Deepwater Drillers Offer Deep Value

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With easier drilling sources reaching their maturity and tapping out, oil companies are forced to drill much deeper for new supplies. Enter the deepwater drillers. These are the companies that lease rigs to the big oil names that need to drill at the most extreme depths of the ocean, a very specific and expensive task. Fundamentally, the economic landscape of the major deepwater drillers looks solid, and these companies should benefit from the robust, long-term demand for oil.

Oil companies are forward-looking by nature. So while oil prices continue to display high levels of volatility, deepwater exploration companies are not deterred. For decades, worldwide oil consumption has risen by 1% to 2% a year, and this growth will not abate now that emerging economies are consuming more and more of the commodity. China, with four times the population of the U.S., only consumes one-third the volume of oil that the U.S. consumes on a daily basis.

As exploration activities focus on more remote and costly drilling locations, owners of deepwater and ultra-deepwater rigs find themselves in a sweet spot. The rigs are designed to drill at ocean depths of over 4,500 feet (deepwater) and over 7,500 feet (ultra-deepwater). They are prized among the biggest oil companies that realize that the days of drilling shallow oil wells are waning and that vast supplies of the slick stuff are to be found at the nethermost regions beneath the ocean floor.

Oil companies continue to lock in expensive long-term contracts for deepwater drilling rigs, and odds are very slim that they will simply walk away from these multibillion-dollar investments.

When oil prices were cheaper than they are today, producers were locking in contracts to lease deepwater rigs for as much as $600,000 a day. It takes years to build a deepwater rig, and oil companies are eager to have them to further their exploration activities. New rigs are expected to fetch nearly $1 million a day upon arrival. At costs ranging from $300 million to $400 million, the return on investment (ROI) can be lucrative as typical contracts are for two to four years. Demand is high, and supply is tight. Brazilian oil giant Petrobras (PBR) has snapped up the leases of many of the deepest-drilling rigs in anticipation of its newest and potentially massive offshore oil discovery.