3 Ways to Play Offshore Drilling’s Rebound

by Susan J. Aluise | April 17, 2012 1:45 pm

Two years ago this week, the offshore-drilling industry nearly sank under the weight of the Deepwater Horizon disaster in the Gulf of Mexico. The blowout of BP’s (NYSE:BP[1]) Macondo well and explosion on Transocean’s (NYSE:RIG[2]) Deepwater Horizon drilling rig was tragic for the loss of life and damage to the gulf’s ecology and economy alone.

The largest accidental oil spill in history also gave lawmakers and regulators ample cause to argue for permanent bans on offshore drilling. In the end, the industry survived the one-year drilling moratorium, and deepwater exploration and production are staging a comeback.

Pricey gasoline is doing its part to fuel offshore drilling’s renaissance. Persistently high oil prices are motivating major energy companies such as Royal Dutch Shell (NYSE:RDS.A[3]), Exxon Mobil (NYSE:EXM[4]) and Chevron (NYSE:CVX[5]) to reinvest their earnings in offshore ventures.

The International Energy Agency predicts that global oil demand will rise from 88 million barrels today to around 99 million barrels 25 years from now. That will boost the market for mobile offshore-drilling units dramatically, according to a new study by Visiongain[6].

What does this mean for investors? Many offshore-drilling companies already are seeing a reversal of their recent ill fortune, but here are three different ways to play the opportunity:

Long Buy-and-Hold

Because National Oilwell Varco (NYSE:NOV[7]) is a global equipment supplier to the oil-and-gas industry, it’s a natural beneficiary of the rebound in offshore drilling. NOV supplies components for 90% of all offshore and land drilling rigs and components. That’s a powerful position to be in — at least until the world casts off fossil fuels in favor of greener energy solutions. But that won’t happen anytime soon.

Last week, NOV announced its acquisition of Schlumberger’s (NYSE:SLB[8]) Wilson International pipe- and valve-distribution business, a deal that could further boost the company’s value proposition. Bloomberg estimates[9] that the all-cash transaction could have cost NOV $800 million.

With a market cap of $33.8 billion, NOV is trading at just under $80. It has a price-to-earnings growth (PEG) ratio of 0.9, indicating it could be slightly undervalued. It has a one-year return of just under 5% and a current dividend yield of 0.6%. The stock is up more than 60% since last October.

NOV likely will continue its mood swings for the next couple of months, but I’ve still got a price target of $95.

ETF Play

If you want exposure to the offshore-drilling rebound but are hesitant about going all in on a single stock, an exchange-traded fund, SPDR Oil & Gas Equipment & Services ETF (NYSE:XES[10]), might be a good alternative. ETFs trade on an exchange just like stocks and usually have lower fees than mutual funds.

XES tracks the S&P Oil & Gas Equipment & Services Select index, which is equally weighted. Holdings include NOV, Diamond Offshore Drilling (NYSE:DO[11]), Core Laboratories (NYSE:CLB[12]) and Seacor Technologies (NYSE:CKH[13]). XES has been around since June 2006, so its track record is longer than those of many of its peers. With a market cap of $302 million, XES is trading around $34.50 now.

The sector overall has had a tough year, so the one-year performance is a rather grim -19.5%. But I think this sector is bouncing back, with returns improving in the second half of the year. XES has a year-to-date performance of -2%, and its expense ratio is a low 0.35.

Put Option Strategy

As one of the companies involved in the Deepwater Horizon disaster, Transocean (NYSE:RIG[2]) saw its stock lose more than half its value from April 20 to June 9, 2010. And given fears about the full magnitude of the company’s liability, it’s not surprising that while it rebounded to more than $75 last April, RIG slipped back to about $38 in January 2012. The company also is trying to block a U.S. Chemical Safety Board probe into the disaster[14].

To make matters worse, Brazil has filed criminal charges against Transocean and Chevron over a November 2011 spill. A judge last week resisted calls to ban the two companies from drilling in the country[15], but this saga is far from over. Transocean suspended its dividend in February, and its one-year return is -31%.

I think RIG has further to fall — the Brazil spills and criminal charges, ongoing inquiries into Deepwater Horizon and other potential liability issues make its near-term outlook murky.

So a good play here might well a bearish options bet. I like the May 2012 put at the $50.00 strike price.

As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here.

Endnotes:
  1. BP: http://studio-5.financialcontent.com/investplace/quote?Symbol=BP
  2. RIG: http://studio-5.financialcontent.com/investplace/quote?Symbol=RIG
  3. RDS.A: http://studio-5.financialcontent.com/investplace/quote?Symbol=RDS.A
  4. EXM: http://studio-5.financialcontent.com/investplace/quote?Symbol=EXM
  5. CVX: http://studio-5.financialcontent.com/investplace/quote?Symbol=CVX
  6. according to a new study by Visiongain: http://www.visiongain.com/Press_Release/166/Visiongain-determines-that-spending-in-the-Mobile-Offshore-Drilling-Unit-(MODU)-market-in-2012-will-amount-to-48-1bn
  7. NOV: http://studio-5.financialcontent.com/investplace/quote?Symbol=NOV
  8. SLB: http://studio-5.financialcontent.com/investplace/quote?Symbol=SLB
  9. Bloomberg estimates: http://www.bloomberg.com/news/2012-04-11/national-oilwell-s-may-have-paid-800-million-for-unit.html
  10. XES: http://studio-5.financialcontent.com/investplace/quote?Symbol=XES
  11. DO: http://studio-5.financialcontent.com/investplace/quote?Symbol=DO
  12. CLB: http://studio-5.financialcontent.com/investplace/quote?Symbol=CLB
  13. CKH: http://studio-5.financialcontent.com/investplace/quote?Symbol=CKH
  14. The company also is trying to block a U.S. Chemical Safety Board probe into the disaster: http://www.businessweek.com/news/2012-04-11/transocean-fighting-subpoenas-in-csb-probe-of-deepwater-horizon
  15. A judge last week resisted calls to ban the two companies from drilling in the country: http://www.bloomberg.com/news/2012-04-11/brazil-judge-denies-suspension-of-chevron-transocean-operations.html

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