by Aaron Levitt | June 6, 2012 7:30 am
In the wake of BP‘s (NYSE:BP) deadly Deepwater Horizon rig explosion and oil spill in the Gulf of Mexico, the Obama administration halted drilling activity and issuance of new permits. For roughly six months the Gulf lay fallow, and more than 33 deepwater wells were essentially shut off.
However, the Gulf is now experiencing a renaissance. The ban has been lifted, new permit issuance is rising and drilling activity is thriving again, thanks to high oil prices and growing global demand. Ultimately, that makes dealing with the various new government regulations and additional costs well worth it for many of the industry’s largest players.
It also creates a lucrative business opportunity for the companies that make advanced safety equipment — and an investing opportunity for investors.
Before getting to those beneficiaries, let’s review the emerging regulatory landscape. In an effort to prevent another BP-style disaster, the newly reconfigured Bureau of Ocean Energy Management & Regulatory Enforcement (BOEMRE) and the U.S. Interior Department continue to add costly safety measures into new drilling permits. Stricter provisions for well blowouts and spill containments are now the norm for any exploration and production firms wanting to drill in the Gulf.
And it’s not just the U.S. that’s taking safety to heart. Regulators everywhere, from Europe’s North Sea to China’s coast, are considering more such provisions.
Key to those provisions are essential pieces of safety equipment: blowout preventers (BOP), which sit nearly five-stories tall and cost as much as $45 million each. A failed unit aboard BP’s Horizon rig was the main culprit for the disastrous fire and spill.
These devices are critical both onshore and off. At its core, a blowout preventer is a large, specialized valve used to monitor, control and seal oil and gas wells. BOPs are designed to regulate the pressures and uncontrolled fluid flows that occur during drilling. If the device fails to control the fluctuating pressure, a large blade, or ram, is designed to “cut” the pipe to choke the flow and prevent explosive gases from reaching the rig and crews on the surface. BOPs come in a variety of different styles, but they roughly function in the same way.
As Deepwater Horizon reminded everyone, blowouts can be particular hazardous events, despite the fact that “gushers” were an icon of oil exploration during the late 19th and early 20th centuries.
Following guidelines from a National Academy of Engineering report, the Interior Department has called for major changes to BOP design and testing to ensure they can work under a wide range of scenarios. BOPs will be beefed up with a second set of rams, which will increase the odds of it successfully slicing through the drill pipe to seal off an uncontrollable well. In addition, workers will need to be better trained to operate these devices in emergencies.
Already, many producers in the Gulf — including BP — have begun adopting two-ram systems in anticipation of the new regulations. Royal Dutch Shell (NYSE:RDS-A, RDS-B) has pledged to use two rams on its BOPs in exploratory drilling in the Arctic Chukchi and Beaufort Seas this summer.
While some smaller shallow-water drillers, like Hercules Offshore (NASDAQ:HERO) have complained about the pending rules — an extra set of rams could make BOPs too tall for certain types of rigs — odds are the regulations will get enacted. Even the American Petroleum Institute (API), the largest oil-industry trade group, is considering adding a requirement for double-shear rams into its own BOP standards.
With the new requirements looming, it stands to reason that the companies making these advanced BOP systems should see increased business. Several oil service companies, like Cameron (NYSE:CAM) and Tesco (NASDAQ:TESO), produce BOPs, but the king of the group and perhaps the best choice for investors is National Oilwell Varco (NYSE:NOV).
It’s the leading maker of rigs, bits and other necessary drilling equipment, with its parts and components incorporated into nearly 90% of all drilling rigs on the planet. However, the coming BOP regulations could lift demand for National Oilwell’s products and increase its $10.3 billion rig technology backlog. The company’s Shaffer pressure control equipment and Koomey BOP systems are some of the most advanced and can be used in well depths up to 30,000 feet, temperatures of 650F and pressures of 15,000 psi. Likewise, Varco’s NXT BOP is double-ram compliant and should see increased demand as the regulations get enacted.
National Oilwell’s domination in “all things rig related” has allowed it to operate with very little debt and more than $8 of cash per share on its books. At the same time, the market’s recent fall has made NOV shares even juicier. At $65.69, they can be currently had for a P/E of just 12.7, at about $22 below the 52-week high in February.
That gives investors plenty of energy-value for not much price. Overall, the long-term trend of drilling deeper coupled with stricter safety mandates should help pad National Oilwell’s and investors’ pockets.
As of this writing, Aaron Levitt doesn’t own any securities mentioned here.
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