Working on an oil rig is a dangerous job. A friend of mine trod the decks for many years and has several harrowing tales of near-death experiences in high seas and gale-force words. Ultimately, he gave it up. "The money's not much use to my family if I'm not there," he said.
But money's a big draw, and while he may have quit, more and more people are taking his place. The industrialisation of Asia has sent oil demand – and prices – through the roof. After years of underinvestment, companies are now pumping money into finding new fields and boosting production from old ones.
All that means a boom in offshore exploration. Much of the world's offshore oil is off limits when prices are low, because it's more expensive and difficult to tap than easier, onshore targets. But high prices change all that. Offshore exploration is hot again and Asia is one of the top destinations …
Asia has plenty of oil – under the sea
Like Britain, many Asian nations have little or no oil onshore. But there's a decent amount lying off their coasts. One reason it hasn't yet been widely exploited is that it's often in quite deep water, or subject to other conditions that make it hard to access. But with governments keen to boost production to improve energy security and cut export bills, exploration activity is rocketing.
The number of offshore rigs under contract in the Asia-Pacific region is 104, up from 92 this time last year, according to the latest weekly survey from ODS Petrodata. Almost all available rigs in the region – a full 98% – are booked.
This boom is not going away anytime soon. While the price of oil looks likely to fall back further as the global economy slows, this is a short-term cycle in a long-term bull market. Asia's demand for oil can only grow as it gets richer and richer – per person, China still only uses 10% as much oil as the USA. Sure, alternative energy sources and greater energy efficiency are going to be very important, but they can't plug the gap alone. We need higher oil production and we need to be investing for that now if we don't want to have a serious supply shortfall in the future
So it's a good thing that even if the oil price weakens, exploration is likely to continue. Even now, no oil company is making its investment decisions for new projects based on $150/barrel oil or $120/barrel or even $100/barrel. Around $60-$70/barrel is typical for large producers, and since it's hard to see oil prices falling below this level, there will be plenty of busy rigs off the shores of Asia over the next few years.
How to profit from rising exploration costs
But what's the best way to invest from this offshore drilling boom? The oil companies are one route – but they don't always make as much money as you might think. Governments pocket a hefty share of the proceeds, while rising exploration and production costs eat into returns. For example, take a look at this chart, from ODS Petrodata. It shows how the daily cost of hiring a high-end drilling rig has soared since 2005, while capacity remains exceptionally tight.
The oil majors generally are still decent long-term investments, especially given their hefty dividend yields. But right now, the best way to make money in the oil sector is through those firms that benefit from rising costs – the oil service providers.
These companies work for the oil producers, doing everything from operating rigs to scanning potential drilling areas and recruiting staff, to developing software. They range from international giants such as Schlumberger and Halliburton to one-man firms operating out of the back of a jeep.
Investors are already awake to the potential of many of the big stocks. Schlumberger trades on a forward p/e of 20 and Halliburton on 15. This is still pretty reasonable given their growth prospects. But plenty of other firms out there are less well-known and offer even more upside.
Great growth from deep water
One such company is Singapore-listed Ezra Holdings. Ezra is an offshore support services provider. It operates a fleet of boats that can tow rigs into position, anchor them and ferry supplies to them - known as anchor handling tug supply (AHTS) vessels. The company has been in this business since 1992, but in 2004 it made a very canny decision that is paying off in style.
Ezra's management recognised that producing oil from fields that are a long way off shore, in deep water and often harsh conditions, was going to be a key growth area. As the easy-to-tap fields are exhausted, dependence on deep-water oil (as well as other expensive, unconventional sources) will increase. As the chart below shows, deep-water production is on track to quadruple between 2000 and 2010.
Ezra realised that there would be high demand for vessels capable of supporting deepwater rigs. So they began to replace and upgrade much of the company's fleet. Today it operates a young, modern fleet of 32 boats – almost all less than five years old – with around 75% capable of operating in deep water. This move has lead to spectacular revenue growth, as the table below shows.
Ezra's deepwater niche allows it to command higher rates for its fleet: its charter rates are up by around 45% since the start of 2007. The tight market for deepwater-capable vessels has seen producers book ships on multi-year contracts. That gives Ezra a nice reliable earnings stream on its existing boats, while it's still able to profit from any further growth in charter rates as it steadily adds new vessels to the fleet.
Having gained an early-mover advantage, the firm is now diversifying and moving into higher-margin work. It has five multi-functional support vessels (MFSVs) on order for delivery in 2009 and 2010. These higher-end, more powerful ships will let it serve clients operating in ultra-deep water.
It also has exposure to the market for heavier vessels through a 48.9% stake in Oslo-listed EOC. This once wholly-owned subsidiary was spun off last year. It currently operates four large vessels, including crane barges and a newly-commissioned gas floating production, storage and offloading (FPSO) system, which has already been booked for a five-year, US$400m-contract in the Gulf of Thailand. EOC is growing as strongly as its parent, with profits up 267% in the nine months to May.
