An Energy Trend That Runs Deep

12/19/2012 8:30 am EST

Focus: ENERGY

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Deepwater drilling is expected to rapidly take over a sizable share of global oil production, says Elliott Gue, who names 4 companies that stand to benefit the most.

We're getting deep with Elliott Gue. Elliott, you have been talking recently about deepwater drilling and how the activity has picked up. Could you talk to us about that?

Sure. It is probably the fastest-growing part of the oil business right now-and natural gas business-internationally. In 2000, deepwater production worldwide was maybe 0.25%-one-quarter of 1%-of global oil supply. By 2020, Exxon Mobil (XOM) estimates it is going to be 10% of global oil supply. That is a pretty dramatic change in just a 20-year period.

By midcentury, some people believe it could be one-quarter to one-third of global production coming from deepwater. The reason for that is that a lot of the big onshore fields have already been found. The 20 largest fields in the world average over 50 years old. They are very mature fields. A lot of them are in the Middle East. They have already been discovered.

The big, new deposits of hydrocarbons out there are in places like the deepwater-the Arctic-very difficult-to-get-to areas where the technology really didn't exist to drill some of the wells that are being drilled these days.

In the Gulf of Mexico, we are drilling wells in water that is two miles deep. We are drilling wells underneath the sea floor that are over 30,000 feet long. The technology to do that wouldn't even have existed ten to 15 years ago. So that is where the big deposits of hydrocarbons are being found, and that is where we are seeing a lot of exploration and production activity these days.

Yeah, Brazil's the same way; and some of that technology, too, is changing the way that we drill for oil everywhere.

Yes, absolutely. Oil is becoming...I like to say that we haven't achieved peak oil, because global oil production is still rising, but we have seen the peak of easy oil. So we are going after more technically complex reserves-Brazil, Gulf of Mexico, and West Africa-and now whole new markets.

It used to be that those three markets-we used to call it the Deepwater Golden Triangle-accounted for over three-quarters of global spending on deepwater drilling: West Africa, Gulf of Mexico, Brazil.

Now, East Africa, Mozambique, Tanzania, possibly Kenya; off the coast of Norway and the Bering Sea in the Arctic; off the coast of Australia and other places in Asia, we are finding big deposits of hydrocarbons. So you are seeing deepwater spending really become a global phenomenon, instead of just a phenomenon for those three markets.

Who benefits? Who are the drillers that you like in these spaces? Are they in all the fields, or do you have various companies that are in different places?

Well, you certainly have the big producers; you certainly have companies that specialize in certain areas. For example, Eni (E)-the Italian energy giant-they tend to be very strong in Africa; obviously a lot of historic ties between Africa and Italy. Total (TOT) is another one, the big French energy company. They tend to be very powerful there in Africa.

But I think really the best play of all would really be to look at the services and contract drilling firms that operate worldwide in these plays. On the services side, look at Schlumberger (SLB). A well drilled in deepwater requires 13 times more services spending than a well drilled onshore, so each well that is being drilled in deepwater means 13 times the revenue for a company like Schlumberger than a simple onshore well.

As we migrate more and more towards drilling in these technically complex areas, the revenue opportunity for a company like Schlumberger, which is a leader in the deepwater business, is huge. Things like services related to evaluating formations...they also have a huge seismic services division using sound and pressure waves to map those subsurface rock formations looking for new oil and gas deposits. That expend on that exploration area is really accelerating now.

On the contract drilling side, my favorite is Seadrill (SDRL). I've mentioned this one before on a lot of shows. It is one of the largest owners of deepwater and particularly ultra-deepwater rigs. These rigs are in very tight supply. There are only about 30 or 40 of them worldwide that are capable of doing the very deepest drilling. Most of them are already booked up under contracts with major oil companies.

There are only a few available, so the day rates-the rates they charge for leasing these rigs-has absolutely skyrocketed from $400,000 a day-which was pretty expensive a couple of years ago-to $650,000 a day now. Not only that, but they are able to book them out five, six, seven years in the future at those sky-high, near-record day rates.

It's a big opportunity for Seadrill, because they have a number of new rigs due to be delivered from shipyards in 2014 and into early 2015. As they bring those rigs out of shipyards and put them onto contracts, big cash flow upside-already upwards of 7% to 8% yield right now.

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