD.

[MartinR]

Another good one to consider is Seadrill, a Norwegian Deep water drilling company that is growing and also has several new rigs coming on line this year and next.

[David White]

I should have added a couple of other factors that bode well for these stocks. First many oil companies have announced increases to their exploration budgets recently. Second President Bush is trying to get legislation enacted that would speed the permitting process for exploration. Both of the above should have a positive impact on these stocks.

[Niksurfs]

I could not agree with you more on your assessment of these stocks. I currently have long positions in NE, RIG nothing in DO. I entered into these positions based on future growth and valuation. I consider them both best of breed and I think they have significant assets anbd relationships that will continue to propel much higher over the next 12-18 months.
I also have a large psoition in NOV which I have cultivated over time, I would submit they would be a good addition to any services portfolio, they are a key player in all the rig players supply chain.

[liquideagle]

I think your thesis is a little backwards. Oil prices probably need to come down some for these mining companies to really flourish.

Otherwise too much demand destruction will occur resulting in weaker economies, lower demand, higher adoption of non-oil alternatives.

Plus, expect the Asian countries to consume less oil (near term, over the next couple of years) than they do now as those subsidies are phased out. Too much money is getting into the system which is causing runaway inflation over there.

[fredthfox]

Bend over and grab your cheeks, the next congress will be drilling us for more tax revenue.

[Sophisse]

The way I see it, these drilling companies will do well regardless of whether oil rises more or falls - as long as it doesn't collapse due to some economic meltdown, which I think highly unlikely. (Note that I said economic meltdown, not market meltdown.)

I don't think their results will vary that much depending on oil price - they don't really get a cut (do they?). At anything close to today's oil price, their services are gonna be at max demand and they'll be building capacity and hiring workers as fast as they can. There's a limit to how fast they can expand.

So that's why I like them - they won't float with the oil price, either up or down - they're solid.

But I'm no expert, someone correct me heh.

[IdiotKiller]

"Bend over and grab your cheeks, the next congress will be drilling us for more tax revenue."

It's hard to believe they could get more from us than the Republicans did for their endless wars, illegal wiretaps and gay sex in public restrooms.

[pamploma]

Hey IdiotKiller: believe me, with his endless social programs, Neville Chamberlain-like attitude towards Iran and other totalitarian nations, and outright contempt for Wall Street, Obama and his like will crush everyone from titan CEO to small business owner with taxes.

[gaucho]

Another deep sea driller is a new player called Dry Ships DRYS. They have diversified into deep sea drilling through an acquisition 2 deep sea rigs and a purchase of another two deep sea rigs through Cardiff and are building another two deep sea drilling ships for dilivery in 2010. These guys have a PE of 3!!! They are the most profitable dryshipping company around. Look into them for yourselves

[freefall51]

What I like about these drillers is that the dayrates of today have been negotiated a few years ago, when oil was was what ... $ 40 - 60/ barrel? Since a certain portion of the service contracts say 20 % are renegotiated every year they still have a lot to catch up to todays oil prices. I like in particular that RIG has the biggest asset base after they merged with GFS. Inflationary steel and other prices will push the prices for new rigs up and will define the re-negotiated dayrates in the future. I assume this will in a way lift the price level of the whole existing fleet.

I believe the US outer shelf will be opened for drilling, since the public pressure on the politicians will be untenable over time not to. I that happens the guys that have the drilling rigs in place will be in the driver seat.

If I were to hire a company for a deep sea drilling project that would cost me a couple of hundred million dollars for a hit or miss I would go with the best in class.

Bigger is apparently better. It was recently announced that RIG holds the standing record for deep drilling ~ 40,000 ft down. RIG is the biggest animal in that market and they are performing.

[Davo]

I noticed recently that a lot of money managers are going to cash. What do they know?

[marvin gortler]

Deepwater exploration for oil is the last frontier.
Oil co's have so much money that to justify their greed must invest in deepwater exploration.
No one knows with any degree of certainty how much oil is in deepwater ie. more than 20000 ft below seabed.
If oil is discovered how will it be extracted? and in the quantity to
justify the investment?
The technical problems are enormous.
Getting the oil to market from a new discovery will be take more than 5years.
I have more questions to ask when the above is answered

[paultaut]

Rowan, RDC, is drilling in the Gulf. 70 feet of water.
Ultimate depth will be 35,000 feet. Show me another deep sea driller that has beaten that.

[Albatross HU-16E]

President Bush and Sen. McCane have just recently become strong advocates of increased drilling. Unfortuneatly, the principle drillers mentioned are all busy and maxed out in drilling utilization. Drilling manufacturers, which are few in number, NOV for example, are contracted out for the next several years. The CEO of NOV has sold all his shares the past month, approx. 475,000 shares. What does that portend? Just how can there be much of an increase in drilling with current max utilization and production? Transocean (RIG) has 8 new ultra deep water floaters on order to be placed in use 2009-2010 in the Gulf, India and Angola. Drilling rig contracts are rising as new contracts are written. Petrobas needs approx 40 rigs and cant find them. The drillers and manufacturers are all maxed out right now! Price growth should be strong but predictable.

[David White]

China announced today that they are going to raise their internal fuel prices. This will likely curb demand for oil from China to some extent. This may mean a short term drop in the price of oil. Of course, the long term increasingly higher demand picture is still in place. Still this will likely have a negative effect on the oil and oil service stocks short term.

[alphameister]

Love the group. My largest holding is DRYS where I love the low p/e and the ultra-deep drilling kicker. Also have major positions in RIG and ESV based on PEG ratios. I own and prefer ATW and NE to DO, but all offer tremendous appeal. Adding to NE today.

[Jake2]

Nice work. I bought RIG today, before reading your artcle. I was torn between RIG and NE. (PS: Goldman supports you.)

