Here’s Why Offshore Drilling Stocks Are Up Big Today

What happened

On June 27, shares of Seadrill Ltd (NYSE: SDRL), Diamond Offshore Drilling Inc (NYSE: DO), and Ensco PLC (NYSE: ESV) traded up more than 10% at various points. And while they’ve cooled off a bit — up 9.9%, 10.3%, and 8.9%, respectively, at recent prices — they continue to march toward today’s close with big gains. And while not quite as much as the three aforementioned companies, shares of Transocean LTD (NYSE: RIG) and Noble Corporation PLC (NYSE: NE) are showing big days as well, up 6.4% and 7.2% in late-afternoon trading.

So what

More oil supply news is driving today’s big price jump. Following last week’s generally positive news from OPEC, which said it would increase oil production by a modest level, oil markets were stunned today when it was announced that nearly 10 million barrels of oil were removed from U.S. storage facilities last week. This big drop in the amount of crude oil in U.S. inventory was more than triple what was expected.

Image source: Getty Images.

In response, both U.S. and global crude oil futures surged again today. West Texas Intermediate climbed almost 3%, closing just below $72.50, while Brent futures gained 1.3% to $77.35. Furthermore, there are serious reasons to expect U.S. oil inventories could fall even more during the peak summer driving season as supply challenges from major sources in Canada and West Texas remain constrained.

Lastly, the U.S. government is ramping up its pressure on Iran, with the State Department now threatening sanctions against other countries who accept crude from Iran once the calendar turns to November. Most experts say it’s unreasonable to expect other producers could offset that production by November, or for Iran to cut output that quickly.

Now what

The reality is, today’s higher oil prices mean very little for offshore drillers, since their operations are under contracts at set prices unrelated to oil or gas market prices. But on the other hand, the supply concerns, along with rising prices, could bode very well for the entire offshore sector in coming years.

Offshore oil and gas resources can be very expensive to bring online, and they can take years to develop. But once they start producing, these offshore plays generate some of the cheapest oil in the world, making those start-up costs well worth it. And if oil producers see an environment where they can project long-term demand and higher prices, it’s a lot easier to justify the multi-year, multibillion-dollar investments it takes to bring offshore oil online.

After years of cuts, it’s looking more and more like oil producers are going to start spending more offshore in coming years. 2018 has seen a modest increase in offshore development from last year, but investments are still lower than they were just a few years ago. And that’s going to have to reverse at some point, simply to make up for the natural decline from oil fields.

And I think now’s a good time to consider investing in the space, with all of the major drillers’ stocks still trading at a substantial discount to the book value of their assets (though I would suggest waiting for Seadrill to emerge from bankruptcy before considering it.) At the same time, this segment isn’t for the faint of heart; there will be plenty of days in coming years where offshore drilling stocks move by double-digits. Just remember that some of those days will be down, too, and invest according to your ability to ride out the volatility.

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Jason Hall owns shares of Diamond Offshore Drilling, Ensco, Noble, and Transocean and has the following options: long January 2019 $15 calls on Transocean. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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