Ezra is also building a manufacturing and training yard in Vietnam, which already has an order book of US$214m. It has a nascent energy services unit, which it hopes will tap high-growth markets in well maintenance work, and also holds a 21.8% stake in Ezion Holdings, a small Singapore-listed offshore services provider of jack-up rigs and offshore accommodation.
Ultimately, the firm plans to expand from being a regional provider to a global one, growing its services in other areas where deep-water exploration will be a key part of future production. Most important are the North Sea, West Africa and especially Latin America, where Petrobras's recent discovery of several deep-water fields in the Santos Basin is likely to further increase demand for deep-water support vessels.
The best thing about Ezra – it's cheap
All this should add up to many years of strong growth at Ezra. Yet the share price doesn't reflect that. After falling 50% from its peak in November 2007, it now trades on a forward p/e ratio of just 10.6 for 2009 and a dividend yield of 1.9%. The sharp fall in Asian equities pulled it down in the first half of the year, followed by a 33% fall since the beginning of June as oil slumped, even though at these levels, a $30/barrel fall in oil will have little impact on service providers' earnings.
So what are the risks with the stock? The main one is that the market for support ships ends up being oversupplied and charter rates fall abruptly. That's possible. This is a cyclical industry that tends to suffer supply gluts and there are around 200 AHTS vessels on order at shipyards around the world. But there is also a large order book of new drilling rigs – around 180 - that will require AHTS vessels to support them, while much of the AHTS fleet is old and will need to be replaced over the next few years.
Combine that with the likelihood that we are in a secular oil bull market – instead of the cyclical boom-and-bust markets of the last couple of decades – and the risk looks limited. That's especially true in Ezra's niche of modern, larger, deep-water capable boats and the firm's goal of steadily moving into more advanced areas such as ultra-deep-water support should ensure that it doesn't have to worry too much about an excess of competition as long as the deep-water drilling boom remains in place.
Of course, with any company that's expanding rapidly, there's always a risk that it could overstretch itself. But the presence of a highly-experienced management team who've been through many oil-industry cycles means it's unlikely to fall into this trap. And after the spin-off of EOC last year, the balance sheet looks solid enough to support its growth plans. As of May 2008, the ratio of interest-bearing debt to equity was just 0.3 and it had $145m of cash on hand.
With increased oil demand a major consequence of the Asian growth story, it's a good idea to have a high-quality stock that plays this theme among your holdings. Ezra looks an excellent way to gain exposure and at this price, is great value. There is a risk that shares will drift lower in the near term, especially if oil comes off further, as we expect. But for investors with a long-term view, it's a buy.
Turning to the markets …
There should be no doubt that Asia – like the rest of the world – is in a near-term bear market. Last week was again a sea of red across the board. China's CSI 300 index bounced 8% at one point in the week on speculation of government measures to strengthen the economy and more rumours of direct intervention in the stockmarket. Yet by Friday, it had given up all those gains and still closed down 1.7% on the week.
In Thailand, the flight of ex-prime minister Thaksin Shinawatra has not buoyed the bourse. Thaksin, who was facing charges of corruption, has gone into exile and claimed asylum in Britain. But few believe his departure will solve the country's political problems. Both he and the current government of Thaksin loyalists are highly popular in rural areas, but widely disliked by the urban population. Consequently, the country's power struggle is likely to continue, with the opposition using every trick to undermine the government and increasing the risk of political paralysis.
As usual, Vietnam bucked the trend, closing up 7.8% as the market continues to regroup after its impressive implosion earlier this year. Investors are also warming to the country in the currency markets. Three months ago, they were betting on a full-fledged currency crisis and the dong collapsing from around 16,000/USD to 25,000/USD over the next twelve months. Now, after a small devaluation and signs that the worst of Vietnam's problems may be priced in, traders have slashed their expectations, Markets now expect the dong to weaken to around 19,000/USD by this time next year.
Despite the gloom, investors still seem upbeat on the infrastructure theme. China South Locomotive, the state-controlled firm that is the country's largest train manufacturer, floated successfully in Shanghai and was up 45% by Friday. The stock also listed in Hong Kong at the end of the week. China Railway Group, one of the two state-controlled railway construction giants, rose in Hong Kong on speculation that it will report higher-than-expected earnings this week.
• This article is from MoneyWeek Asia, a FREE weekly email of investment ideas and news every Monday from MoneyWeek magazine, covering the world's fastest-developing and most exciting region. Sign up to MoneyWeek Asia here .
Published in Stock markets
| More articles
by
Cris Sholto Heaton
Related articles
-
By Cris Sholto Heaton, Dec 01, 2008
-
By Cris Sholto Heaton, Nov 24, 2008
-
By Cris Sholto Heaton, Nov 17, 2008
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.
