Oil Driller's Rigs Prowl The Planet For More Lucrative Oil Reserves

A sluggish U.S. economy has not kept prices down. Turkey's announced plans to invade Northern Iraq to attack Kurdish rebels could push prices even higher.

OPEC said it will boost daily output by 500,000 barrels in November to stave off surging prices. But the recent hike came after the Energy Department warned that U.S. oil demand could outpace supply in the fourth quarter.

Coupled with China's growing appetite for the black gold, that has pushed oil exploration and production firms to find more reserves.

All this is driving business for drillers such as Atwood Oceanics (NYSE: - ).

Operating In Hot Markets

The Houston-based firm runs eight rigs in some of the world's hottest markets for offshore drilling.

Its geographic footprint covers the coast of West Africa, the Black Sea, Thailand, Malaysia, Australia and the Gulf of Mexico. It also operates in Singapore, though that unit will move to India in December.

Atwood owns five deep-water rigs called semisubmersibles. They sit in water as deep as 5,000 feet and can drill down 25,000 feet or more.

It also owns two shallow-water rigs, known as jack-ups, and one submersible that sits in water 100 feet deep or less.

Atwood rents out its rigs by contract to the highest bidder. Long-term contracts help shield the firm from volatility in the market.

For instance, when a violent storm like Hurricane Katrina shuts down a rig, Atwood still gets paid.

"Management executes a risk-averse strategy that positions the company to maintain high rates of utilization for its offshore drilling rig fleet through the oil-field services activity cycle," said analyst Curtis Trimble of Canaccord Adams. "Long-term contracts ensure that none of the company's rigs will be sitting idle, like other competitors' rigs that operate in the spot markets."

Chief Financial Officer James Holland said Atwood has firm contracts in place for 98% of this year's drilling days, 80% of next year's and 30% of 2008's.

The contracts set a daily rate for the rigs' use, and day rates are surging, Trimble said.

Much of the free rig capacity for 2007 has gone for sharply higher rates than in 2005 and 2006.

"Rates vary from rig to rig, but our semisubmersibles fetch the highest rates," Holland said. "Our Eagle rig off the coast of Australia generates the highest rates for us."

The Eagle is expected to earn an average of $164,000 a day this year. That's up 27% from last year and 73% from 2005. Holland said he expects $400,000 a day by August of 2008.

"Atwood has far greater visibility in the deep-water market than some of its rivals primarily due to high day rates, which are the name of the game for offshore drilling companies," Trimble said.

Day rates for Atwood's jack-up rigs, the Beacon and Vicksburg, will rise 19% and 21% to reach $134,000 and $120,000, respectively.

But Holland doesn't expect much more than that due to softness in the shallow-water market, especially in the Gulf of Mexico.

In February of 2006, Atwood placed a $165 million order for a new jack-up rig. The Aurora, due in the second half of next year, will be Atwood's ninth rig.

Trimble said that today, the order would cost well north of $200 million. Even with its estimated $160million free cash flow this year, Atwood can't afford a new build.

Trimble says the issue now is what the firm does with that money.

"Even a buyback would be counterproductive given management's past efforts to increase its float," he said. "I expect them to declare a special dividend. Somewhere in the range of $7 to $9 seems sensible."

Trimble expects the offshore drilling market to do well in 2007 and 2008, which bodes well for Atwood.

Revenue for the sector will grow 32% to $34.9 billion in 2007, according to market research firm Spears & Associates.

Offshore drilling has posted a compound annual growth rate of 16.4% since 1999, the firm said. Over the past eight years, it has been one of the most dynamic subsectors in the oil-field services industry.

Offshore, deep-water drilling in hot spots such as West Africa and Southeast Asia has translated into big business for Atwood, accounting for more than 60% of revenue.

Sales Increase

Atwood's third-quarter sales rose 37% to $98.4 million. Earnings jumped 28% to $1.00 a share, but that fell a penny shy of Street views.

Expenses such as executive bonuses and rig maintenance pushed results below views in five out of the past six quarters. Despite this, Atwood has posted triple-digit growth over that span, excluding the third quarter.

Atwood released a fleet status report last month that forecast lower costs than it previously had expected. The firm now thinks that its drilling expenses will slide to $46.3 million from $49.4 million.

This prompted Trimble to raise his fourth-quarter profit outlook by 11 cents to $1.35 a share. Analysts polled by Thomson Financial expect $1.40 a share.

"Atwood should exhibit one of the lowest rates of operating volatility in the oil-field services sector," Trimble said. "Expectations for the company's performance largely hinge on management's ability to contain costs and maintain operating margins, something of which they are keenly aware."