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Offshore Drillers


dcollon
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Have any of you taken a look at the offshore drillers? 

 

We have been following ESV, DO & NE closely for a while.  DO has mostly been an interest because of our ownership in L.  However, due to the significant decline in prices (for a potentially good reason) we have spent the better part of the last week working on all of them in greater detail.

 

I would appreciate any thoughts, especially from some that might have industry specific knowledge.

 

 

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I have owned Ensco for 2 years and have lost money on it (mainly due to my love of options / leaps). It remains mines, and Robert Rodriguez highest conviction pick. It reminds me of ATSG, I have lost money on it for years but feel that now is the sweet spot. I also work in oil field services (not the drillers).

 

Buying today has a bit of a political bet factor. The US has placed a moratorium on offshore drilling and the stocks will flounder till that is lifted. My guess is the Gulf is given the green light with higher safety requirements, but we dont get much of an expansion anywhere else except for perhaps some shallow water. The risk is that they ban deep water outright, but I dont see that happening (the gulf is already wrecked and we need oil).

 

Here is an interesting article from James Altucher (there is a video) - http://finance.yahoo.com/tech-ticker/article/495818/Sad-Truth%3A-We-Need-Oil-Drillers-%22More-Than-They-Need-Us%2C%22-James-Altucher-Says

 

I think Ensco and Diamond are the best run in the space and all have been hit hard by the Horizon ordeal. Ensco is trading at 4x cash flow and has the best safety record, a great / growing fleet, and $1 billion in cash. I thought with the top kill working that the stocks would move up so I rushed to buy today.

 

I sold my $60 Ensco options to harvest tax losses and bought the $35 leaps. Ensco is also trying to buy Scorpion which appears to be a great move. I wanted to buy before all of this was factored, so I bought today. It could go down more, but at 4x cash flow ... I noticed DO hit its 52 week low and I am hoping Loews is buying more, this would be a great use of their excess cash. I may buy DO but have a full position with Ensco and am building one on Loews. I have attached my write up (its not very good), and would highly recommend checking out slides on Ensco and Scorpion. They have excellent presentations for each of them on the Website. The Scorpion one highlights how old the current Jackup fleet is worldwide and also shows that premium fleets are rewarded with long term contracts and higher day rates. One of the fallout from this disaster is an emphasis on newer better equipment.

 

If Ensco can still Scorpion away from Seadrill at a decent price then things could really get interesting.

 

Most importantly what are your thoughts? I have been in Ensco since $70. I feel that 10 - 15x CF is the right multiple and never thought we would see 4x. I may be a bit over attached to it. This is a very interesting topic seeing that I bought today. I have a fairly decent size cash position and am a bit annoyed by the rally. The most hated stocks right now are the offshore drillers.

 

Here are the presentations - http://www.scorpionoffshore.com/investor/pdf/01.10.08.pdf

http://www.scorpionoffshore.com/investor/pdf/01.10.08.pdf

 

I really like Scorpion and hope they dont overpay. I also hope they are buying back stock at this point. Ensco in my opinion is the easiest to understand, best operators, and best value. Diamond has the best record on capital allocation (maybe due to Loews).

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We did a surface look at offshore vs onshore drilling, re future (1-2 yr) flow of drilling $.

 

Its very dependant on location, sovereign/culture, & age of field. The Yellow Sea/West Africa is very different to the North Sea & very different again to the Grand Banks/Arctic. Where practice is well established (the vast majority of drilling) we expect continued drilling, but with additional costs (upgraded BOP's, more testing & standby requirements, additional graft, etc). The frontier stuff is effectively dead.

 

We expect cancellation costs to essentially wash. Operators cutting day rates on their SP rigs to keep them working, more/easier holes being drilled in shallower waters to use up the remaining 2010/11 budget, & a 5-10% difference going to land drilling. 2011/12 is the watershed.

 

Medium-term (3-5 yrs) we see the frontier $ shifting to Oil Sands/Coal Research, and an industry rethink/upgrade of existing technology.

