In yesterday’s Money Morning (see: The oil price just won’t stay down) we mentioned the rallying oil price and suggested that the UK‘s blue-chip oil majors look rather inexpensive in light of oil‘s continued strength.
But there’s another group of shares that might be of equal interest.
They say that when there’s a gold rush, you should buy picks and shovels. Well, these companies provide the picks and shovels when there’s an oil rush…
Years of cheap oil hammered investment in the industry – there’s not much point in hunting for more if it costs you more to get out of the ground than you can sell it for. And because oil companies weren’t looking for oil, the companies building and supplying the drilling rigs didn’t build anymore rigs.
However, when the oil price soared, suddenly everyone wanted to go hunting for oil. And that meant soaring demand for drill rigs.
According to Bloomberg, “Orders for offshore rigs have surged six fold in the past five years, and rental rates are at their highest… The wait for the most sophisticated rigs, which can drill in waters more than a mile deep, is a record three years, and the cost to lease one has quadrupled since 2004, climbing to more than $500,000 a day.”
It’s also become much more expensive to build new rigs, because of rising steel costs, and a squeeze on the equipment and shipyard space needed to construct and store new rigs – the lack of investment goes all the way down the chain. The price has near-doubled in less than a decade, reckons JP Morgan analyst David C. Smith.
And the problem’s not going away. Small oil explorers are finding it particularly difficult – UK-listed Desire Petroleum’s chief executive Ian Duncan tells Bloomberg: “It is difficult to find a rig anywhere.” The company has been looking for one since early 2005 to explore off the Falkland Islands.
The number of rigs on order has jumped to 115 from just 18 five years ago, says ODS-Petrodata. But with few delivered as yet, the total number of rigs available worldwide, at 657, has changed little over the same time period.
And the good news is that by signing long-term leases with oil companies, rig companies can lock in current high prices. This makes earnings less volatile than oil producers.
As fund manager Don Hodges of US-based Hodges Capital Management tells Bloomberg: “There is a shortage [of rigs], it takes time to build one and it takes a lot of money. Their earnings are going to go up every year for the foreseeable future.”
US drillers you might want to take a look at in particular are those with deepwater drilling capacity – Robert Aronen on Motley Fool reports that between five of the biggest drilling companies in the world, there are only 11 active rigs “capable of drilling in 10,000 feet or more.” Clearly, this lack of supply is good news for these companies, which includeTransocean (NYSE: RIG), GlobalSantaFe (NYSE: GSF), and Noble Corp (NYSE: NE). Noble trades on just 8.1 times expected earnings, while Transocean trades on around 10.9.
Turning to the stock markets…
In London, stocks neared a new 6-year high yesterday but lost momentum late morning. The FTSE 100 went on to end the day 33 points higher, at 6,434. Associated British Foods topped the FTSE leaderboard with gains of over 4% after it announced expectations of strong second-half growth and good sales at its Primark stores.
Across the Channel, the Paris CAC-40 ended the day 46 points higher, at 5,762, whilst the Frankfurt DAX-30 ended the day 35 points firmer, at 7,027.
On Wall Street, the stronger oil price had investors worried about slowing growth. The Dow Jones industrials closed 15 points lower, at 12,632, as Boeing, Hewlett-Packard and IBM weighed. The tech-heavy Nasdaq lost 10 points to end the day at 2,504, whilst the broader S&P 500 closed down 2 points, at 1,448.
In Asia, the Nikkei ended its 3-day winning streak, closing 95 points lower at 18,119.
Crude oil had climbed 20c to $61.59 this morning. Meanwhile, Brent spot was 18c higher at $60.13 in London.
Spot gold was last quoted at $685.30 today, down from $686.10 in New York late last night. Silver had slipped to $14.66/oz.
And in London this morning, Sports Direct International – Britain’s largest sports retailer and owner of Original Shoe Company – announced that it had made as much as £929m for founder Mike Ashley in an initial public offering. Sports Direct’s stock had risen by as much as 1% in early trading.
And our two recommended articles for today…
Is the bear market about to make a comeback?
– February may have been another great month for global stock markets, but there are strong signs that we could be about to see a return to the bear market that began in 2000. For the RH Asset Management team’s look at the latest clues from the markets, click here: Is the bear market about to make a comeback?
Don’t forget about Africa
– Don’t dismiss Africa as a basket case, says Merryn Somerset Webb. What with its vast reserves of commodities, Chinese investment and increasing political stability, you really should think about investing in the continent now. To find out where to begin, read: Don’t forget about Africa.