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Transocean: The deeper they drill the higher their stock will go

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April 09, 2008 – Comments (0) | RELATED TICKERS: RIG

Anyone who has ever read anything that I have written probably knows that I am very bullish on the price of oil long-term.  The much publicized collapse in commodities prices that Barron’s recently predicted has yet to materialize.  As I write this oil is sitting at over $112 per barrel.  Oil is becoming increasingly expensive for a number of reasons, including increased demand from emerging markets like China and India, the fact that there is a finite supply of it, the falling dollar, and most importantly for the purpose of this article because a lot of the low hanging fruit has already been picked.  Not only has a great deal of the easy to get at oil already been used up, but the higher oil prices that we have been seeing simply make going after it in places that were not economically viable in the past possible today.  One such place is deep down on the ocean floor, aka deepwater drilling.  Technically deepwater drilling is defined as any drilling activity that takes place at depths of 4,500 feet or greater.  I believe that deepwater drillers are poised to profit handsomely from the high price of oil that we are currently seeing.

When one talks about deepwater drillers, they have to start with Teansocean (RIG).  Its corporate web site is www.deepwater.com for goodness sake.  Headquartered in the Cayman Islands, Transocean was already the world’s largest offshore driller prior to taking over the number two player in the industry, Global SantaFe back in November.  Now the company is an absolute leviathan, with over 140 rigs, 28 of which are rates as being capable of deepwater drilling.  RIG has another eight deepwater rigs currently being built.  The company has slowly been selling off a number of its shallow water rigs so that it can focus its efforts on the more profitable deepwater drilling segment.  

Just this week the president of Transocean told his audience at the Howard Weil Energy Conference that the demand for deepwater drilling rigs remains strong.  The market for these rigs is so tight that current offshore projects are enough to keep the world’s fleet of existing rigs working straight through the year 2010, and this is without any new projects coming on-line, which will undoubtedly will happen.  The huge Tupi deepwater find off of the coast of Brazil by Petrobras is one of new projects that are expected to launch in the coming years.  As of the fourth quarter of 2007, Transocean had a backlog of nearly $31 billion. 

At the Weil conference, the CEO of the oil services giant Schlumberger stated that there is currently a tight market for drilling rigs, especially deepwater rigs.  This high level of demand for a limited number of deepwater rigs is going to enable Transocean to dramatically increase the dayrates that it charges customers, which have already been rising at a rapid rate.  The company just signed short-term contracts for two of its deepwater rigs for over $600,000 per day and long-term contracts on a couple of them for over $500,000.  It is difficult to say where dayrates will settle short-term, but that contracts for over half a million dollars will become the norm. 

As if the increasing demand for its services was not enough of a reason to like Transocean, it has not even begun to fully realize the potential cost savings from its recent merger with Gobal SantaFe.  RIG expects to achieve an additional $100 to $150 million in cost savings through synergies by the year 2010, half of which may be realized as early as 2009.  In addition to cost savings, the deal provides Teansocean with access to new markets where it previously had no presence, like Saudi Arabia.

In 2007 RIG earned $14.14/share, versus $6.10 in 2006.  This increase is slightly smaller than it initially appears because of a number of asset sales and because it includes a month’s worth of earnings from Global SantaFe.  Nevertheless, the company’s earnings are growing very rapidly.  Its stock currently trades at slightly more than 10 times these earnings.  That’s quite a bargain for the dominant company in an industry that is experiencing such rapid growth.  Until we develop some sort of viable alternative energy source, people are always going to need oil. 

Of course, any investment has risks.  In order for Transocean to capitalize on this trend, the price of oil has to remain high.  A massive global economic slowdown that causes the price of oil to plummet would obviously be bad for any driller, especially for one that focuses on the expensive deepwater end of the market.  Also, RIG’s costs are rising.

Overall the positives for this company far outweigh the negatives.  During the 1970s, the last time that the price of oil rose as rapidly as it is doing today, drillers were among the best performing categories of stocks.  During that decade, on average the stocks of drillers and oil services companies rose at an annualized rate of approximately 30%, vastly outperforming the overall market.  I personally believe that Transocean will soundly outperform the broad market well into the future. 

Deej

Long RIG in CAPS and in real life

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