 

SD

 

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Myth,

 

Thanks for sharing all of your thoughts.  There are a few things that we are thinking about:

 

1. Valuations

2. Political issues

3. Diversity of revenue

4. Mix of deep water v. shallow

5. Age of fleet

6. Balance sheet

7. Buyback history

8. Margins

9. Business relationships

 

I think by my previous post you can see that we are focusing on the companies with the best balance sheets.  I also like the fact that a few in particular have used their cash to repurchase shares and currently have open repurchases.  Our hope is that management teams are using the weakness to retire some shares.

 

We have attempted to run multiple scenarios based on margins and loss of business.  We are not of the opinion that business globally will be significantly impaired, but realize with excess product, margins could continue to be under pressure.  Thinking in these terms we are still working on our range of estimates for fair value.  It's most likely a situation where they will all recover similarly if and when there is more "certainty" (I always laugh at that word).

 

This will give us some more work to do over the holiday weekend. 

 

Thanks again for sharing your thoughts.

 

 

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Ensco has been very shrewed but was buying back shares at a high price and then stopped during the financial crisis. I didnt like it but cant fault them. They have upped the dividend and resumed buybacks. I dont know what they are doing now but they could use cash to take out 20% of their shares at this price. They also basically have no debt.

 

I now also know why the drillers fell today and why PDS and the land drillers rallied. Obama has formalized and extended the driller ban to 6 months. Day rates will be cut and things could get very interesting. It should be very interesting to watch this all unfold. I missed the boat a bit on PDS but will be buying soon, I thought I had more time with this one.

 

If I was buying more I would focus on Loews/DO and Ensco. Ensco is overcapitalized and is looking for uses of the cash, hopefully they are buying shares, and are definitely looking into M&A. I also like that they didnt want to overpay for Scorpion. Ensco has stressed that they have some of the lowest costs (great designs, and no debt) and can run their fleet at much lower prices then some of the new entrenches to the market.

 

Now deep water drillers are getting day rates which may not cover interest, and may be faced with cancellations due to the ban. There are a few companies like Scorpion with 2-3 Deep Water rigs and tons of debt, imagine if these rigs are all drilling in the US. I also would imagine that jackup rates will also fall further straining things. Ensco and DO (via Loews) are awash with cash and looking to spend. Sounds like a perfect storm, we could have 6 months of acquisitions and buyouts then a flood of new projects in 6 months.

 

From my past investment in Loews, I know they dream about these types of situations and this is how Diamond Offshore was built. Interesting times. 

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Relatedly, I think there might be some opportunities on the shipping side instead of drilling. At these prices, Tidewater (TDW) looks pretty cheap, they have a great balance sheet, international operations to offset from the gulf moratorium, and a good history of capital allocation. Over the last decade they have refashioned some of their oil shipping vessels and resold to other acquirers.

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You might find the following algorithm usefull:

 

[(((Geology x Tech x Proven Reserve)/Collection )-1)+1)^N  x (market price/break-even price)]/PV(COD) = >1.0. Geology is your knowledge of the oil traps characteristics, pressure, porosity, etc. Tech is the reliability & availability of existing technology that can exploit the oil trap. Proven reserve is the total amount of oil that you can actually extract. Collection is the amount of proven reserve you can extract from the trap & deliver to market every year. N is the expected extraction life of the proven reserve. Market price is today’s commodity price. Break-even price is the minimum commodity price you need to make the project viable. PV(COD) is the present value of the future cost of developing the field & bringing the oil to market.

 

Technology is the primary multiplier; until you punch holes into the target zone with successful results, you can’t prove that you have either the geology or an economic reserve. If you’re near an existing collection system that you can tie into, your break-even price & COD drops rapidly. Same thing if you can drill multiple wells from the same central platform. And what you cannot do today you may well be able to do 10 years from now; extract more from an existing field, drill deeper, etc.

 

Market price is only a secondary multiplier. The more above break-even it is, the more $ you can invest in collection; to sell more product into the market, & in additional drilling to increase total extraction.

 

Notable is that if you just buy someone else, the primary risk is market price; the average price/bbl for the proven reserve is enough to pay for acquisition, extraction, & the required return. It can be easily hedged, & most technology advances work in your favour. The deep sea wild-cat is effectively the opposite extreme, & an all or nothing bet. Screw up, & the tendency is to reinvest the high cost of these wells in the least risky alternative.

