From Standard & Poor's Equity Research
With oil prices hitting new highs and natural-gas prices staying at historically lofty levels, oil and gas producers, faced with declining output from mature fields, are ramping up capital spending to replace reserves.
On Apr. 20, crude oil delivery for May fell 22 cents, to $71.95 a barrel, on the New York Mercantile Exchange after reaching a new record closing high of $72.17 on the previous day. Natural gas traded at about $8.06 per million British thermal units (MMBtu) -- a bit below the $8.65 average for 2005, but significantly higher than the $4.27 level achieved in the last cycle peak in 2001.
In order to produce oil and gas, the companies need drilling rigs. Oil and gas producers don't own them, so they contract with the companies that do. And with so many producers interested in drilling right now, there's a scarcity of equipment. That has led to record-setting increases in the rates the offshore drillers, such as ENSCO International, GlobalSantaFe, Noble Corp., and Transocean, can charge each day.
RIG SHORTAGE. Oil and gas producers "are facing production declines from their existing wells and need to increase production to meet global demand," says Stewart Glickman, senior industry analyst at Standard & Poor's Equity Research. "One way of increasing production is to construct new wells in reservoirs believed to contain crude oil and natural gas, which is where the offshore drillers come in."
According to industry researcher ODS-Petrodata, effective rig utilization (the percentage of actively marketed rigs which are currently earning a day rate) was recently at 98.0% in West Africa, 100% in the Middle East, and 100% in the North Sea. Baker Hughes (BHI), which tracks the worldwide rig count for the oil-services industry, reported the number of rigs at work in March was 3,069, an increase of 452 from a year ago.
Day rates have skyrocketed, partly because of a scarcity of available rigs for hire. According to ODS-Petrodata, in November, 2005, the leading-edge day rate for a jackup rig in West Africa (rated for drilling in water depths of 250 feet to 300 feet) was $92,500 per day. By March, 2006, however, the day rate for this class of rig had jumped to more than $135,000 per day.
FRONTIER REGIONS. Similarly, day rates for heavy-duty jackups in the North Sea rose to about $243,000 per day from $171,000 per day in the same period. Leading-edge day rates for deepwater floaters (capable of drilling in water depths in excess of 5,000 feet) rose to about $400,000 per day, from $345,000 per day in November. The integrated supermajor oil outfits are focusing their attention on long-term, lower-cost projects overseas and divesting mature, higher-cost assets in North America, Glickman said.
West Africa and the Middle East are considered "frontier regions, where the potential for big offshore finds is higher," Glickman says. "The North Sea is a more mature market, but it has undergone a renaissance over the last year or so," he added.
One beneficiary is ENSCO International (ESV), a Dallas-based driller with about a third of its fleet in those three regions. Glickman expects ENSCO's fleet to be almost 100% utilized in the regions in 2006 and predicts further gains in rig rates.
GSF RISING. In S&P's view, ENSCO's revenue should increase 43% in 2006 and 22% in 2007. Earnings per share are expected to rise to $3.98 in 2006 and $5.27 in 2007, from $1.86 in 2005. Glickman expects earnings per share of 83 cents when the company reports its quarterly results on Apr. 25. The shares are ranked 4-STARS (buy) by S&P.
Another beneficiary should be GlobalSantaFe (GSF), a Houston-based offshore driller. The company signed a six-month contract for a jackup rig with a rated water depth of 270 feet for $120,000 per day in January, then a record for that class of rig in the Gulf of Mexico. Glickman estimates day rates will average $122,000 in 2006 on utilization of 96%. He also sees revenue growth of 40% and operating margins of 39% to 40%.
"We look for a continued uptick in fundamentals for GSF's jackups in 2006, especially in Northwest Europe, West Africa, and the Middle East, where nearly 45% of GSF's rigs operate and should be the beneficiaries of rising demand," he says. He estimates that the company has about 45% of its total operating days for 2007 uncommitted, which should yield opportunities for further day-rate gains.
Glickman expects earnings of $4.38 per share in 2006, and $7.47 in 2007. In 2005, GlobalSantaFe earned $1.73 a share. S&P expects the company to report quarterly per-share earnings of 69 cents on May 3. He rates the stock 4-STARS.
IMPROVING MARGINS. Noble (NE), a Sugar Land (Tex.)-based offshore driller, is another potential beneficiary. Noble, which S&P expects to report first-quarter financial results of $1.15 per share on Apr. 20, should post a 51% increase in revenue in 2006, according to Glickman's estimates.
"Although we expect domestic revenue growth to outpace international revenue growth this year, we still see international drilling comprising 65% of total 2006 revenues," Glickman says of Noble. "The market for jackups in several international markets -- notably the North Sea, the Middle East, and West Africa -- is projected to tighten, which should buoy day rates in these regions."
S&P expects Noble's operating margins to improve to 45% in 2006, from 28% last year. Glickman also foresees further margin expansion in 2007 and revenue growth of 22%. Per-share earnings, according to his estimates, should increase to $5.87 in 2006 and $8.45 in 2007, from $2.16 in 2005. Glickman has a 5-STARS (strong buy) ranking on the stock.
DEEP DIVER. Transocean (RIG), based in Houston, is the industry's largest contract driller and is expected to benefit from strong demand for its deepwater rigs. S&P expects the company to report quarterly earnings of 61 cents per share on May 4.
"The Northwest Europe, West Africa, and Southeast Asia markets have been improving, and could see rig shortages later in the year," Glickman says. "With deepwater rigs almost fully utilized, the mid-water market is enjoying a resurgence in utilization, and we project this market will continue its recent upward momentum in 2006."
Glickman expects Transocean's day rates to average $143,000 in 2006, a 30% improvement from 2005. He also sees revenue growth of 37% this year; operating margins of 40% -- up from 23% in 2005; and earnings per share of $3.80 -- up from $2.13 last year. He rates the stock 3-STARS (hold).