“Double Your Money in the Coming Oil Shock” (Mark Skousen)

by Travis Johnson, Stock Gumshoe | May 23, 2012 4:18 pm

Sniffing out a Deepwater Driller teased by Skousen's Forecasts and Strategies

“12,000 Feet Below the Surface of the Ocean the Last Untouched Reservoir of Crude Oil Lies Waiting — and Only One Company Can Bring It to An Increasingly Desperate World!…

“… now oil[1] could be heading for $150 a barrel… politicians are talking about attacking Iran … and everyone is scrambling to tap the tens of billions of barrels of pure crude located on the ocean floor….

“Find out how you caould make a killing investing in one of 8 companies with ‘ultra deep water[2]’ rigs …”

Good intro, right? I can’t take the credit, it’s from Mark Skousen[3]’s copywriters.

We received a lot of skeptical comments when we sleuthified the “oil to $200 by July 1” teaser from Dr. Kent Moors[4], but I know that a lot of Gumshoe readers are betting that oil prices are likely to rise in the years to come (and I generally agree, though oil is in an oversupplied/too much inventory crisis right now in the US that could certainly bring prices down before they rise again).

So in light of that, today we’re looking at an “oil is going higher” teaser from another guru, and another doctor (the PhD kind, not the medical kind) — Dr. Mark Skousen, who is a libertarian economist and has been putting out his Forecasts and Strategies investment newsletter [5]for more than 30 years now.

And in order to try to get new subscribers, he’s teasing us with an idea that he thinks will do well as oil exploration grows more desperate with higher prices, and as explorers move further and further offshore to find new oil. Here’s how he puts it:

“The company I want to tell you about is particularly well placed for explosive profits: it’s one of the tiny handful of drilling companies that specialize in deep-water rigs.

“What’s more, you can buy this company for pennies on the dollar.

“That’s because offshore drilling contractors like Transocean and the company I’m talking about took it on the chin when British Petroleum suffered the worst oil spill in history in 2010. Understandably, their stocks plummeted! Some lost HALF their market cap in a matter of months!

“But now that the Gulf oil rig has been plugged, deep water offshore drilling is making a comeback — big time.

“The company I’m talking about specializes in what’s known as ‘ultra-deep water drilling’ — which means they run rigs capable of drilling below a water depth of 7,500 feet or more.

“Of the five deep water rigs this company operates, two of them bring in $600,000 — per day.

“They operate in Brazil[6], Norway, and the West African coast — specifically, off Angola and Nigeria. What’s more, they are building five new rigs capable of operating below a water depth of 12,000 feet.

“And if the price of oil continues to rise, this company’s stock could do a moon shot…”

Which sounds pretty good, right? Offshore drilling is still hurting in some areas, with the shallow water companies particularly having some trouble and stacking a lot of rigs (“stacking” really just means they’re in storage and not being used, but us pundits have to use fancy words — otherwise you might find out that you can figure out the business on your own. Horrors!)

And yes, most of the offshore drillers took a hit following the Deepwater Horizon disaster — some because they were, like Transocean, potentially liable themselves or maybe using the same faulty equipment, but most because there was a fear of drilling moratoriums or new, more expensive, safety rules. Most of them also bounced back pretty nicely, so I don’t think you can say that any of the deepwater driller stocks, with the possible exception of Transocean, are really suffering still from the aftereffects of the spill.

Which one could it be? If you’re talking about only owning five deepwater rigs, that makes you a pretty small player — and there aren’t any really exact matches, though the DryShips spinoff Ocean Rig (ORIG) is close and has been a special situation/value investing favorite for those who can stomach the DryShips connection, and there are a couple other firms with small fleets of deepwater rigs like Atwood Oceanics (ATW)[7]. But I don’t think he’s referencing those, and neither is getting $600,000 day rates on two vessels (ORIG is getting that rate on one of their rigs, Atwood has mostly older rigs that are a little bit lower spec — more 5,000 foot depth than 10,000 foot — and therefore get lower day rates).

Then we get into some clues that tell us he was actually being a bit misleading with that “five rigs” bit … here’s the next part of the hinting spiel:

“Clearly, deep sea drilling is the final frontier of oil exploration — despite risks to the ocean environment from spills and leaks.

“Oil companies long ago stopped using offshore platforms anchored to the ocean floor. Instead, the latest technology is ‘semi-submersible’ drilling rigs that float atop the world’s oceans, bobbing above miles of water.

“Its hazardous work — and only about a dozen companies in the world have the knowledge and financial heft to undertake it.

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“The one I am recommending was founded in Norway in 2005 and operates 44 deep water rigs in Norway, the UK, off the west coast of Africa and in Southeast Asia[8].

“Its revenue growth has been solid: from $9 billion in 2007 to $23 billion in 2011. Equally impressive have been its profits, with EBITDA earnings more than tripling from $4 billion in 2007 to $13 billion in 2011.

“In comparison, one of this company’s key competitors, Transocean, has seen its earnings plummet from $3.45 billion in 2007 to $1.92 billion in 2011.

“Out of respect for my subscribers, I can’t tell you the name of this company just yet. But I can tell you this: Its return on equity (ROE) is reaching 32%. Plus, thanks to the hysteria over Deep Horizon, it’s still cheap, selling for only 4.5 times it’s current earnings.

“And as I said, its profits are HUGE! They are so large, in fact, it’s been paying an annual dividend of 8.5%!”

OK, so those clues are far more definitive — and I don’t even have to back the Thinkolator out of the garage to tell you that he’s touting Seadrill (SDRL)[9], our long-time favorite deepwater driller here at Stock Gumshoe.

