3 Deepwater Stocks for Your Watchlist

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Owning oil and gas E&Ps is a very popular way to benefit from rising prices in the energy sector, but there's a lot to be learned from the leading service and supply companies that help the E&Ps find and extract what they need. These global players are intimately involved with every facet of the E&Ps' activity, including providing equipment, surveying prospective acreage, and drilling and completing wells. I've decided to look into the deepwater space for potential investment opportunities.

Intensity means opportunity
As a leading oilfield services company, Halliburton (NYS: HAL) often talks about service intensity, which is the revenue opportunity available for service companies. Halliburton notes that over the last 10 to 15 years, this has grown at a rate of 10% a year. This is not surprising, given that one of the ongoing themes in the energy sector is the slow and steady decline in the discovery of super oilfields. As companies look for oil and gas in harder-to-reach areas, service intensity should continue to increase at a healthy clip.

Over the last two years, Halliburton has enjoyed 25% service intensity growth, particularly in North America. This has been caused by a surge in horizontal drilling and hydraulic fracturing. Due to the growth in hydraulic fracturing and the drilling of more oil wells, pressure pumping has grown at a 17% rate over the past decade. This has caused pressure pumping to become Halliburton's biggest product line.

If the rig count were to stay flat in 2012, Halliburton still believes that the service intensity would grow about 10%. In the U.S., companies have been shifting away from dry gas plays in favor of oil and liquids. That's a favorable shift, since oil drilling carries a service intensity that is 1.4 to 1.8 times greater than that of gas drilling. As onshore E&Ps in the U.S. and Canada continue to shift toward liquids-rich production profiles, Halliburton should benefit from the increased revenue opportunities.

In the offshore markets, Halliburton is bullish on deepwater drilling. The company believes that a deepwater rig can be up to 13 times more service intensive than a land rig. That's a significant revenue opportunity, and the company believes it is well-positioned. It is No. 1 in completions in deepwater and No. 2 in directional drilling and wireline, along with other services.

Longer term, Halliburton is quite bullish on its future (as if that weren't clear already). Despite the robust growth over the last 10 to 15 years, the company believes that trend will only continue because it's going to get more complex and challenging from a technology standpoint, which means more service intensity, or revenue opportunities, for the company and its peers.

Benefitting from increased offshore drilling
Transocean (NYS: RIG) is the largest offshore contract driller. As such, the company benefits from increased offshore oil and gas exploration. That condition hasn't been much of a problem in recent years, as companies have increasingly moved further offshore to look for oil. As the easy-to-find oil slowly disappears, producers will have to continue looking deeper and deeper.

Currently, Transocean has just over $23 billion of contracted backlog. To put that in perspective, analysts currently expect Transocean to earn $2.3 billion in the fourth quarter of 2011 and $10.4 billion for 2012. Considering how fast drilling appetites can fall in times of economic uncertainty, a backlog provides visibility of revenue.

While the backlog looks strong, the company still needs to continue improving. Last quarter, Transocean missed consensus estimates by a mile, clocking $0.07 in earnings per share vs. the expected $0.72. In order to address its performance shortfall, Transocean plans on focusing on revenue efficiency, minimizing rig out-of-service time, and keeping an eye on operating costs. The company believes these three issues will help avoid a repeat of the poor third quarter.

Longer term, Transocean is looking to focus on high-specification drilling and de-emphasize low-specification commodity assets.

More drilling and intensity means more equipment
National Oilwell Varco
(NYS: NOV) is a leader in oilfield products and services. It provides major components for all kinds of land and offshore rigs, well completion, and more. It's a very acquisitive company, having made more than 200 acquisitions in just the past 12 to 15 years. That's a trend that's likely to continue, as the company continues to add more capabilities and regions to its distribution network.

Last quarter, the company announced capital equipment orders totaling $3.9 billion. That increased the company's capital equipment backlog to $10.3 billion, up 33% sequentially. Like the previously mentioned companies, National Oilwell Varco benefits from increasing technological complexity.

One example of the company's technological innovation is its Arctic offshore rig, which runs $700 million to $900 million and is built specifically to withstand harsh environments. The Arctic offshore rig is one of many enhancements made by National Oilwell Varco to meet the needs of its customers. This is the type of high-specification equipment that Transocean is targeting as well.

When National Oilwell Varco reports results this Thursday, consensus analyst estimates call for 27% revenue growth for the quarter and 19% for the full year. Analysts have extended their strong growth projections for 2012 as well, projecting further sales growth of 21%.

Foolish bottom line
All told, I will be following these companies to see how they perform in the quarters ahead. They're all poised to benefit from increased deepwater oil and gas exploration all over the world. If oil prices hold steady, that should continue to be the case.

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At the time this article was published Paul Chi is an analyst on the Fool's Alpha and Duke Street services. You can follow him on Twitter to stay up-to-date on his latest market commentary. Paul and Matt Argersinger co-manage the Street Fighter portfolio, where they look for cheap, unloved stocks with home run potential. Paul owns long-term call options on Transocean. The Motley Fool owns shares of National Oilwell Varco and Transocean. Motley Fool newsletter services have recommended buying shares of National Oilwell Varco. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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