Transocean: Drilling Deep for Profits

With the pullback in oil, many of the oil service companies have seen a dramatic decline. This is strange as many are not linked directly to the commodity itself and still have very nice looking futures ahead.

The best looking of the bunch seems to be Transocean (RIG). They not only have a monopoly in the area of deep oil drilling, but they are financially sound and in a sector that looks good going forward. Even with the price of oil at $100 a barrel, it is profitable to pay Transocean as much as $500,000 per day. Since many of the large land finds with respect to oil are gone, exploration is moving outward into the deeper levels of the oceans and this may be where some of the largest finds are yet to come.

Even though I did predict a pullback in the price of oil, I thought $120 was where resistance would be, but now it looks like $100 may be where it stops. RIG has many things going for it. The first is their patented deep water drilling technology. Other deep drilling companies have to pay a percentage of revenue if they use the technology on any of their new builds, or any upgraded ship, submersibles or jackups. This technology improves drilling times so much that they gladly pay the percentage of their day rates.

Looking at their last quarter, Transocean is still doing very well. Net income was $3.45 per share as opposed to the same quarter of 2007 where their net income was $2.63 per share. The total net income was $1.107 billion compared to last year's $549 million. Revenues with respect to quarter two of this year were $3.012 billion. Last year the quarterly revenues were $1.434. From the first quarter to the second quarter of this year, revenues were down $8 million. This was due to unplanned days in the shipyard. Even with revenues down, drilling rates were up from the first to second quarter of this year from $229,000 per day to $238,000. The unplanned shipyard days increased expenses and lower revenues.

The influx of shipyard days are not just the fixing of equipment, but it must be remembered that they are selectively upgrading their fleet to make it capable of deeper drilling as this seems to be the way that the world is moving with respect to oil drilling. The deeper out the ship is, the less the negative impact, as occurs with tourism, due to eye sores viewable from the beach.

On July 15th of this year, RIG received a contract totaling 22 years of rig usage. The very large find off the coast of Brazil has caused an increase in demand from PBR. This contract has an estimated $3 billion in revenues over that time period. On July 8th, they also received a contract from Eni. This five year contract is worth an estimated $1.1 billion. On July 2nd, Eni also signed a two year contract for approximately $412 million. Many of these contracts do not start until as late as 2011, showing the demand for their high specification floaters.

RIG has the largest worldwide drill fleet. They have 138 total rigs. The second largest is Noble (NE) with 62, but the majority (44) are jackups. RIG's 39 high specification floaters are the most of any driller, with NE a distant second with 11. RIG has also differentiated itself by moving more into international markets where the dayrates are higher. This not only increases dayrates but the weak dollar also adds to increased compensation. They currently have 14 floaters in the GoM and North America. South America has 8 floaters and 2 jackups. The North Sea has 14 floaters and 7 jackups. The Middle East has 1 floater and 20 jackups. Western Africa has 16 floaters and 13 jackups. There are 6 floaters and 7 jackups in India. Asia has 4 floaters and 16 jackups. Newbuilds are as follows: 7 floaters, 2 JV floaters and one Sedco upgrade.

There are 80 newbuilds currently under construction within the industry. Of these, 74% are contracted. RIG has stated that they will only build rigs that are contracted, and has stuck by this as they want as many working as possible and they do not want to flood the industry as they want day rates to stay high. RIG has also reported that they will have full utilization of their fleet through 2010. They are in contract negotiations for contracts as long as ten years.

As of May 31st of this year, RIG reported a very strong backlog. Looking ahead, 2008's backlog is $7 billion, 2009 has $9 billion, 2010 $6.6 billion, 2011 is $4.6 billion, 2012 is $3.1 billion and 2013-2016 is $3.9 billion for a total of $34.2 billion. Of the 48 rigs in their high specification floater fleet, this year is fully contracted. 2009 is 94% contracted and 2010 is 76% contracted. These ships are the most profitable and will drive revenue going forward (numbers are as of March 31st of this year). Any new information can be found at www.deepwater.com under 'fleet status'.

