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Transocean--An Opportunity Amid Uncertainty

We like this offshore drilling firm's profit potential and prudent approach.

Stephen Ellis, 07/30/2010

These articles were originally published in June and July 2010 for the Opportunistic Investor newsletter.

We think that opportunities are opening up across the energy industry because of the whole Gulf oil spill fiasco. One of these is Transocean RIG, whose rig BP BP was leasing when the disaster struck. The market is currently terrified of anything connected with BP or the Gulf of Mexico. Because Transocean is smack dab in the middle of the mess, its stock has fallen to $45* from $92 in a rapid fashion. 

There is no question there is a tremendous amount of uncertainty around the company and the industry. Deep-water drilling is heavily restricted in the Gulf of Mexico, and thousands of barrels of oil have leaked into the Gulf. The eventual damages will reach tens of billions of dollars. Despite these risks, we think investors have also unduly punished Transocean. As we will show below, we think the oil spill will affect the company's fundamentals less than what investors are expecting, and the stock represents a compelling investment today.

Impact of the Oil Spill on Transocean
The loss of Deepwater Horizon, though tragic, doesn't have a huge impact on Transocean's financial health. The rig was insured, and the insurance already paid out the claim. In fact, in the short term, the $560 million insurance payout is a good thing for Transocean.

We think there are two main sources of uncertainty for Transocean:

* Potential financial liability from the oil spill

* Structural changes to the deep-water drilling industry, especially if drilling in the Gulf is banned for a long period of time.

Let's tackle these one by one. The regulatory/legal framework governing the spill is the Oil Pollution Act, enacted in 1990 after the Exxon Valdez disaster in 1989. The OPA basically sets up a mechanism where affected people (fishermen, people who own beachfront property, and so on) can receive compensation from a "responsible party," which is designated by the Coast Guard.

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