[ACEMAN]

Y'all need to consider the best of the lot and that is PDE based on intrinsic value, low debt, low P/E, low PEG and not burdened by old rigs. This is the comer for the next curve up in platform and deepwater drilling.

[David White]

I heard an alternate thesis about the effect of the Chinese government raising the internal fuel prices. This analyst thought that the increased price might allow the Chinese government to make the supplies more plentiful. This might cause gasoline usage, etc. to go up. Apparently with the old price scheme you could not always get all the gasoline you wanted. I personally thought this idea had some merit. For the moment I am now thinking that the Chinese price increases are going to be a wash as far as demand goes. Some people will use more because they will now be more easily able to. Some people will use a little less because it is more expensive. Overall China will still eventually use more. That is a virtual certainty as long as their economy continues to grow quickly.

[oldgoldbug]

Hey Dave, tell us more about money managers going to cash. Are you talking about oil/oil service or market in general?

[David White]

oldgoldbug: It wasn't me who said that. It was Davo. It is news to me. However, I am not surprised to hear that people are going to cash as the market declines. That is the normal reaction. Also there is the thought that there may be a second round to the credit crisis in which a number of businesses get hit. People in commercial reall estate are now telling me that credit is extremely hard to get for commercial right now. If some people have to sell, this could mean they may have to sell at firesale prices. Still many others (including our former Fed Chairman, Alan Greenspan) are saying that the crisis is mostly over. Perhaps a short commercial real estate crisis will be the end of it??? Perhaps the rising oil prices will bring on a global recession??? I think there is a risk of both of these things happening. There is also the possibility that we have already seen the worst. We may get a recovery later this year??? Perhaps mangers are converting to cash because they cannot predict what will happen. They can always buy back when the market starts to go up.

[David White]

There is fairly strong support for the S&P500 at 1250. Perhaps the market will reverse before that? Or perhaps it will not stop at 1250 this time, as now the Fed is threatening to raise rates as opposed to cutting them? I have somehow lost my crystal ball.

As for RIG, it is still looking like it wants to break out to the high side. It appears as if the current market downtrend has prevented it from doing so to any great extent. When the market turns upward (or perhaps even when it stabilizes), RIG should be a leader in the move upward.

[David White]

I should point out definite, "extraordinary&qu... reasons for the markets' downward movement at this time:
1) The Israeli's are practicing taking out Iranian nuclear development capabilities (i.e. perhaps about to start a war with Iran).
2) The Nigerian Oil production has been virtually shut down due to attacks by rebels.
3) The Midwestern U.S. has suffered catastrophic flooding recently with multi billion dollar damages to property and crops. I am not sure what the total figure is at this moment, but it is very significant. Many people are saying they will be permanently moving out of the areas involved.
4) Many western states are experiencing significant wildfire problems, which only look like they will get worse as the summer goes on.
5) The Fed now feels it must soon start to raise rates in order to fight inflation.
6) There is fresh news of bad loans form many of the banks, including regional banks. GS estimated banks will have to raise another $65 billion in capital to cover their losses. Many banks are laying off workers. Commercial real estate credit is very tight. The banks are decreasing their leverage, which in one sense is good. They are opting for a safer strategy. However, this also means there is the decreased leverage multiple times less credit available. This is puting a strain on other things, such as commercial real estate.
7) Let's not ignore the 8.0 or so earthquake in China, which has had a significant effect on China's economy. This has rippled into U.S. and other markets.
8) The price of oil has risen 30+% since the beginning of the year. Many other commodities have risen significantly also.
9) The U.S. Dollar fall has exacerbated the commodities' increases. It has also destabilized the markets to some extent. Hopefully it is near its bottom. If so, this should help to stabilize the markets.

[Socialism cannot compete!]

marvin gortler:

"Oil co's have so much money that to justify their greed must invest in deepwater exploration."

Greed? The integrated oil cos. profit margins are actually not any larger than other companies. For example, the ROE (TTM) for Coca Cola (KO) was 30.9%. BP's ROE (TTM) was 20.7%. Why don't we hear people talking about the "greedy cola companies"?? Oil is a much more volatile business, with greater geopolitical risks - I'd tend to allow them a higher profit margin given the importance of oil to my life (fuel, plastics, etc.) compared to cola, which I can live without!

"No one knows with any degree of certainty how much oil is in deepwater ie. more than 20000 ft below seabed."

Technologies have greatly improved for both exploration and extraction. Of course drilling must be done before we can ascertain with a high degree of confidence...but we can find likely areas with current technologies. Look at what Brazil is doing.

"If oil is discovered how will it be extracted? and in the quantity to
justify the investment? The technical problems are enormous."

Um...not really. The technology is there. Environmental groups are blocking it in the U.S. Other countries are doing it. Again, look at Brazil. And read Eric Bolling's recent piece on the need to drill *now*. He talks about how Cuba may begin drilling and tap out huge reserves that actually exist mostly under U.S. domain, but extend slightly to Cuba's (since we are close). They could usurp huge volumes just by virtue of getting down to it first, because we are too tied up with needless environmental worries: how many spills occurred with Gulf-area rigs during Katrina or any recent hurricane in the last 15 years, for that matter? 0. We now have systems that allow drilling and extraction with very, very little spill risk.

"Getting the oil to market from a new discovery will be take more than 5 years."

Nope. Again, google and read Eric Bolling's recent article - he talked to an executive from Transocean (RIG) about how long it would take begin bringing oil up from a new site. He was told that it could be as early as 1 year...but up to 5 years for the ultra-deep, hard-to-reach sites, and that taking longer than 5 years would be hard to fathom in any situation. So again, the American people are being lied to by some who are saying it's at least 5 to 7 years before we'd see results. That is simply not so!!