More Ripple Effects from the Oil Spill

04/28/2010 5:20 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Transocean (NYSE: RIG) is the owner of Deepwater Horizon, the drilling rig that caught fire on April 20 and eventually sank in the Gulf of Mexico with the loss of 11 workers. Those workers are still missing but presumed dead. Oil continues to leak from the well 4,500 feet below the surface.

The US Coast Guard is setting some of the huge spill on fire as a way to reduce the danger to the Louisiana coast and the Gulf of Mexico.

I by no means want to say that this human and ecological disaster should be measured only in dollars and cents. But let’s face it: The cost of this tragedy is what will drive the price of Transocean shares in the short term.

The rig that was destroyed was one of Transocean’s most advanced rigs. Replacing it will cost about $700 million. Most of that—$560 million, according to Transocean—will be covered by insurance. At the current day rate of $500,000, lost revenue on the remaining five months of the rig’s contract to BP (NYSE: BP), the owner of the well, is close to $75 million. That’s equal to less than 1% of 2009 annual revenue for Transocean.

The Deepwater Horizon won a safety award from the US Minerals Management Service in 2009, and the agency didn’t find any safety violations during three safety inspections this year. That, of course, doesn’t preclude lawsuits from the families of the missing workers.

The biggest unknown is the size of the bill for the ocean cleanup work and for any possible damage to coastal areas, with their valuable mix of beaches, oyster beds, and wildlife refuges.  BP estimates that the cleanup costs are running at $6 million a day. But the flow of oil from the well still hasn’t stopped.

Post-fire earnings estimates by C.K. Cooper & Co. shave 2010 earnings per share to $9.05 from a previous $9.35 and 2011 estimates to $11.30 from $11.70. That seems reasonable to me.

The big worry is that there’s no way to estimate the impact of continued stories about the disaster and the approach of the oil slick to the Louisiana coast on Transocean’s share price. Obviously, the longer oil continues to flow from the well, the larger the potential damage and final bill.

The stock was having trouble getting through strong resistance in the $85 to $90 range even before the disaster. (Part of the problem has been the falling price of oil. For more on the threat to oil prices from OPEC cheating, see this recent post.)

Since then, the stock has clearly been outperformed by the shares of other drilling and oil service sector stocks, such as Schlumberger (NYSE: SLB) and Weatherford International (NYSE: WFT).

I’m inclined to wait and see what the company announces in its first quarter earnings report on May 5 and in the May 6 conference call that will follow. There’s a good chance that management will be able to reduce the uncertainty. That in itself would give a boost to the stock price.

If I don’t like what I hear, however, it will be time to move to another name in the sector. As of April 28, I'm leaving my target price at $105 by November 2010. (It closed below $85 on Wednesday, April 28.)

Full disclosure: I own shares of Schlumberger and Transocean in my personal portfolio.

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