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Gushing Revenue for Drillers

By Stewart Glickman Tucked into the new Energy Policy Act of 2005, signed into law by President Bush on Aug. 8, is a provision that could benefit oil and gas drilling outfits.

Under the new legislation, drillers, who pay the government royalties when they produce oil and gas, will see additional relief from those royalties -- i.e., Uncle Sam will get a smaller portion -- for deepwater and ultradeep gas production in the U.S. Gulf of Mexico. The upshot: The new law could provide a greater incentive for these companies to drill new wells.

While we would note that the extent to which such relief will be incremental to existing royalty-relief programs is unclear, we are maintaining our positive outlook on the drilling subindustry.

RECORD FEES. Our assessment stems from extremely high oil and gas prices, production declines for existing wells, rising day rates (daily rig-operating fees charged to customers) for contract drillers, and high rates of rig utilization. We think that capital spending will remain high, particularly in international regions with low-cost drilling opportunities.

We believe drillers may see more of an upside even after a remarkable run thus far in 2005: Through Aug. 5, the S&P Oil & Gas Drilling index had advanced 37.6%, vs. a 1.8% gain for the S&P 1500 index.

Onshore North America has seen a number of land drillers generate record day rates and daily margins in 2005. We attribute the high day rates in part to a significant scarcity of available drilling rigs.

MIGRATING RIGS. With oil and gas producers concerned as much about rig availability as pricing -- and expectations that rig demand will remain high in the near future -- there recently has been increasing interest for long-term deals that secure rigs for up to three years. In some cases, land drillers are embarking on programs to build new rigs in exchange for such long-term commitments.

In the Gulf of Mexico, day rates are on the rise due to a combination of high demand and tight supply. With the migration of rigs to other regions around the globe, such as the Middle East, day rates will continue gaining, we believe. Information from ODS-Petrodata, an energy data and consulting firm, indicates that average day rates for 300-foot independent-leg cantilevered jack-ups (a type of mobile offshore drilling rig) hit more than $65,000 per day in July, 2005, up more than 30% from the beginning of the year.

Day-rate gains for semisubmersible rigs (floating offshore drilling units whose pontoons and columns, when flooded, cause the unit to submerge to a predetermined depth) have been similarly impressive, with average day rates up more than 40% since the beginning of the year.

DEPLETION EXPECTED. The GSF Celtic Sea, a 4th-generation semisubmersible owned by GlobalSantaFe (GSF

; recent price, $47) and capable of drilling in 5,750 feet of water, recently signed a one-year contract to commence in September, 2006, at a rate of $325,000 per day -- compared to a previous contract high of $175,000 per day.

Internationally, supply-demand fundamentals look very strong in the Middle East, West Africa, and the North Sea, where we think demand could exceed supply in 2005. Russia should see strong growth, although we think concerns over potential supply disruption and political issues make this a higher-risk region.

Over the longer term, we expect demand for drilling services to increase. In the U.S., we believe high depletion rates for existing oil and gas fields and increasing demand for natural gas will continue to support healthy drilling activity, both on land and offshore.

HOT INVESTMENTS. Internationally, we expect additional spending by major oil companies, as well as by state-owned oil companies, to serve as the main growth driver for drilling, as they continue to search for low-cost opportunities, mainly in new regions around the world. Planned building activity for new drilling rigs is modest, but rising, with 30 to 35 new jack-up rigs currently anticipated in the next several years.

Where does S&P see opportunity for investors among the drillers? Our top names in the group include GlobalSantaFe and Nabors Industries (NBR

; $67), both of which are ranked 5 STARS (strong buy), and Noble Corp. (NE

; $69), which carries a 4 STARS (buy) opinion.


S&P STARS: Since January 1, 1987, Standard & Poor's Equity Research Services has ranked a universe of common stocks based on a given stock's potential for future performance. Under proprietary STARS (STock Appreciation Ranking System), S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential versus the expected performance of a relevant benchmark (e.g., a regional index (S&P Asia 50 Index, S&P Europe 350 Index or S&P 500 Index), based on a 12-month time horizon. STARS was designed to meet the needs of investors looking to put their investment decisions in perspective.