 

SD

 

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Looks like there was a mini "flash crash" again today around 2pm for drillers, or just a weird coincidence. I'm looking at day charts for ESV, ATW, RDC, HAWK, HERO, PTEN, etc. Just an interesting observation.

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The good news is that it's in only 500ft of water (more available options). The bad news is that if it is leaking, & they can't stop it quickly, the current moratorium may well extend to shallow water drilling as well. The wildcard is that the damage goes back to 2004; has it been leaking since then & authorities have allowed it to continue? or is the alleged leak something new that's just started?

 

Should evidence surface that leak correction is being systematically deferred/ignored, an offshore shut-down is virtually guaranteed.

 

SD   

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I think short term this will add fuel to a raging fire. Thankfully as you said its in shallow water.

 

----

 

Call me crazy but long term I think this will be slightly positive for the industry. I think the suppliers will sell new equipment, and the Drillers will have margins squeezed by insurance costs, new equipment costs, more inspections but will pass some of this on to their customers. The big upside for drillers is a change which could require the drilling of a relief well at the same time. Senator Kerry spoke about it on Charlie Rose, and it seems to have a small chance of being included in plans. That should require 2 rigs. It would pull down returns and would require a higher oil price but, would workout well for drillers once prices exceed the hurdle rates.

 

It will be interesting to see what the shallow water requirements look like in a few days.

 

----

 

Looks like your fears were right. This things been leaking since 2004. Really did a number for Diamond. 4x average volume. I wonder if they are buying back shares at this point.

 

http://www.latimes.com/business/nationworld/wire/sns-ap-apfn-us-oil-obama,0,5467547.story

 

There was also a report that another rig was leaking oil into the Gulf. Taylor Energy, which owns that rig, said it has been leaking since 2004 when it was hit by Hurricane Ivan and a pipeline broke. Taylor says repair work has been going on ever since and a dispersant ship has been handling the leak.

 

------

 

Here is another update. Doesnt look so bad for Diamond based on this.

 

http://www.businessweek.com/news/2010-06-08/diamond-offshore-falls-after-report-of-gulf-oil-leak-update2-.html

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Well I'm now a happy shareholder of ESV, but to me, it sounds like I am more speculating then investing. Oil driller are out of my circle of competence and I don't feel comfortable holding it.  I'm looking for some good reading material to train me in regards to oil and gas drilling investing. I basically want to be able to transform a good speculation into an informed investment (I know I'm doing it in the reverse order...)

 

Here was my thesis for speculating in ESV.

 

Pros

-There is a great confidence crisis in the US in regards to oil driller

-The market are behaving like a chicken without a head, selling anything that has oil in it.

-The golf of mexico is not the center of the oil universe. If regulation strengthen in the US it will not affect other regions immediately.

-The oil and gas industry has always been able to pass the costs to the upper level in a medium term

-The oil drillers do an extremely vital part for the society. I don't see the US banning offshore drilling and killing their economy for the next century.

-I don't see any long term impairment to the oil drillers

-This can be considered as a Net-Net ala David Winters

-Solid balance sheet, it can whistand low oil prices for the next 10 years and still be business

-Their rig are the most secure in the industry

-Will be a great FCF generator in the next few year provided oil prices stay flat or up

 

Cons

-Profits are prone to market fluctutations

-Past lucrative oil contract are being replaced by lower margin contracts

-Subject to greater scrutiny by the authorities for the next months

 

I have no way of knowing the future prices of oil or what exactly will be the impact of the renegociating of their deals (they can reduce income by 30% and still generate some money) but I believe those unknown were fully taken into account by Mr.Market before the explosion. With all those facts taken into account I had to buy.

 

Now if someone could recommend me some reading material to bring me up to speed with oil drilling that would be great...

 

BeerBaron

 

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Thanks for the lead on offshore drillers. 

 

Doing a quick screen search of the industry it appears this sector is cheap following the Gulf oil spill.  Particularly some names already mentioned in the above post (ESV, DO, NE).

 

The stock screener does show one really cheap company Sea Hawk. 

 

Market Value:  $122 million

 

Cash:  $73 m

T current Assets: $139 m

T Current liab:  $103 m

 

Working capital:  $36 m

 

 

No long term

 

BV:  $434 M

 

 

Inc loss $-22 m

 

 

 

 

 

Sea Hawk looks relatively cheap on the balance sheet side from my really quick glance.  I’ll definitely have to do more homework on the stocks listed above.