And yes, you can massage the numbers to fit Seadrill — they do have five currently operating deepwater rigs of a special class, and two of those five are currently working at $600,000+ dayrates. Those are Seadrill’s Drillships, though, a category that’s usually collapsed in with the deepwater semi-submersible rigs because they have very similar capabilities (ie, drilling to 20-40,000 feet below the ocean floor, drilling in 8-12,000 feet of water).

And they do have a number of latest-spec drillships on order, three for next year and three for 2014, which will drill in 12,000 feet of water and reach 40,000 feet — so that’s six 12,000 foot drillers on order, not five, which we’ll call “close enough.” But if you add in all of Seadrill’s ultra-deepwater rigs (anything for water depths greater than 7,500 feet), there are 14 on the water and eight on order (two semi-submersible rigs, with 10,000 foot depth capability, in addition to the six drillships). They also do have some high-spec jack-up rigs (those are the shallower water rigs that actually stand on the ocean floor, generally limited to about 400 feet of water), and a large fleet of tender rigs (fancy support rigs, basically). As far as I can tell from their latest fleet status update, every piece of equipment is under contract except for the newbuilding rigs that aren’t yet complete (most of their newbuilds have historically been under contract well before completion, they seem to be holding out for better rates now).

Among their most valuable stuff, the deepwater rigs and drillships, there’s precious little availability — they have two or three rigs coming off contract over the next year, but most of them are under contract for several years into the future. It will be interesting to see if they continue setting new dayrate records for the rigs and drillships that are coming off contract or out of the yard (one rolls off contract in October, then newbuilds arrive in the first and second quarter next year — those are the next availabilities), but whether the day rate sets records or not they’re almost certain to be extremely profitably occupied.

Seadrill, as those who have been around these parts for a while might remember, was our first “Idea of the Month” pick way back in 2008 — that turned out to be terrible timing, since oil was just about to crater and the stock had a very bad year or so following, but it has now recovered and is spitting out the high dividends[10] we expected (I’ve personally owned it for longer, since 2006 when almost all of their assets were just orders in the yard). John Fredriksen, the Norwegian magnate who founded Seadrill and turned it into an ordering and acquiring machine when others (like Seadrill, Pride, Ensco, Diamond Offshore, etc.) were being much more conservative, is focused on creating companies that are effectively pass-through cash flow entities that generate huge dividends and pay him (and us) to own the stock. As with Frontline, the oil tanker company he built before Seadrill, the earnings are not necessarily the key (since earnings are heavily impacted by depreciation of these hugely expensive assets) — the key is the ability to generate cash, use leverage[11] effectively to keep cash flow high, and pay out substantial dividends.

I think RIG or Diamond Offshore (DO)[12] is probably a safer pick in some ways — they haven’t been nearly as aggressive as Seadrill in building a brand new, next generation fleet, but they do own a lot of great rigs and drillships and they’re making a lot of cash as well … but RIG just canceled the dividend for this year in order to shore up their balance sheet and help with the costs of modernizing their fleet, and Diamond’s fleet is getting pretty long in the tooth and they haven’t shown a lot of interest in heavy spending to upgrade (DO is run by Loews Corp, which I think enjoys having them as a cash cow). Seadrill’s aggressive moves include a dividend raise this last quarter as well as a small add-on special dividend, so the yield, if they keep the dividend the same, will be just about 9% from this point (you won’t get the June dividend if you buy today, the stock just went ex-dividend on May 22).

So yes, Seadrill is still my favorite driller, and it’s still one of the largest positions in my portfolio — with some nice dividend compounding that can really heat up when the payout is this high. If you want to ride the continuing rise in demand for better, faster, newer, deeper drilling rigs as offshore Africa and Brazil heat up along with the deepwater Gulf of Mexico[13], offshore China[14], and the near Arctic, I don’t think you can do better than Seadrill … but if you think oil will drop to $60 in the next year and some of that demand will slow a bit, it’s very possible that you’ll be able to buy Seadrill at a cheaper price.

There is a lot of inventory coming in to the deepwater fleet over the next few years, but capacity still appears to be in strong demand and the shipyards that build these rigs are specialized and busy (if you want to order a high-spec rig or drillship now, you won’t get it until late 2014 at the earliest, and oil companies are still booking these rigs out to 2016 and later to ensure access). I don’t think we’ll soon get into a situation as we have with oil tankers and dry bulk tankers, where capacity overwhelms the demand because of overbuilding, in part because the investment for these new rigs is so massive and capacity to build them somewhat limited, but that is also a possible risk if demand and exploration activity in the deep water slack off.

I think Seadrill is still well positioned, they are taking advantage of the fact that aggressive offshore exploration is going to take place almost regardless of oil prices (Namibia[15], Mozambique[16], China, Brazil, Mexico, Angola, the list goes on … they want and need to develop offshore reserves for the long term, they won’t stop even if oil prices force the companies exploring their waters to slow down a little). But since they borrow lots of money to finance their fleet, and spit out most of their free cash flow to shareholders, there isn’t a lot of ballast in these shares and the ride can be quite bumpy.

My last comment on Seadrill to the Irregulars suggested that buying it on the dips down near $30 was awfully appealing, and with the continued strong underlying performance and the strong market I think buying even at the current $35ish will probably work out well over the long run — just note that, as I said, the shares will be sensitive to oil prices as well as, God forbid, to any accidents (though minor accidents from older rigs can sometimes help, since Seadrill can boast a fleet of newer rigs with the latest safety equipment that increases their relative value). For the actual “money where your mouth is” facts, the last time I bought shares was last Summer around $27.50 when the effective dividend yield bumped up to 11%.

So what do you think? Like the Norwegian swashbuckler who likes to throw cash at shareholders and ride the big waves, or do you prefer something a little bit more conservative? Let us know with a comment below.

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