In Part I of this series, I established that the energy sector appeared attractively priced relative to the other sectors and that oil & gas related companies had favourable long-term prospects. Within this article, I plan to outline what type of drilling environments have the best long-term prospects and which companies are best positioned to take advantage of those prospects.
The drilling process begins when contractors lease their rigs to Exploration & Production (E&P) companies. The contract drilling service market is described by dayrates, utilization and fleet size:
- Dayrate is the daily price to lease a rig and it generally includes the use of the rig and crew; it does not include the drill stem or consumables used to create the well (ie. drill bits, drill fluids, casing, completion equipment are exclusive).
- Utilization is the ratio of rigs currently contracted compared to those available for lease.
- Fleet size is the number of rigs available in a given geographical region or for a particular drilling contractor.
As regional demand meets available supply, dayrates tend to rise. Demand for drilling is driven by the capital spending patterns of E&P companies, which in turn, is based on operator’s expectations of future oil and gas prices.
As described in Part I, the long-term demand for oil & gas looks strong, but it is the regions & environments that will dictate the long-term prospects of the various drilling contractors. Industry trends suggest the biggest growth opportunities are in:
- Hard to reach, ultra deepwater offshore markets.
- Onshore unconventional (ie. shale) plays.
These are two very different working environments, so for purposes of this article, we will focus on the offshore market.
Let’s start by defining offshore rig types. Although there are other types, offshore drilling is dominated by 4 rig types:
- Drill ships: Along with Semi-submersibles, drill ships float on the water while drilling. Drill ships are typically employed in deep and ultra-deep waters. Modern drillships are capable of drilling in waters up to 12,000 ft (>3,500 m) deep.
- Semi-submersibles: Typically chosen for their stability, semisubs being built today are capable of drilling in waters up to 10,000 ft (> 3,000 m) deep.
- Jack-ups: Resting on the seafloor, modern jack-ups are capable of drilling in waters up to 400 ft (~120 m).
- Platform rigs: Placed beside the production platform, rig up and rig down of platform rigs is much more time consuming and they often remain with the platform long-term.
The following table (courtesy of Rigzone) shows the breakdown of offshore rig utilization by region:
From the table above, we see that Brazil’s deepwater market is experiencing the highest rig utilization rate at over 95%. To further drill down (pun intended), we can look at utilization by rig type (again, courtesy of Rigzone):
At first glance, the data from this table appears contradictory to my prior claim of high demand for deepwater rigs; however, the data above from Rigzone includes rigs currently under construction. Breaking down rigs under construction and subsequent utilization rates, you get the following::
- Drillship utilization rate is 99%. 68 new rigs being built (+40%).
- Semi-sub utilization rate is 90%. 28 new rigs being built (+11%).
- Jack-up utilization rate is 93%. 123 new rigs being built (+19%).
- Platform rig utilization rate is 94%. 0 new rigs being built (+0%).
The new build percentages are telling. The market is demanding deeper reaching drillships and to a lesser extent, higher specification jack-ups. But, what are the dayrates telling us (again, courtesy of RigZone):
As you might expect, it is the rigs capable of drilling in the deepest waters that are fetching the highest rates. So which offshore rig contractors are best positioned to take advantage of the trend? Let’s take a closer look.
There are nearly 1,500 offshore drilling rigs in existence with more than 180 companies owning at least one rig. The 30 largest rig contractors and national oil companies own more than 1,100 (or 78%) of those rigs. If you divide the top 30 into categories, the publicly traded companies with the most attractive mix of rig types include the following:
| Size Rank | Rig Manager Company | Ticker | Drillships | Jack-ups | Semi- submersibles | Total |
| 1 | Transocean Ltd. | RIG | 31 | 17 | 50 | 98 |
| 2 | Noble Drilling | NE | 14 | 49 | 14 | 77 |
| 3 | ENSCO | ESV | 10 | 45 | 19 | 74 |
| 5 | Seadrill Ltd | SDRL | 17 | 29 | 14 | 60 |
| 7 | Diamond Offshore | DO | 5 | 7 | 33 | 45 |
| 11 | Maersk Drilling | AMKAF | 4 | 16 | 5 | 25 |
| 21 | Atwood Oceanics | ATW | 4 | 5 | 6 | 15 |
| 29 | Ocean Rig Asa | ORIG | 9 | 0 | 2 | 11 |
| All | Total | N/A | 94 | 168 | 143 | 405 |
Now that we have a workable list of potential companies with favourable long-term prospects, what about profitability and valuation?
| Size Rnk | Offshore Drilling Contractor | Ticker | ROE% TTM | ROC% TTM | P/E TTM | EV/EBIT TTM | EV/EBITDA TTM |
| 1 | Transocean Ltd. | RIG | 5.6 | 7.4 | 10.2 | 9.5 | 6.8 |
| 2 | Noble Drilling | NE | 8.4 | 7.0 | 9.6 | 11.2 | 6.7 |
| 3 | ENSCO | ESV | 11.3 | 12.2 | 8.1 | 9.0 | 6.9 |
| 5 | Seadrill Ltd | SDRL | 12.3 | 65.5 | 7.0 | 12.8 | 7.2 |
| 7 | Diamond Offshore | DO | 8.0 | 13.4 | 11.0 | 8.1 | 6.0 |
| 11 | Maersk Drilling | AMKAF | 11.2 | 19.9 | 8.2 | 7.8 | 4.4 |
| 21 | Atwood Oceanics | ATW | 14.5 | 10.9 | 8.4 | 10.1 | 8.1 |
| 29 | Ocean Rig Asa | ORIG | 5.3 | 6.2 | 35.1 | 17.9 | 12.4 |
| All | Median | N/A | 9.8 | 11.6 | 9.0 | 9.8 | 6.9 |
Based on the table above, I would eliminate RIG, NE, DO and ORIG based on ROE. For the purposes of analysing drilling contractors, I would also need to eliminate Maersk because while it looks potentially attractive, Maersk is a conglomerate mostly known for shipping. That leaves us with 3 potentially attractive options in ESV, SDRL and ATW.
That’s where I’ll end today, but in future articles, I will analyze the stocks in greater detail.
To view Part I, follow the link below:
http://www.gurufocus.com/news/251316
Disclosure
At the time of writing, I do not own positions in any of the companies discussed.
