New rules that will change the game for deepwater drillers

08/11/2010 10:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

(I'm on vacation until August 24. From now through Friday August 13 I will be posting on a reduced schedule of once or twice a day on Jubak Picks. The site will go completely dark from August 13 to August 24 and then I will resume my normal schedule of posts.)

Age counts, according to legislation passed by the House of Representatives on July 30 designed to prevent a repeat of the Deepwater Horizon disaster in the Gulf of Mexico.

And that could be a game changer for global deepwater drilling companies.

Here’s the issue:

The legislation would set minimum safety standards for well design—and here’s the biggy—require oil drillers to use an enhanced blowout preventer. It was the failure of the blowout preventer that led to oil gushing uncontrolled from BP’s well after an explosion at the well.

But many older rigs are too small to accommodate the newer generation of blowout preventers. It will cost drilling companies billions to upgrade them and many older rigs either aren’t upgradable at a reasonable cost or upgradable at all. If the proposed regulations pass, these rigs will be out of U.S. waters (and out of the waters off countries that adopt similar rules) and they’ll wind up competing in more crowded and less lucrative markets with older and less stringent regulations. Only 16 out of the 33 floating rigs in the Gulf of Mexico have blowout preventers that would pass the new rules (after relatively minor work or with none at all),  according to ODS Petrodata.

Investors can expect to see some drilling rig owners start to do everything they can to conserve cash. Diamond Offshore Drilling (DO), for example, has cut its dividend for the second quarter in a row by 45%.

As a general rule, the younger a drilling company’s fleet the easier and cheaper it will be to meet the new rules. Some older rigs, for example, don’t have room to add the new generation of blowout preventers with their extra set of sets of shears to cut through a drilling pipe in the case of an accident. Some older rigs don’t have the hoisting capacity to lift the newer and heavier blowout preventers from the ocean floor.

I haven’t dug deeply enough into the data on fleet age to give you a thumbs up on any company (and the legislation still has to make its way through a deeply dysfunctional U.S. Senate.) But a name that’s come up frequently in my research is Norway’s Seadrill (SDRL). The company has invested in rigs heavily over the last five years, which gives Seadrill one of the young fleets in the industry. Norway had some of the toughest regulations in the world on deepwater drilling even before the BP disaster and that also gives the company an edge.

Just a heads up—not even a new stock for the watch list--as I drill deeper.

Full disclosure: I don’t own shares of any stock mentioned in this post in my personal portfolio.

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