S&P Earnings & Dividend Rank (also known as S&P Quality Rank): Growth and stability of earnings and dividends are deemed key elements in establishing S&P's earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of rankings:










Above Average


In Reorganization




Not Ranked


Below Average

S&P Issuer Credit Rating: A Standard & Poor's Issuer Credit Rating is a current opinion of an obligor's overall financial capacity (its creditworthiness) to pay its financial obligations. This opinion focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. It does not apply to any specific financial obligation, as it does not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation. In addition, it does not take into account the creditworthiness of the guarantors, insurers, or other forms of credit enhancement on the obligation. The Issuer Credit Rating is not a recommendation to purchase, sell, or hold a financial obligation issued by an obligor, as it does not comment on market price or suitability for a particular investor. Issuer Credit Ratings are based on current information furnished by obligors or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any Issuer Credit Rating and may, on occasion, rely on unaudited financial information. Issuer Credit Ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or based on other circumstances.

S&P Core Earnings: Standard & Poor's Core Earnings is a uniform methodology for calculating operating earnings, and focuses on a company's after-tax earnings generated from its principal businesses. Included in the Standard & Poor's definition are employee stock option grant expenses, pension costs, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, purchased research and development, M&A related expenses and unrealized gains/losses from hedging activities. Excluded from the definition are pension gains, impairment of goodwill charges, gains or losses from asset sales, reversal of prior-year charges and provision from litigation or insurance settlements.

S&P 12 Month Target Price: The S&P equity analyst's projection of the market price a given security will command 12 months hence, based on a combination of intrinsic, relative, and private market valuation metrics.

Standard & Poor's Equity Research Services: Standard & Poor's Equity Research Services U.S. includes Standard & Poor's Investment Advisory Services LLC; Standard & Poor's Equity Research Services Europe includes Standard & Poor's LLC- London and Standard & Poor's AB (Sweden); Standard & Poor's Equity Research Services Asia includes Standard & Poor's LLC's offices in Hong Kong, Singapore and Tokyo.

Required Disclosures

In the U.S.

As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 30.2% of issuers with buy recommendations, 57.5% with hold recommendations and 12.3% with sell recommendations.

In Europe

As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 34.4% of issuers with buy recommendations, 46.8% with hold recommendations and 18.8% with sell recommendations.

In Asia

As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 33.3% of issuers with buy recommendations, 47.2% with hold recommendations and 19.5% with sell recommendations.


As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 31.0% of issuers with buy recommendations, 55.4% with hold recommendations and 13.6% with sell recommendations.

5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.

4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.

2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.

Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index and in Asia the S&P Asia 50 Index.

For All Regions:

All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.

Additional information is available upon request to Standard & Poor's, 55 Water Street, NY, NY.

Other Disclosures

This report has been prepared and issued by Standard & Poor's and/or one of its affiliates. In the United States, research reports are prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"). In the United States, research reports are issued by Standard & Poor's ("S&P"), in the United Kingdom by Standard & Poor's LLC ("S&P LLC"), which is authorized and regulated by the Financial Services Authority; in Hong Kong by Standard & Poor's LLC which is regulated by the Hong Kong Securities Futures Commission, in Singapore by Standard & Poor's LLC, which is regulated by the Monetary Authority of Singapore; in Japan by Standard & Poor's LLC, which is regulated by the Kanto Financial Bureau; and in Sweden by Standard & Poor's AB ("S&P AB").

The research and analytical services performed by SPIAS, S&P LLC and S&P AB are each conducted separately from any other analytical activity of Standard & Poor's.


This material is based upon information that Standard & Poor's considers to be reliable, but neither S&P nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. With respect to reports issued by S&P LLC-Japan and in the case of inconsistencies between the English and Japanese version of a report, the English version prevails. Neither S&P LLC nor S&P guarantees the accuracy of the translation. Assumptions, opinions and estimates constitute Standard & Poor's judgment as of the date of this material and are subject to change without notice. Neither S&P nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue. Prices, values, or income from any securities or investments mentioned in this report may fall against the interests of the investor and the investor may get back less than the amount invested. Where an investment is described as being likely to yield income, please note that the amount of income that the investor will receive from such an investment may fluctuate. Where an investment or security is denominated in a different currency to the investor's currency of reference, changes in rates of exchange may have an adverse effect on the value, price or income of or from that investment to the investor. The information contained in this report does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.

For residents of the U.K.: This report is only directed at and should only be relied on by persons outside of the United Kingdom or persons who are inside the United Kingdom and who have professional experience in matters relating to investments or who are high net worth persons, as defined in Article 19(5) or Article 49(2) (a) to (d) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001, respectively.

Readers should note that opinions derived from technical analysis might differ from those of Standard & Poor's fundamental recommendations.

Analyst Glickman follows shares of oil and gas drilling companies for Standard & Poor's Equity Research Services

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