Bet on offshore revival

A boring yet asymmetric idea for offshore investors

We are more often wrong than right. Especially on the markets. Even worse, being directionally correct is not enough. The missing ingredient is timing.

Oil rigs were one of those ideas I got wrong. I anticipated a bull run for 2024, but the chart shows that I was too early on the party.

If I stayed invested, it would be an epic failure. As you can see, all drill majors have scored double-digit losses YTD. They even “outperformed” crude oil.

That’s why we need to master, as Stanley Druckenmiller says, “a strong conviction, weakly held” attitude. Develop a well-articulated thesis yet continuously ready to slash the idea. I have tried entering the market twice over the last 12 months. My timing was wrong. Risk management comes first; cut the losers and keep the winners.

Is the future for oil rigs that bleak?

I do not think so. I expect DW (deep water) and UDW (ultra-deep water) projects to propel rig demand in the years to come. Recent market weakness may continue in the coming quarters, which means better entry prices. After the declines, we can buy a dollar in sophisticated floating steel for less than 50 cents.

This is the October equity idea for TheOIdEconomy paid subscribers. The topic is drill ships as an Alpha opportunity.

Drill ships are scarce, complex, and expensive assets. An 8G (latest generation vessel) drill ship costs more than $1.0 billion. For reference, a top-notch LNG carrier with a MEGA engine is $260 million. Ordinary vessels like Capezise bulker cost around $75 million, while VLCC cost $125 million.

So, what makes drill ships lucrative despite their prohibitive price?

UDW projects combine attractive economics and low geopolitical volatility. The chart below compares various types of oil fields based on break-even prices. Chart via BORR Drilling.

UDW projects are economically competitive compared to US shale. They also offer a lower reserve depletion rate and lower CO2 intensity. The most attractive UDW projects are in the Atlantic Ocean. This means almost nonexistent geopolitical risk.

On the other hand, the supply of drill ships is limited due to a lack of new orders and available shipyards. The shipyards took a massive hit during the latest market downturn, and now they are very cautious when considering oil rigs.

Next chart tells the demand story:

Accelerating reserves depletion and lack of capital investments are prerequisites for strong UDW tailwinds (the right graph). On the other hand, the left chart illustrates that fossil fuels are here to stay longer than the green cult says. In summary, the long-term demand for UDW offshore equipment is resilient.

Then, where to look for opportunities?