2 Offshore Plays Yielding 6% or More

07/04/2011 10:45 am EST

Focus: STOCKS

Carla Pasternak

Editor, The Income Investor

The end of cheap oil doesn't mean the end of oil demand, and these two companies will be growing fast in years to come, writes Carla Pasternak of High-Yield International.

A little more than a year after the March 2010 explosion of the Deepwater Horizon in the Gulf of Mexico, President Obama is joining the Republicans in calling for expanded offshore drilling.

This May, the Republican-controlled House of Representatives passed three bills that would expand and speed up offshore drilling off the coasts of Alaska, the Gulf of Mexico, and California. The bills would also make it more difficult for those opposed to drilling to challenge it on environmental grounds.

It's estimated that roughly 40 billion barrels of oil lie trapped in these pools—enough to replace overseas imports for years to come.

In response to near-$4 a gallon gasoline and the Republican initiatives, Obama called for expanding drilling in Alaska's National Petroleum Reserve, and speeding up seismic work to evaluate drilling options off the Atlantic coast.

His latest proposals are a reversal of previous calls for permanent drilling bans on Alaska's environmentally sensitive areas, and the current moratorium on offshore Atlantic drilling until 2018.

What's behind the government's new-found urgency for offshore drilling?

"The easy oil is gone," as Michael Klare, author of Rising Powers, Shrinking Planet, puts it. "From now on, we're going to have to dig deeper into the earth, farther offshore, farther north into the Arctic."

Andrew Gould, CEO of oil-services giant Schlumberger (SLB), believes much of the new oil will come from offshore drilling. He says that in the last ten years, more than half of all new reserves have been offshore.

By 2015, offshore oil could supply 35% of world production, and by the late 2020s that amount could be as high as 50%, Gould says.

In the search for new reserves, oil companies are expected to spend increasing amounts on offshore exploration.

From 2004 to 2008, companies spent about $278 billion globally on offshore drilling, according to UK energy analysts Douglas-Westwood. That number is expected to jump more than 30% to around $367 billion over the period from 2009-2013.

With increasing amounts of money being allocated to offshore drilling, the outlook for offshore drilling stocks is bullish. But offshore drillers with yields of 6% or better are few and far between.

TransOcean (RIG), Noble (NE), and Ensco (ESV) offer yields of less than 3%. Diamond Offshore (DO) is one of the higher yielding players, with a yield of nearly 5%. However, I found two strong prospects with yields of above 6%.

Seadrill Limited (SDRL) is a pure offshore deepwater-drilling play that yields close to 8%. Teekay Offshore Partners (TOO) is a diversified offshore oil-drilling service operator with a yield of nearly 7%.

When you enter the world of offshore drilling, you're presented with a strange array of drilling technologies. Seadrill touts its fleet of 60 drillships, jack-up rigs, semi-submersible rigs, and tender rigs. Teekay Offshore talks about its shuttle tankers, floating production (FPSO) and floating storage (FSO) solutions.

Just to give you a quick rundown of what these names mean, drillships allow Seadrill to drill between 5,000 and 10,000 feet down into the deep and ultra-deep waters off Norway, Brazil, and West Africa.

The company is awaiting delivery of ships with an even deeper drilling range of 14,000 to 15,000 feet. That's equivalent to a 1,500-story building!

Unlike drillships, jack-up rigs need to be towed to the drilling site. They are so called because their legs are lowered until they rest on the seabed. They're useful for drilling in the shallow waters off of Southeast Asia, at depths up to roughly 350 feet.

Semi-submersible rigs are also brought into place rather than self-propelled. They are set up on giant pontoons which are then filled with seawater at the drill site. The seawater weighs them down so they are partially submerged, hence the name.

They're very stable, and can withstand rough seas and hurricanes while drilling down up to 10,000 feet in the harsh waters off Norway, Brazil, and China.

Tender rigs are set up on a wellhead platform, and used to store drilling supplies, generate power, and provide living quarters and a helicopter deck. They can drill down up to 6,500 feet, but are used for calmer waters in Southeast Asia.

Seadrill's offshore vessels are built for drilling, but Teekay Offshore's fleet specializes in processing, storing, and shuttling the offshore crude once it's drilled.

The company claims to be the world's largest owner and operator of shuttle tankers. These "floating pipelines" move crude oil from offshore to onshore storage terminals or refineries.

Teekay's Floating Production, Storage, and Offloading vessels (FPSO) processes the raw oil from producing wells on the seabed. Impurities such as water, gas, sand, and stones are removed. The crude is stored on board, then offloaded to shuttle tankers.

Floating Storage and Offtake (FSO) is just a big name for simply floating oil-storage facilities. Typically, these FSOs are just old oil tankers, moored to the seabed and used to store raw crude oil from deepwater offshore oil fields. The crude is then shuttled to shore, where it is refined.

Both Seadrill and Teekay Offshore offer income investors a rich yield and strong growth potential, as offshore oil production becomes increasingly important for meeting world energy needs.

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