A Reviving Gulf Brings Drilling Opportunities

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Sep 16, 2013
Back in 2010, the Gulf of Mexico and BP PLC ADR (BP) made the news as the Macondo prospect gave proof of the difficulties associated with deep-water drilling. Since then, the region became associated with exhausted opportunities in the eyes of the oil and gas industry. Recent developments, however, seem to bring new life to the region as the BAHA project discovers oil-rich sands. The newly found reserves are said to be worth around $1.5 trillion. Can Seadrill (SDRL, Financial) or Transoncean (RIG, Financial) rip any benefits?

Meeting Safety Standards and Pushing the Bar

Seadrill is the largest drilling company in the oil and gas industry by equipment and market cap ($22 billion). Its operations are concentrated in West Africa, Brazil and the Mexican Gulf. Over the last quarter, performance continued to improve, and George Soros has entered the group of gurus holding stock from this company.

In the short run, Seadrill looks to continue to improve its rigs’ performance by raising the percentage of floaters used. Also, focus will be driven towards securing future projects for the four new ultra-deepwater rigs and jackups, scheduled to be delivered in late 2015. The new findings in the Mexican Gulf offer a great opportunity for its new assets, in one of the most important regions for the company. Additionally, changing regulation in Mexico offers great opportunities for growth.

For the long run, Seadrill has great potential. After the Macondo disaster safety and security measures have been raised, and the company has the newest and most advanced fleet. This characteristic gives the company a very important advantage over the competition when thinking about exploiting opportunities in the Mexican Gulf. More, offshore exploration continues to be an important growth catalysts for international oil companies since land based reserves are controlled by state-owned firms.

Financially, Seadrill is hard to asses. Operating margin stands at almost 40%, while debt doubles revenues. In great part, debt is explained by the issuing of the same in order to pay for the new rigs. I feel this strategy is at least risky especially when cash flow is low. But, I bow to the effort made at updating its fleet to comply with new regulation.

Tainted Reputation and Troubled Future

Transocean is the second largest company in the industry by market cap, but holds the largest fleet in the business. The most recent news had delinked the firm from the oil spill that occurred in 2011 off the coast of Brazil. Although the company was operating the rig in the name of Chevron, the American oil giant will bear the burden. Also, gurus have made a great bid on the company last quarter. Carl Icahn continues to increase his holding in the company, and many others have followed suit.

Today, Transocean has to recover the ground lost to its main competitor, Seadrill. In other words, due to past incidents, security and safety regulations have tightened and the firm has not renewed its fleet. Hence, it holds the largest outdated fleet in the market. Additionally, the company remains very tightly linked to the Deepwater Horizon incident, and its reputation remains tainted. Moreover, Chevron may bear the economical sanction for the Frade incident in Brazil, but it is Transocean’s business reputation that pays the heaviest price.

For the long term, prospects are not very promising for Transocean. Day rates have declined $150 million from a $750 million high, and there are no signs in the market of a reversing trend. In consequence, long-term contracts have been shortened from five to three years, increasing future uncertainty for the firm. To make matters more complicated, Brazil continues with plans to build its own rigs to replacing Transocean. On the up side, the new opportunities in the Mexican Gulf can offer opportunities for growth, but only if rigs are updated to meet new safety and security standards.

Financially, Transocean is troubled. Debt doubles revenue and cash flow, and net income remains very weak. And, in comparison to Seadrill, Transocean’s operating margin is only half. Hence, I do not share the optimism held by Carl Icahn and PRIMECAP Management, because the company navigates a troubled present and lacks future opportunities for growth.

Conclusion

I prefer Seadrill because it has made the necessary updates to avoid further incidents. Also, it finances, although somewhat hard assess seem to be in better shape. At last, my bullish sentiment is backed by the entrance of George Soros to the list of gurus holding shares, and Jim Simons has increased his position.

Disclosure: Vanina Egea holds no position in any of the mentioned stocks.