Why higher oil price is positive for offshore drillers

Market Realist

Oil price: A key driver

Oil price is a factor that can influence the capital expenditure levels of oil companies. An attractive level of oil price will encourage oil companies to spend on exploration, drilling, development, and construction activities. On the other hand, when oil price falls, companies will likely scale back on new capital expenditures.

(Read more: Diana Shipping: the most undervalued dry bulk shipping company)


Oil price rose because of Syria

Prices for Brent oil, citing data from ICE Futures, have been rising lately on the back of another possible crisis in the Middle East. This time, it’s Syria. After political upheaval and unrest in Egypt since July sparked concerns that access through the Suez Canal would be restricted, which a large percent of the world’s oil supply are transported through, oil prices have been climbing higher. Labor protests in Libya, which led to port and plant shut-downs in July, also contributed to higher prices.

Talks of a western airstrike against Syria’s use of chemical weapons were the catalyst behind the $6 increase in oil price over just two days (August 27 and 28). Although Syria isn’t a major oil producer, fears that any combat will have a spillover effect on neighboring countries could disrupt oil supply lines. Historically, tensions in the Middle East have often led to higher oil prices.

(Read more: Dry bulk capacity growth slows further, encouraging sign for later half of 2013)

Possible outcomes

If tension escalates, several analysts expect oil price to hit $125 or higher. While negative for the world economy, this would be positive for offshore drillers that are situated in locations such as the Gulf of Mexico, the South East Asia Sea, and off the coast of Brazil if price remains high for the long term. This is because capital spending on off-shore drilling can be quite expensive, so oil companies aren’t willing to jump right into more off-shore spending if they expect a price increase to be just temporarily. This is particularly true for the deepwater and ultra-deepwater segment. Factors such as idle capacity of 2 million barrels per day of production in Saudi Arabia, the coordinated release of oil reserve, and lower demand are possible reasons that the increase would be just temporarily. Besides, it’s not yet clear whether a strike is to happen.

(Read more: New spear bit increases unconventional shale play drilling efficiency 22%)

Impact on offshore drillers

This may seem negative. But industry experts say that off-shore drilling spending could continue to rise as long as oil price is maintained above $90 per barrel. With OPEC (Organization of the Petroleum Exporting Countries) likely to cut production if oil prices do fall below that point, lower oil prices are unlikely to have a material impact on the share prices of Transocean LTD (RIG), Ensco Plc (ESV), Diamond Offshore Drilling Inc. (DO), Noble Corp. (NE), and Seadrill Ltd. (SDRL) over the medium to long term. This also applies to the Market Vectors Oil Services ETF (OIH) as well as the iShares U.S. Oil Equipment & Services ETF (IEZ).

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