Weekly Offshore Rig Review - The Market "Bears" Down

This week, worldwide offshore rig utilization remained largely unchanged, dipping just slightly as the Pride North Sea came off contract for a short shipyard stay before going back to work in April. In a fairly quiet week for rig activity, no idle rigs started contracts this past week.

While this may have been a calm week in terms of rig contracts and utilization, it has been anything but calm for the stock prices of the major offshore drilling contractors. On Tuesday, February 14th, Transocean announced its 4th quarter and fiscal-year results for 2005. Even though the company reported 11% growth in gross revenues and a 370% increase in net income for 2005 over 2004, the news that revenue growth would be slow for at least the first half of 2006 sent the company's stock price falling about 9%.

Although Transocean was the first rig contractor to provide earnings results for 2005, the market punished all of the drilling contractors listed on the NYSE, driving their average share prices down more than 7% from their closing prices on Feb. 9th to their closing prices on Feb 15th. TODCO, whose stock price had already dropped significantly since the start of the year, fared the worst of all the NYSE-listed rig contractors, watching its stock price fall nearly 14% over the last 5 days of trading. On the other end of the spectrum, Noble's share price felt the smallest decline, dropping only 3.6% over that same time frame.

This morning, the stock price of every major NYSE-listed drilling contractor has rebounded from the lows that they hit yesterday. Even the shares of Transocean and TODCO have begun to recover some of the value they lost over the course of trading on Tuesday and Wednesday.

So, why the strong sector-wide reaction to the Transocean earnings report? The most significant item reported by Transocean was the fact that operating and maintenance expenses for 2006 would be higher than in 2005 and that revenues for the first half would be hampered by out-of-service time on its rigs in shipyards for maintenance and mobilizations. The company stated that these higher costs, although particularly noteworthy for Transocean because of the costs associated with reactivating rigs, would likely affect all the rig contractors across the board. This particular item, which was picked up by press reports on the Transocean earnings report, seems to have sparked the sell-off of rig contractors' stocks.

Now that the dust has begun to settle and stock prices are ticking back up, it is useful to look at two related factors that play a role in the valuation (and the recent drop) in these rig contractors' stock prices. The companies whose stock price fell the most were those with the most cold-stacked rigs. Todco, with 6 cold-stacked MODUs, and Transocean, with 4 cold-stacked MODUs, saw their share prices fall 14% and 9% respectively. Nabors, which is traded on the American Stock Exchange, has 5 cold-stacked MODUs, and its share prices fell about 7%. In terms of the market reaction, these cold-stacked rigs effectively represent unrealized revenues in a market that has a very strong appetite for rigs. And beyond that, the costs to reactivate these rigs is rising, making the potential reactivation an even larger expense than just last quarter.

On the other hand, companies with no cold-stacked rigs and rigs under construction, including Noble (3 rigs), Diamond (2 rigs), ENSCO (3 rigs), Rowan (4 rigs) and Atwood (1 rig), saw the smallest decreases in their share prices. They each seem to have been bouyed by the fact that they are not faced with rising reactivation costs, and that their fleets are growing and opening up new revenue opportunities.

As an interesting aside, the rigs under construction by these major contractors represent only a small portion of the total rigs under construction. The companies that are actively building the most rigs are new and smaller players, including Premium Drilling with 13 rigs being built, SeaDrill with 8 rigs, Maersk Contractors with 6 and Scorpion with 5.

While this analysis of the factors affecting rig contractors stock price is very simple and only looks at a couple of indicators, it does point to the rather interesting fact that the market seems to value (or at least not penalize as harshly) offshore drilling contractors with rigs under construction.

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