Seadrill: In-Demand Service Means Large Dividend Should Be Sustainable

| About: Seadrill Limited (SDRL)
This article is now exclusive for PRO subscribers.

Gas production in the US from unconventional shale fields has soared, reaching record levels in early 2012. Although a slowdown in gas-directed drilling this year may dampen production, accelerating activity in oil and liquids-rich plays such as the Eagle Ford Shale in South Texas will offset any decline.

Rising demand for natural gas in the power sector won't be sufficient to absorb excess supply. The equation won't change meaningfully until the latter half of this decade, when the nation should begin to export liquefied natural gas in earnest.

The outlook for crude oil and natural gas liquids (NGL), a group of heavier hydrocarbons that includes ethane, propane and butane, is far more sanguine.

Global oil demand in 2012 should eclipse 90 million barrels per day, a record high. US oil demand has remained fairly steady after recovering from the financial crisis and Great Recession; emerging markets such as China continue to drive global oil consumption. At the same time, non- OPEC supply is growing at a far slower pace, forcing Saudi Arabia to dip into its precious spare capacity.

The ongoing shale oil and gas revolution has led to a surge in NGL production. Nevertheless, this market has avoided the supply overhang that will continue to plague natural gas. US propane exports have reached record levels, while the abundance of ethane-a critical component in many plastics-has prompted domestic petrochemical operations to add capacity.

These developments on the demand side have ensured that NGL prices have remained relatively resilient. (See "Oiled Up, Gassed Out.")

Exploration and production in deepwater and other harsh environments-the final frontier for major oil finds-has continued apace. Between 2008 and 2010, operators announced an annual average of 23 discoveries in water depths of at least 4,500 feet, compared to 16 in 2002- 04 and four in 1996-98.

The three main areas of deepwater development-the Deepwater Golden Triangle-are offshore Brazil, the Gulf of Mexico and West Africa. Producers have announced a number of significant discoveries over the past 12 months, including major finds offshore Africa's east coast.

In late April 2012, Seadrill (NYSE:SDRL) announced that it secured a three-year fixture for one of its deepwater semi-submersible rigs for a potential day-rate of almost $650,000. The contract begins in the second quarter of 2013, and the rig will operate offshore West Africa.

Day-rates earned by deepwater rigs eclipsed $600,000 when deepwater exploration peaked in 2008. The willingness of producers to pay up to secure rigs in 2013 suggests that the supply-demand balance remains tight and the existing fleet can't handle all of the impending deepwater work.

With one of the highest-quality fleets in the business and a dividend yield of almost 9 percent, Seadrill offers a good mix of income and growth potential.

Disclosure: I am long SDRL.