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Four Picks for Investing in the Deep-Water Boom

These service firms and drillers deserve attention from investors.

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Deep-water exploration is seen as the new frontier for oil and gas companies seeking the next big find. With offshore wells costing up to $200 million to drill, it is an expensive decision for oil and gas companies. As a result, the firms rely on oil services companies to provide additional expertise in finding, analyzing, and drilling for the valuable resources. Accordingly, our oil services universe is enjoying some of the strongest results in more than two decades, as high oil prices have created a windfall for oil and service firms alike.

Finding and successfully exploiting a deep-water find such as  Petrobras' (PBR) Tupi, estimated to hold 5 billion to 8 billion barrels of oil equivalent, is certainly a challenge for any firm. First, extensive seismic shooting (often covering hundreds of miles) must be done to determine where the reservoir is located and where the first wells should be drilled in order to obtain the most information about the size and quality of the reservoir. Seismic firms, like  CGGVeritas (CGV), provide survey vessels to get the job accomplished. These vessels are equipped with air guns that fire on regular intervals towards the sea floor as the vessel moves along a predetermined surveying path. Long streamer arrays contain hydrophones that collect any energy reflected from beneath the sea floor. Once the survey is completed, seismic firms and producers will analyze the data to determine the best drilling sites. Second, a drilling contractor, such as  Transocean (RIG) or  Pride International  (PDE), needs to be hired to drill the well. The well can be as deep as 35,000 feet, requiring months and months of expensive drilling time and equipment built to withstand the high temperatures and high pressures at the bottom of the well. Ultra-deep-water rigs that can drill in waters up to 10,000 feet deep may cost up to $750 million and command day rates of more than $650,000 a day. In addition, highly trained employees from both the driller and a services firm such as  Schlumberger (SLB) must keep the project on track and continuously assess the reservoir to figure out exactly what type of oil services (such as fraccing) are needed to best exploit the reservoir. Once the well is completed, subsea specialists such as  Acergy (ACGY) may be hired (depending on the economics) to install pipelines that stretch hundreds of miles from the bottom of the ocean floor to a land-based production facility.

Given these stiff technological challenges, which companies are best positioned to solve them and are therefore worthy of investor consideration? We should consider firms that are able to charge premium prices for their technological expertise or control the low-cost position in their respective sectors. This article will highlight some of the experts in our oil services universe that have recently traded at attractive prices. Please check our latest Analyst Reports for up-to-date star ratings and Consider Buying prices.

 CGGVeritas  (CGV)
Shooting seismic has come a long way since the 1980s, and seismic surveys are now a requirement for many oil and gas companies, especially offshore. CGGVeritas owns one of the largest marine fleets in the world, with many of the vessels capable of high-end 4D (time-lapse) seismic. In addition, new technologies such as electromagnetic imaging and wide-azimuth seismic offer better pictures of reservoirs and provide more information to customers. What separates this company from its peers is that it also owns one of the world's leading seismic-equipment manufacturers, Sercel. By owning Sercel, CGGVeritas has a good chance of benefiting from any offshore or onshore seismic activity, by either providing the equipment or crews needed to do the work. While we acknowledge the seismic market is quite volatile, with painful periods of oversupply, we think the market is overlooking the huge opportunities for new seismic surveys worldwide from Brazil to Gabon.

 Transocean (RIG)
Transocean benefits from owning one of the largest ultra-deep-water fleets in the world, which specializes in drilling in water depths of 10,000 feet or more. Higher oil and gas prices have led to increased offshore activity as deep-water depths are now proving economic to drill. However, a global capacity constraint in rig construction has led to a huge shortage of offshore rigs capable of drilling these deeper wells. The average offshore rig is over 20 years old and was built during the 1980s when the global rig supply chain could churn out over 100 jackups annually. After decades of underinvestment due to low oil and gas prices, rig manufacturing capacity is only a fraction of what it once was and now struggles mightily to deliver 30 jackups annually. In an environment where offshore rigs are a scarce commodity, Transocean's fleet has substantial pricing power. With a $41 billion backlog, we think the market is severely discounting the company's huge earnings potential.

 National Oilwell Varco (NOV)
A survivor of the brutal 1980s equipment bust, National Oilwell Varco took lemons and made lemonade. The firm spent years acquiring competitors and now retains a dominant position in the rig equipment market, and as a result, 90% of all rigs have NOV's equipment on board. NOV can earn up to 50% of a rig's construction cost and has a $10.8 billion backlog for its efforts. Like Transocean, National Oilwell Varco benefits from a constrained global supply chain for rig equipment and as a result has pricing power over its customers. However, its low-cost manufacturing base ensures it will survive any bust. With sustained offshore drilling activity looking likely for years to come, we think NOV should benefit from upgrading ancient rigs and delivering advanced deep-water rig equipment to customers. With drillers having little choice but to order from NOV, we expect terrific results for the company for the next few years.

 Rowan Companies (RDC)
Rowan offers some of the world's most powerful jackups. Its jackups drill in shallow waters, yet it still benefits from the increase in the deep-water offshore activity. Risk-averse peers prefer to build deep-water rigs because they can be contracted immediately upon ordering. This is not the case for premium jackups, which often take longer to contract and expose the driller to greater financial risk. This situation helps limit the supply of new premium jackups and, in our opinion, gives some short-term pricing power to Rowan. The firm is taking full advantage of demand for its rigs from the Middle East by ordering enough new rigs to effectively double its rig fleet in a decade. We think the market is valuing the firm as a conventional jackup driller, for which the long-term outlook is decidedly weaker.

Stephen Ellis does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.