Recent Rise In Shallow-Water Oil Drilling At Gulf Of Mexico Producing New Opportunities

12 17, 2012 by Forbes

In the search for exciting energy investment plays, the Gulf of Mexico still remains a hive of activity that gushes huge oil money. But the opportunities have narrowed, mostly to the major oil exploration companies — and most of them are no longer as undervalued as they once were.

But one sector in the Gulf that has become more active with a number of little-known companies participating is in oil drilling in the shallow waters, as opposed to deep-sea exploration where Big Oil remains dominant.

Shallow-water drilling activity has recently mushroomed as demand has started to spiral amid scant supply of drillers, dominated mainly by mid-and small-cap oil drilling companies.

That has drawn extra-attention to Hercules Offshore(HERO), a provider of shallow-water drilling and marine services to the oil and gas exploration and production industry mainly in the Gulf of Mexico. Day rates for drilling equipment have started to rise following the increase in demand from shallow-water operators, says John Keller, analyst at investment firm Stephens, in Little Rock, Arkansas.

Hercules is well positioned, says Keller, to gain from the lift in demand as the major oil explorers have regained confidence in the prospects of oil and gas exploration in the Gulf’s less explored shallow areas. Hercules has started reinvigorating its rigs in anticipation of continued upturn in demand, he notes.

Keller has upgraded his recommendation on Hercules’ stock to overweight from underweight, following the company’s most recent fleet reactivation in the Gulf. “It increases our confidence in the sustainability of strong U.S Gulf of Mexico market fundamentals,” says Keller. Day rates on new contracts tend to trend higher than modeled rates, he notes,

As a result of a favorable supply-demand balance, fundamentals continue to improve, with day rates increasing and contract duration extending further,” Keller says. The improved picture has also driven up the signing of longer-term contracts. So Keller has raised his earnings estimates to reflect the improved situation.

For 2013, the analyst has boosted his earnings forecast to 20 cents a share on estimated revenues of $921.3 million, from 14 cents on $886.1 million, vs. a projected loss for 2012 on revenues of $687.7 million. Keller also upped his price target for the next 12 months, to about $6 to $7 a share from $5. The stock has ticked up of late, to $5.13 a share.

But other Hercules watchers think the stock will in fact jump to much higher levels, based mainly on the recent reactivation of some rigs and improved lift-boat utilization. Hercules operates a fleet of 57 rigs (49 in the U.S. and 8 overseas) and 63 lift-boats.

Matt Beeby, analyst at Williams Capital markets, who rates the stock as a buy, has raised his price target to $8 a share. “We believe the company will further benefit from the Gulf of Mexico jackup (rig) shortage,” which is adding to backlog orders, says the analyst.

Overall, fleet backlog is now nearly 8 months per rig (232 days, up from 174 days), says Beeby, who sees more upside ahead in rig utilization. The two small jackups for Chevron (CVX) were also reconstructed by Hercules for one year at higher rates, notes Beeby.

The company is adding backlog at higher than expected rates, as domestic demand keeps rigs working at high utilization while rate growth continues, notes Beeby. The potential for multiple expansion exists, he says, as rate upside seen recently provides improving cash flow for debt reduction, mergers-and-acquisition, or reactivations.

So “we believe the shares are undervalued and reiterate our buy rating for Hercules,” says Beeby.

Frank Harestad, analyst at Pareto Securities, who is also bullish on Hercules, notes that all of the company’s jackup rigs are now locked up in contracts through 2013, with average contract duration more than twice what it was a year ago. “with a solid cash position available for accretivce investments, we congtinue to view Hercules as an ingteresting bet on older jackups and liftboats,” says Harestad, who rates the stock as a buy.