Women love good Rigs. Ask any gym bro and they’ll be able to recount a time when they were a weedy little kid in high school with lots of spots and none of the girls were interested in them. Determined to win over least 1 woman they spend the next months, or even years, slaving away in the gym, proving they have the strength and determination to be a man worth considering. This is great. But what women love even more though, is when you have s***loads of money. This is the topic we’ll be exploring today. This will be an analysis of the offshore drilling company Transocean, under the ticker symbol, $RIG.
What do they do?
They own lots of these things.
It’s an offshore oil drilling rig. They’re absolutely massive and contain lots of high tech expensive equipment. They’re used to drill holes in the ocean floor so we can extract oil.
How does the industry work?
You’ve got the big oil producers (Shell, BP, Exxon), we’ll use BP in this example. BP will own the mineral rights to a patch of oil in the ocean. If they want to start drilling that patch, they’ll contact an oil drilling company (Transocean, Valaris, Noble - Transocean in this example). BP will make a contract with Transocean to rent a drilling rig for a period of somewhere between 3 months to a couple of years. Transocean will then go and drill a load of holes in the patch, plug them up, and then an oil platform will come along later, reopen the hole and extract the oil from it. The amount Transocean gets paid for this is called the day rate.
So, Transocean's market is really simple, they own lots of oil drillers. If day rates for them go up, they make more money, if they go down, they lose money. What determines day rates? The demand/supply of offshore oil drillers.
What's the investment thesis?
This is how the stock has performed in the last 15 years. A 99.6% loss from peak to trough.
What happened?
Do you remember in Part 1 when we discussed how everyone had a bit of a panic around the 2000's because we didn’t really have a lot of supply coming online in a world where we were constantly demanding more?
Part of that Panic involved ordering a lot more drilling rigs. It made sense, a large portion of the reserves of oil majors were deep sea, we needed more oil, so we needed more drillships to extract that oil.
The problem is, when shale oil came online in 2010, we now had a massive new supply of cheap oil. It no longer made sense to use the more expensive offshore drilling rigs. This was disastrous for the drillship companies. Because the drillships are so expensive they had bought all the new ones with debt, so when they stopped receiving income they expected from building new ones they were unable to repay the debt interest payments. This caused pretty much every company in the sector to either go bankrupt or experience >95% drawdowns.
What's happening?
Most people think these things are toxic waste. You look at RIG’s chart, or any other oil drillers and most people get scared. They want the comfort of buying NVDA or Property because they always go up, right? Yet the classic rule of investing is to buy what everyone hates and sell what’s hot. The public exuberance in either direction is what makes these things mispriced and you must go against the grain if you want to make money.
As discussed in part 1, US shale has peaked, and we desperately need other ways to bring on new supply. Deep sea will be one of the solutions. Drilling rigs will be absolutely vital for this. So how are they priced?
Valuation
Transocean owns 37 drillships.
A lot of estimates say a newbuild would cost north of $1B, so lets call it $1B to be conservative.
$37B total worth of drillships.
Admittedly, these ships aren’t new now, and they last about 30 years, so we definitely need to subtract a bit from these totals for wear and tear, let's half the total. Also, they have $7.3B debt, so let's subtract that too.
That leaves us with $11.2B.
This represents what Transocean should be worth if you just look at the assets they hold, however the market cap is currently $4.26B. So it's a pretty easy 2.5x. But there’s a couple of reasons I think it could really overshoot this.
Turbo juice
Shipyard capacity has been slashed in the last 10 years, not just due to the bear market in drillships, but also in the wider shipping sector in general. These are very difficult to bring back online and will take years and require highly specialized labour. This will mean when day rates do start to go up, and the drillships are making so much money that it makes sense to start actually building new drillships again, there will be a large delay, not just because they take years to build, but also because the actual shipyards which are used to build them will also take years to build. This provides a nice runway for day rates to really go up to well above what’s required to incentivize new drillships to be built before we start seeing new drillships come online which would bring the price down. Higher day rates will really mean these things start to get re-valued to new levels.
I didn’t really know where to add this above but a big part of the thesis is that drillships last about 30 years, and the dayrates aren’t high enough to incentivize new ones being built. This means drillships will just keep getting scrapped and no new ones will come online until dayrates go up.
Thoughts
The gap between reality and what everyone believes is a vast chasm, and we are here to exploit it. They will hate you for it. When you are making millions driving a yacht around the Caribbean, they will be squealing that they can’t make their latest mortgage payment as their energy bill has gone through the roof so they must live in a cardboard box. But you will be the reason we corrected this mess at a faster pace.
The Pattern
In the first article of this series. We discussed how shale oil in the US was peaking, a complete game changer for the supply of oil moving forward. In the meantime demand will continue to rise. In this article, we explored how $RIG is one of the best ways to play this.
This is all part of a wider pattern though. There’s been a complete lack of respect for the resources which sustain our modern, high quality standard of living. Capital has been starved from these industries in favour of overhyped US tech companies, and taking out 10% loan to value mortgages to pump up the housing market, because the housing market always goes up, of course. A reversal of the 40 year trend of declining interest rates, won’t have any effect on the size of mortgages people can afford.
Anyway, there's a lot of other ways to play this meta-theme of us not investing enough in the capital required to sustain and grow the production of vital resources. I cba to write an article on all of them, so here’s a few others people have written:
Disclaimer: I’m meant to put a disclaimer saying this isn’t financial advice, do your own research, and you should consult a financial advisor. I fully agree with the part which says do your own research. You should. Read lots of books/interviews and form your own ideas on the market. Financial advisors are often idiots though, I’ve spoken to a few of them and they were mostly clueless and they’re literally trained and forced by regulation to give you terrible advice like buying bonds is safe 🙇
Cheers! Give this one a read by ferg too https://open.substack.com/pub/traderferg/p/going-from-fcked-to-sort-of-shitty?utm_source=share&utm_medium=android&r=5qwsz
I think Dolphin Drilling might actually be better than Rig, I just didn't want to copy ferg + You need to have some large balls for this 😂
Nice one, the long-term chart of RIG once again gives me some motivation finally open a position. I'm watching this market since early 2021 and never got into it. (ouch, yes). Always was thinking I missed the move.