6-8x Upside For The Entire Industry

The great thing about starting a newsletter on investing is all of the connections I have made. Through the past few years I have gotten to know a lot of you on a personal basis and have made some valuable connections. One of these connections recently sent me a 100-page presentation on my new favorite industry: offshore drilling.

The presentation is impressive and lays out the thesis on why offshore drillers are going to make a lot of money over the next few years. The presentation is confidential so I can’t share it with all of you. But I have decided to write about the industry in this post and I have pulled a few slides from the presentation. If my analysis on the industry is correct, public equities will be multi-baggers over the next few years. Day rates will continue to improve, costs will stay the same and operating leverage and free cash flow will kick in.

The oil and gas industry is in the middle of an inflection point and we are about to see some incredible returns. Returns will come because capital expenditures for the oil and gas industry have fallen from $700 billion in 2014 to only $300 billion in 2021. The demand for hydrocarbons is back in full swing and the price of oil is elevated and likely to stay there for years to come. Said a better way, there is a massive amount of “catch-up” needed on the capital expenditure side of the equation that will keep energy prices elevated and cash flows flowing.

In my opinion, the companies and industry who will benefit the most from a resurgence in oil and gas investment is offshore drillers. The thesis is simple:

1. Offshore drilling is essential for the future source of oil and gas production. If you want to consume oil and gas you need offshore drilling.

2. The industry went through a massive restructuring and bankruptcy process that has changed the dynamics of the industry. Almost all players have clean balance sheets and investors want a return of capital.

3. 50% of the fleet was scrapped during the past nine year downturn. There is likely to be a rig shortage that will drive up day rates.

4. The costs to build a new drillship is over $1 billion and will take 2-3 years to complete. No one is building new drillships at current day rates. For more supply to be added we need rates to at least double. Should rates double, operating leverage will kick in and offshore drillers will print money.

5. Public equities are trading at $0.20 on the dollar per replacement cost. Investors are essentially buying $1 billion drillships for $200 million, with an extremally tight market and day rates expected to rise.

The setup for offshore drillers looks incredible. You don’t often find equities trading for pennies on the dollar with vastly improving economics. An investment in the industry looks like a homerun. And I am swinging hard. As some of the greatest oil and gas investors recently said just a few months ago…

“When the global economy recovers, we can expect demand to rebound further, eliminating the little spare oil production capacity out there,” Aramco’s chief executive officer, Amin Nasser, said in a speech on Tuesday. “By the time the world wakes up to these blind spots, it may be too late to change course. I am seriously concerned.”

So let’s have at it. This is why I am buying offshore drillers. This is why I am buying the entire industry. I am buying everyone of them.