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Is Now the Time to Get in Too Deep?
Oil companies are probing deeper and deeper waters in search of monetary gains. Deepwater drilling is oil and gas exploration far from the coastline in the ocean’s depths. Investment in deepwater capital expenditures total billions of dollars; it would seem that oil companies see vast profit potential in drilling the ocean’s depths. Meanwhile, many of the companies mentioned in this article that will be supplying the equipment and services for this deep drilling have experienced share price declines of late, and the equities are now trading closer to the low end of their 52-week ranges. Will the future fruits of deepwater drilling reward the long-term investor for taking the plunge into these volatile equities at today’s entry points? A cursory look at these company’s operations could provide better insight into this promising trend.
Drilling at great depths is done mostly with either rigs or drillships that are especially suited for the purpose. (Jackups, named so because they can stand on the ocean floor, are unattractive at deepwater depths.) Regarding deepwater units, the current leader with 43 (as of its April fleet report) is Transocean (RIG). Among these units are semi-submersible rigs, which remain in place thanks to anchor chains. (Notably, Transocean continues to navigate through the fallout caused by the semi-submersible Deepwater Horizon oil spill in the Gulf of Mexico, a spill that sparked a ban on offshore drilling in the area.) Other notable players include Ensco (ESV), with 19 deepwater units, and Seadrill (SRDL) with 24.
Regarding ships that drill in deep waters, companies like Transocean, Noble Corporation (NE), and Rowan Companies (RDC) are making big capital expenditures to get ultra-deepwater drillships online. For example, according to recent reports, Noble has five under construction, Rowan has three, and Transocean has two. Besides the aforementioned newcomers, Ensco is already in the game with five ultra-deepwater drillships and a sixth is on its way, while Seadrill has four, with an additional six on the way. Most of these new builds are being constructed by ship-making stalwarts, Korean chaebol affiliates Samsung (the world leader) and Hyundai Heavy Industries.
While the new builds show some enthusiasm on the part of oil companies, there are still a lot of risks (including political and economic) to consider when it comes to investing in the oil service and equipment stocks mentioned above. Specifically, investors should be aware of the company’s operating environments, including the counterparties and regional politics involved.
Along with the Gulf of Mexico, some of the biggest reserves of deepwater oil are off the coasts of Brazil and Western Africa (these three geographical area form the so-called “Golden Triangle”). Angola, in Western Africa, for example, is one of China’s biggest suppliers of oil and ended a destructive civil war in 2002.
According to sources, spending from Brazilian energy giant Petrobras (PBR) is expected to constitute about a quarter of the deepwater and ultra-deepwater capital expenditures. Petrobras is the largest company in Latin America by market capitalization, after going public and raising about $70 billion in 2010. This being a capital-intensive business, Petrobras and the more familiar Western so-called “supermajors” Chevron (CVX - Free Chevron Stock Report), Total (TOT), Shell (RDS/A), BP PLC (BP) and ExxonMobil (XOM - Free ExxonMobil Stock Report), should make up the majority of the spending here. A number of other exploration companies, like Noble Energy (NBL) or Russia’s state energy giant Gazprom, for example, will likely be involved, as well.
The biggest single determinate for these companies success is the oft-volatile price of oil. The higher the price of oil, the more marginal projects will be undertaken, and the more profits for oil companies. In a way, an investment in one of these companies is also a gamble on the price of the black stuff. It seems that, as oil is a limited resource, however, its price should trend up with time, increasing the economic incentive to undertake new and deeper projects.
Right now, oil companies are ratcheting up capital expenditures in anticipation of big profits from deepwater drilling. For more information, and for the particular investment merits of the stocks mentioned in this article, subscribers are advised to monitor our regular quarterly coverage in The Value Line Investment Survey, while keeping an eye out for Supplementary Reports when breaking news takes place.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.