Deepwater drilling and the future of energy stocks
Despite the tragedy in the Gulf of Mexico, deepwater drilling will go on, says a U.S. advisory which discusses the fate of seven energy stocks.
There’s more than oil spilling out into the Gulf of Mexico.
Accusations and counter-accusations are flowing as freely as the crude that is creating an environmental disaster of unprecedented proportions.
And let us not forget, eleven people died in the original explosion.
It will take years to sort out the responsibility and the costs of this catastrophe, and many questions will never be answered.
All we can reasonably discuss at this point is the future of energy production in North America.
Is this the death knell of offshore drilling? Will this work to the advantage of other sources of energy, like Alberta’s oil sands?
For a reply to these questions, we turn to a leading U.S. advisory. Mr. Elliott H. Gue, the editor of Personal Finance, has no doubt on one score. This disaster “won’t spell the end of drilling in the Gulf.” The world, and America in particular, simply cannot do without this resource.
Mr. Gue delves deeper into the matter, and discusses the prospects of seven energy stocks in light of these events — two oil producers, two drillers, two service firms and one cleanup specialist.
Not enough alternatives
We need this oil, states Mr. Gue. “The deepwater Gulf of Mexico has been the only source of U.S. production growth for the past two decades.”
Deepwater deposits accounted for 3 per cent of global oil output in 2002. That number will rise 12 per cent in 2012 as Brazil’s offshore deposits come on stream.
There simply aren’t enough alternatives to deepwater drilling, in the oil sands or elsewhere, to pull the drills out of the world’s oceans.
“Without a credible near-term alternative to oil, a disruption to deepwater production would make the U.S. more reliant on imports,” says the editor. “The resulting pull on supplies would devour spare production capacity, sending oil prices into the stratosphere and putting the still-fragile global economy at risk.”
The world’s easy-to-produce onshore fields are mature and waning. Over 70 per cent of oil discoveries in the past two years have been offshore. They are deep and costly to exploit.
But that spells opportunity for firms that have mastered offshore drilling, and for investors who are willing to wade into those deep waters in search of future profits.
Punished excessively
BP (NYSE-BP) is not the only producer with a stake in the Macondo well whose explosion triggered the disaster. It holds a 65 per cent interest.
Anadarko Petroleum (NYSE-APC) holds 25 per cent and Japan’s Mitsui (NASDQ-MITSY) has 10 per cent.
BP quickly assumed responsibility for the spill and the cleanup (as agonizingly slow as that has been) but “don’t assume the U.K. oil giant alone will be liable,” says Mr. Gue. Anadarko and Mitsui will have to pay their share of the bill.
In the first three weeks after the spill, BP shed $40 billion in market value. Naturally it is facing intense “headline risk” and a big hit to its reputation. Nonetheless, says the editor, if you can stomach the volatility and controversy, BP is a buy under US$55. From a high of $62 in January, it is now at $43.59 and yields a hefty 7.4 per cent on its $3.36 dividend.
But if you want growth, says the editor, look to Anadarko. Traditionally a gas producer, Anadarko has stepped up its offshore oil work in the Gulf and West Africa.
Before the spill, Anadarko had been doing nicely — five of its seven discovery wells were successful. It also had a stellar first quarter. Anadarko’s insurance won’t cover all its cleanup costs, but the stock was punished excessively, says the editor. It’s a buy to US$70. From an April high of $75 it’s at $53.64, yielding 0.7 per cent on its 36-cent dividend.
The most modern fleet
The Deepwater Horizon rig at Macondo belonged to Transocean (NYSE-RIG), the world’s biggest offshore drilling contractor. But it simply leases its rigs and crew at a day rate and the company takes over.
By contract, drillers are commonly responsible for spills from the unit, but not blowouts, the uncontrolled release of hydrocarbons. Thus Transocean’s liability is probably limited.
Nevertheless, this editor prefers another drilling firm, Seadrill (NYSE-SDRL). Thanks to long-term contracts, this company distributes most of its excess cash in dividends.
What’s more, the explosion of the 10-year old Horizon rig will result in regulations favouring newer rigs, and Seadrill has the most modern fleet in the industry. This firm moved to the New York Stock Exchange in April, increasing its visibility and liquidity. Just added to this advisory’s Growth Portfolio, it’s a buy under US$29.
Swept up in the anxiety over drilling, the stock fell from $28 a month ago to $20.60 and yields a boisterous 10 per cent on its $2.26 dividend.
The company “with the most direct exposure” to the incident at Macondo is oil service giant Halliburton (NYSE-HAL), says the editor. It was responsible for cementing the heavy pipe, or casing, that prevents hydrocarbons from moving from the reservoir to the well.
Halliburton claims it installed and tested the casing, but other firms dispute this claim. The explosion destroyed most of the evidence.
Controversy seems to follow this company, partly due to its connection to controversial ex-Vice President Dick Cheney, its CEO for five years in the 1990s. Its financial record in Iraq remains murky.
Still, the company makes money, and Mr. Gue has it as a buy under US$35. It trades at $24.82 and yields 1.3 per cent on its 36-cent dividend.
The editor is more comfortable with Weatherford International (NYSE-WFT), his “preferred play” in oil services. It is doing most of its drilling in Iraq and Russia, so it is free from Gulf controversies. A buy under US$25, it is at $14.05 but pays no dividend.
Last but very far from least is Clean Harbors (NYSE-CLH), whose name clearly indicates its role. It has 300 people working in the Gulf to remove and dispose of oil waste. Buy this stock up to US$70, says Mr. Gue. It trades at $62.40 and also pays no dividend.
As long as we rely on oil, deepwater drilling will go on. Profits will flow to energy firms and investors. We can only hope that those involved also profit from the hard-earned lessons of the Gulf.
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