For Transocean, bigger isn't always better

The offshore drilling company has a huge advantage when supply is tight. But what about when markets are soft?

By Jim J. Jubak Dec 7, 2010 7:20PM

Jim JubakSometimes it doesn't pay to be the biggest. 

If you're the biggest company in the market and control capacity in your industry, that's a license to print money when supply for your product is tight. When supply runs ahead of demand, however, the pressure is on to support prices across your industry by reducing your capacity. 

This is the story for Saudi Arabia, the swing producer in the Organization of Petroleum Exporting Countries, for Potash of Saskatchewan (POT) in potash fertilizer, and for Transocean (RIG) in the offshore drilling industry.  

Transocean's 139 drilling rigs give the company by far the biggest offshore drilling fleet. And that's a huge advantage when supply is tight in the industry and Transocean can ride the ever-higher day rates for rigs to higher and higher profits. 

Right now size isn't exactly a blessing, because Transocean's huge fleet covers all the segments of the offshore drilling market. 

Some segments are doing just great: Deep and ultra-deep rigs are still in short-supply, even with the drilling moratorium in the Gulf of Mexico after the BP-Transocean-Halliburton Macondo disaster. Day-rates have pushed back over $600,000, and contracts have stretched out to 10 years or more.  

But 65 of Transocean's 139 rigs are jack-up rigs, and the jack-up market is very, very, very soft. And the mid-water market isn't a whole lot better. Transocean's mid-water floater fleet numbers 26.  

By my count, Transocean has stacked roughly half of its jack-up rigs. (That means the company isn't actively marketing the rigs, and they aren't fully crewed in order to save money.) 

And that problem doesn't look like it will get better very soon. A majority of the jack-up rigs set to be delivered over the next few years -- they were ordered when demand was high and companies didn't cancel as many as you might expect because they were worried about losing their place in the shipyard line -- are spec rigs. 

That means they don't have customers waiting to put them to use when they're finished. That will exert more downward pressure on day rates for this kind of rig -- and keep Transocean from moving its stacked rigs back to work very soon. 

Shares of Transocean are up 65.8% from their bottom on June 9 at $42.58 through Dec. 7. Of course, the shares plunged from $92.03 on April 20 to that June 9 low -- or 53.7%. April 20, 2010 was the day that the Deepwater Horizon rig in the Gulf of Mexico blew up, killing 11 workers on the rig. 

I think you can do better in the drilling sector right now with a specialty company rather than going with the biggest player in the sector. 

To make room for a specialty drilling play or two, I'm selling Transocean out of Jubak's Picks today with a 66% gain from the low on June 9 and a 49% loss since I added the shares of the portfolio on Aug. 1, 2008, just before the energy sector tanked in the Great Recession. 

At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. The fund did not own shares of Transocean as of the end of the September quarter. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here. 

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