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Bright Horizons for Deep Sea Drilling?
Posted by: Vanina Egea (IP Logged)
Date: December 13, 2013 09:53AM

It’s not a big secret that oil and gas firms are having to find new drill sites throughout the globe, as more and more wells are drying up. However, with many of the easy-to-reach wells already tapped, where is the future for oil companies such as Transocean Ltd. (RIG)? The answer might very well lie in the ocean’s deep oil reserves. Because oil prices have reached $100 per barrel, and over-drilling in deeper waters has now become a profitable endeavor, Transocean could face a very bright future, as it specializes in deep sea drilling. Also, the construction of five new "high specification Jackups" is a strong sign that the oil drilling firm is preparing itself for a new oil boom, with its own equipment at the front lines of the rush.

New Discoveries, New Potential

Transocean released its findings of deep ocean oil fields, which amounted to a staggering number of 12 billion barrels in new potential reserves. Because of the high demand for oil on a global level, the firm has good chances of making a great profit in the upcoming years. The move away from conventional drilling, towards the new untapped resources, looks particularly promising. And, due to oil prices now exceeding the $100 per barrel mark, these new expeditions are becoming ever more profitable.

Thus, the risks that go along with such operations are becoming increasingly worthwhile, and there will most likely be a large shift to the new deep-water sites. Additionally, the stock enjoys the backing of a major hedge fund the likes of PRIMECAP, which has recently increased its stake in the firm by 71.8% (a total of 11,466,474 shares). Meanwhile, investment guru Joel Greenblatt recently became a Transocean bull, by upping his holdings by more than 720%.

Deep Sea Boom

Many deep sea drilling firms are forecasting high profits in upcoming years. According to Seadrill Ltd. (SDRL), ultra deepwater and ultra deep drilling are the only new sources of oil that can replenish the annual depletion in conventional oil wells. The firm stated that in 2013 new discoveries of roughly 80 billion barrels were made in the ultra deep-water sites. This outshines the 20 billion barrels in deep-water sites, and roughly 10 billion in shelf sites. Thus, oil drilling companies like Transocean and Seadrill are very likely to make a large profit in upcoming years.

Transocean's current financial position is also worth mentioning. The firm currently enjoys a wide operating margin of 17.20%, far more than the industry average. While current returns on invested capital (ROIC) are at 7.6%, a moderate albeit solid number, shareholders must take recent spikes in debt levels into account. Transocean’s debt levels have put pressure on margins, yet the acquisition of debt was also necessary for new investments, such as the five new deep-water platforms being constructed. Lower ROIC and higher risk due to debt, have ultimately led the stock to be trading at 10.9 times its trailing earnings, leading to a price discount of 18.6%. This indicates that it might be a good time for entry, since the company is trading below the industry average, while offering solid growth opportunities.

Investing in the Future

Because of the need for future oil sources, and the high oil prices that are enabling more risky and expensive extraction methods, it is a good bet that Transocean will fare well in coming years. My bullish stance towards the stock stems from the company’s long term potential and their new investments in deep-water drilling equipment, along with the current price which makes entry feasible.

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

Stocks Discussed: RIG, SDRL,
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