Flush with Orders, Oil Drillers Expand

HOUSTON, (Dow Jones Newswires), Jul 31, 2007 (Dow Jones Commodities News)

The planned merger of the two biggest offshore drillers of oil and gas shone a $15 billion spotlight on the massive back orders other companies in the sector have been generating.

Transocean Inc. (RIG) and GlobalSantaFe Corp. (GSF) said last week that they would form a single company, under the Transocean name, in a merger of equals. Shareholders will be paid a total of $15 billion through a recapitalization that will reduce the size of their current stakes in the firms. The cash for the payment will come from a bridge loan from Goldman Sachs Group Inc. (GS) and Lehman Brothers Inc. (LEH).

Bridge loans, temporary financing extended by Wall Street banks to facilitate deals, have recently fallen out of favor with some investors. But analysts say the company can easily afford taking on the debt with its huge backlog of advance orders at a time of unprecedented growth in the oil services industry, raising the possibility that rival rig operators might also be poised to do something with their own mountains of back orders.

With "easy oil" on land increasingly tapped out or in the grip of national oil companies, international oil companies and some national firms are scrambling to find the next big fields offshore. To do it, they have hired virtually all of the world's available rigs capable of drilling in water over 500 feet deep, at rapidly escalating prices. With new offshore provinces opening up everywhere from India to Brazil, producers are booking deepwater rigs years in advance.

In the combined Transocean, advance orders total $33 billion, making it a fairly simple proposition to "monetize" the backlog by borrowing $15 billion to return to shareholders, said Roger Read, an analyst with Natexis Bleichroeder Inc. in Houston.

Backlogs are also approaching $10 billion at Noble Corp. (NE) and Diamond Offshore Drilling Inc. (DO), the next two largest drillers by market capitalization. Both Noble and Diamond are favored by analysts who see potential to convert those backlogs or cash accumulated in the last few years of heady profits into growth. Read gives the edge to Noble as best poised to turn cash into increased size, as a majority of Diamond shares are owned by Loews Corp. (LTR), a family-owned holding company that has been less aggressive about expansion.

"Clearly Noble is a company that wants to build, you have to think of them as acquisitive," Read said. "But...it's not out of the realm of possibility that they could be acquired as well."

Noble, which announced a two-for-one stock split on Friday, saw shares close at $102.26, while Diamond shares closed at $103.27. Noble has a price-to-earnings ratio of 11.3 versus an industry average of 11.2, according to FactSet. Diamond has a P/E ratio of 13.8.

High Drilling Demand Eases Risk

Noble officials have repeatedly come out against buying or selling to a rival, but have left open the possibility of buying part of a competitor's assets. Transocean's method of giving back to shareholders lacks appeal, however.

"As we have said in the past, a leveraged recapitalization is not necessarily the best way for Noble to add value," said spokesman John Breed. "Our superior execution and...margins are things we are doing today that we believe add that kind of value for our long-term shareholders."

Industry observers agree that the drilling boom should extend at least through 2008 in shallower water, and even longer for deepwater rigs. Some rigs are being booked into the next decade, offering increasing evidence that the good times will last well beyond 2009.

So Transocean, Noble and other drillers are putting much of their profits back into their fleets, either by upgrading assets to perform in more challenging environments, or by building new rigs.

The latter approach has become so popular that Transocean and GlobalSantaFe merged in part to stay competitive in areas where they were losing ground.

"Another driver for the...deal is the potential loss of deepwater market share by both companies to the approximately 58 floating rig newbuilds slated to be delivered over the next few years," Jefferies & Co. analyst Judson Bailey wrote in a research note.

Moody's Investors Service said after the deal was announced that it is reviewing both companies' credit ratings for possible downgrade. But it doesn't expect either to lose their investment grade status "given the scale, diversification, quality of the combined rig fleet, and the current fundamentals of the offshore drilling markets."

Transocean, operator of the largest fleet of deepwater rigs by a wide margin, was falling behind in the market for shallow-water rigs, known as jackups. GlobalSantaFe, an international jackup powerhouse, owns a relatively small deepwater fleet.

Noble is building six rigs, including jackups and deepwater, while Diamond is building two jackups. Pride International Inc. (PDE) is one notable new entrant into the premium offshore rig market, as it has taken steps to upgrade its deepwater fleet. The company announced this month that it will build or buy two new drillships, the type of rig capable of drilling in the deepest water, from a Korean construction yard for delivery in 2010.

"They're getting there," Read said. "(Pride) has a potential for committing a significant backlog that could then be monetized."

But not everyone sees bigger as necessarily better. In a conference call with analysts Thursday, Diamond Offshore CEO Larry Dickerson noted that everyone from Atwood Oceanics Inc. (ATW), with 11 rigs, to the new Transocean, with 146, has found recently found success. A merger therefore might not be mandatory to compete, he said.

"Certainly in this market, there's such demand on the floating side for equipment that...a small competitor... does very well," Dickerson said. "Everyone else does well. I think fewer participants, we've seen that in the past, leads to a more orderly bidding process, but ultimately the market does rule."

Copyright (c) 2007 Dow Jones & Company, Inc.

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