 

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Here is a good writeup for Seahawk. There is also a good short writeup for Seahawk on VIC - http://seekingalpha.com/article/208222-seahawk-drilling-facing-a-perfect-storm-which-is-why-i-like-it

 

I think Seahawk is a bet on the industry recovering. I think their and HERO's rigs will be the last ones back to work due to age and technology.

 

---

 

I like drilling because its a play on oil, but you have some protection due to the long term contracts and backlog. The higher quality deepwater / high spec jackup drillers typically have pretty hefty backlog which protects you a bit when prices drop. I think you have the pros and cons for ESV and the industry properly setup.

 

As for further research, I recommend listening to a few of the Conference calls and investor presentations for Ensco. They are a bit repetitive but really give you a good gauge on the industry. Ensco has great margins and probably has one of the lowest break-even costs due to the lack of debt. I also like to look at the monthly rig status reports to get an idea of what the trend looks like. Ensco also makes most of their money abroad which helps.

 

Rig Status - http://www.enscous.com/default.aspx?id=55

Presentations - http://www.enscointernational.com/default.aspx?id=139

 

The big question is what do they do with that cash, especially considering the weakness with the drillers. The way you are thinking about the industry is basically what the Tisches said they thought during the downturn when they acquired the DO assets. They had an investor presentation and will probably also be making some interesting moves during this period.

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Scan some of the european/asian industry magazines. Who are the major investment funds/drillers in the various global fields, who/where does their stock trade, & what are the dominant economics in those locations. If an offshore drilling $ were diverted from the US; where would it likely go ? & how would it show up there ?

 

The underlying premise is that asian operators (CNOC, etc) operating in less regulated areas will be the major beneficiary, & that european/middle eastern players are in a better position to move $ than US players. The investment is probably via a fund (ETF, ADR, etc) not trading on the US exchanges, BP is a dominantly weighting, & there's sovereign backing.

 

You might find Shanghai, Singapore, Dubai/Abu-Dhabi etc. particularly interesting  ;)

 

SD

 

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Here is a good site for actual research.

 

http://www.rigzone.com/

 

They explain alot of the industry jargon (Cold Stacked, Warm Stacked, Ready Stacked, ect. ) and give you a good idea of what rig count numbers look like, where the major rigs are, and who the major drillers are. You can also get utilization by rigs and day rate information. Very useful if you like the detail side of things.

 

http://www.rigzone.com/data/utilization_trends.asp

 

http://www.rigzone.com/data/dayrates/

 

http://www.rigzone.com/data/rig_report.asp?rpt=op

 

Let me know if you find anything really useful.

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  • 2 weeks later...
  • 3 weeks later...

I sold ESV 2 weeks ago, I bought at 35$ and figured I could learn the business. The more I searched, the more I realized this was not in my circle of competence and that it would take me months before I could understand the supply/demand and all the complications of the business. For example, buying an offshore driller at 0.9 BV seemed cheap but by looking at some 1992 reports I could see that it was about 0.5 BV even less. The cycles seemed long too, so I could have bought at the middle of a falling wave, etc...

 

Still made a nice little profit, it is really not my style to hold a stock for 2 weeks but I would hate to lose money by buying at the end of a cycle.

 

BeerBaron

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That may have been a prudent move actually. The spill has changed the nature of the debate and you are correct we are at the tail end of a roaring cycle. Its similar to Shipping. Do we have a big crash with massive declines in utilization and tons of scrapping or a long u shaped recovery where excess capacity is absorbed overtime?

 

My guess is these guys are firmly tied to oil prices but will a bit of protection against volatility due to the longer term nature of the contracts. If oil hangs around $75 we get a U. If oil spikes to $100 we get a V, and if oil drops to $40 we get a W. Deep water, and tar sands have to be where the marginal production is and they will likely be the first to cut and have the highest break-even.

 

Oil will go up in the long run due to peak oil, but in the short run its a slave to the world economy. The drillers minus the bounce they will have once the spill passes are a call option on either the world muddling through or rebounds.  

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