Looking at dayrates going forward, the calculations rely mainly on new contracts as old ones are already complete. Looking at their fleet status will tell you what the increases will be as they have much of their fleet contracted after 2010. As of August 5th, RIG's estimates for their dayrates are as follows: 3rd quarter of 2008 will be $352,000 a day for high spec floaters, $299,000 for other floaters and $159,000 per day for jackups. By the 2nd quarter of 2009, high spec floaters will garner $388,000 per day, other floaters $340,000 per day and jackups $155,000.

One interesting point with respect to RIG's backlog is how it has increased in the last five months. As of August 5th, RIG announced its backlog per year going forward. 2009's backlog has increased $1 billion to $10 billion. 2010's increased $1.5 billion to $8.1 billion. The expected backlog for 2013-2020 sits at $7.7 billion so far.

An investment in this stock (which I currently own), would be influenced by where you see oil prices going. If you think that oil prices will continue to stay above $60 a barrel (RIG's estimate for their profitability at today's day rates), then it is a good investment. Some of their newer contracts are based on the price of oil, but some of the companies are staying away from this as they are worried they will have to give Transocean a cut as opposed to a flat rate, or a rate based on working days of the rig.

From my standpoint, the price of oil will remain well-above $60 - I believe it will hover somewhere in the triple digits for some time to come. RIG has been penalized with other oil stocks and this should not have happened as they operate under fixed day rates and only need to keep their costs down to increase earnings. They are a well managed company that looks good going forward.

Disclosure: Long RIG

Comments

[Colorado In...:]

My guess is that RIG will take off after the 3Q earnings announcement when management will likely announce a stock buyback and/or dividend. Until then, this stock will likely track with the price of oil. Not right, as the author points out, but the market is the market, and its irrationality is what gives opportunities to those of us who can look ahead and be patient.

2008 Aug 20 10:44 AM

[geaston:]

What an excellent article- articulate and insightful. The stock pullback of RIG, NE and DO is baffling yet understandable. I don't care where we need to go for future energy- the bottom line is that oil will continue to be THE main source throughout the world for at least the next 10 years and these companies are positioned as such to take advantage of it. From a casual investor's standpoint, the $60 per barrel profitablity floor is interesting.

2008 Aug 20 12:41 PM

[InvestorCP:]

The exploration and drilling companies (oil services generally) are the areas that are more insulated from the oil price fluctuations than the producers and integrated operations.

I like RIG and DO, as well as FTO,NFX, and CAM. There would have to be a substantial shift to alternative energy sources on the horizon to get to $60 per barrel. That would almost equate to a collapse in the price considering where we have been - unlikely.

2008 Aug 20 02:24 PM

[Ringo:]

"My guess is that RIG will take off after the 3Q earnings announcement when management will likely announce a stock buyback and/or dividend."

Quite unlikely IMO until a lot more of the debt incurred from the Global SantaFe aquisition is paid down.

2008 Aug 20 04:23 PM

[Colorado In...:]

If you listen to the Q2 earnings conference call (www.earnings.com/compa...), management states that debt has been payed down $1.5B so far this year and that it looked like they could (but not a promise) start returning cash to shareholders this year because of continued decreased debt and continued increased NPV of future contracts.

2008 Aug 20 05:59 PM

[WEBISKING:]

Karen finerman see value and so do many others.selling the puts here is the way to go

2008 Aug 21 12:19 AM

[mad man:]

great articale legmaker ! i also like (RES)
check it out www.madmoneyfund.blogs.../

2008 Aug 21 12:50 PM

[Blue collar...:]

At last....I am overjoyed to find a batch of comments, all of which I can agree with (RIG). Hang on and enjoy the ride.

2008 Aug 21 02:09 PM

[Marc Courtenay:]

Very helpful article and I agree especially with Colorado Investor's comments above as well as Geaston's

2008 Aug 21 03:24 PM