This hot sector is producing returns like Nvidia's — and it's got nothing to do with AI

By Steve Goldstein

Critical information for the U.S. trading day

The International Energy Agency last week said demand for all three major fossil fuels will peak this decade. Even beyond a crass "go woke, go broke," many investors just don't agree, and the replacement sources have their own issues. Surging costs have put key U.S. offshore wind projects in jeopardy, as a writedown from Ørsted brought into view, as nuclear projects globally also run into a myriad of cost and operational issues.

And even if you do agree that oil is near its peak, the ESG movement is limiting both the money and places that can be drilled, notes famed investment author John Mauldin. "Economics 101 says that if you reduce a supply of something that has an increasing demand the price is going to rise," says Mauldin, who it should be noted is affiliated with anindependent oil and gas operator.

And that's what has happened, particularly for offshore oil plays. The VanEck Oil Services ETF OIH has shot up 51% over the last 52 weeks, a period in which the S&P 500 has gained 15%. The stock of one oil services company, Weatherford International (WFRD), has surged 202% over that time frame, a period in which Nvidia (NVDA) shares have gained 228%. Transocean (RIGN.EB) and Tidewater (TDW) are pretty close to tripling their value over the last 52 weeks.

Not that anyone seems to care. Check out this photo from a Barclays offshore oil conference, which at least for one session was filled with empty chairs.

Rupert Mitchell, the author of the Blind Squirrel Macro blog, is focused on owners and operators of oil rigs or drill ships, their support vessels, and specialist service providers, with a combined market cap of $30 billion. Valaris (VAL), Noble (NE) and Weatherford each have emerged from bankruptcy with limited to no debt, while Transocean is debt-ridden but has the largest number of high-end assets, putting it in position to be a first mover of taking advantage of rising day rates. Tidewater is a leader in the platform supply vessel market.

His argument is simple -- there's high utilization rates, of more than 90%, and climbing day rates, which as it sounds is just the daily cost for drilling. At the same time, the offshore companies are trading at as much as an 80% discount to the value of their replacement cost, which prevents new equipment from being built. Shipyards, burned by the sector in the past, are focusing instead on hot sectors like liquified natural gas carriers.

"Bottom line -- no new drill ships, floaters, jack-ups, PSVs etc. are going to get built until day rates have spent a reasonable amount of time way above current levels (to make newbuild economics begin to look sensible). We are a way off that point. Oilfield equipment and services players with low average age fleets are going to increasingly become price-makers," he writes.

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-Steve Goldstein

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09-19-23 0336ET

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