Don't Miss Out on These Offshore Drillers

The outlook for offshore drilling companies looks especially strong. A confluence of factors, including high oil prices and a recent spate of major offshore deepwater discoveries, has created an exceptionally strong market for their services. Two offshore drillers in particular deserve to be on any energy investor's radar.

No more easy oil
While shares of offshore drillers took a beating after the Gulf of Mexico oil spill, they've recovered nicely since, especially in recent months. One important factor playing in their favor is $100-plus oil. The higher the price of oil, the greater the incentive for E&Ps to go out and find it tends to be. And with the end of the era of "easy oil," E&Ps have to use craftier methods in harder-to-reach places to extract that precious black gold.

According to Wood Mackenzie, a global energy and mining research and consultancy firm, total exploration spending by major Western oil companies is already over $80 billion this year, a 25% rise from just two years ago. There are two main unconventional sources to which E&Ps are flocking. One is oil and gas shale deposits. And the other is offshore deepwater.

Digging a little deeper
I think if there's one phrase that sums up the trend in deepwater drilling over the past few years, it's "deeper and deeper," as companies explore ever-deeper into the uncharted depths of the ocean. The search for oil has led them to new and exciting frontiers in places like offshore West and East Africa and Brazil. Meanwhile, the lifting of the moratorium on oil and gas drilling in the Gulf of Mexico has reintroduced a flood of companies into that region's deepwaters.

Currently, the deepest offshore production well in the world, located in the U.S. Gulf and operated by Shell, is an astonishing 9,356 feet below the surface. And according to data from IHS Offshore Rig Consulting, ultra-deep wells -- defined as those drilled in depths of at least 4,500 feet -- have accounted for more than half of all global oil discoveries so far this year.

Technological improvements
While sustained high oil prices provide the biggest incentive for companies to take on the higher capital spending required to drill in offshore deepwater locations, breakthroughs in drilling technology have also been a major catalyst.

Think about it for a moment. Companies are now able to find oil even 5 miles below the surface, down in the depths of the sea floor. From this perspective, the progression of deepwater drilling technology over recent decades is nothing short of remarkable. It's a reflection not only of the scarcity and necessity of oil, but also a testament to human ingenuity. But of course, these radical technological advances come at a high price.

Offshore drilling, especially deepwater and ultra-deepwater, is one of the most expensive and complex ways of extracting hydrocarbons. Companies pursuing offshore drilling opportunities have to deal with massive capital investments, long-term contracts, and a growing need for service and technological expertise.

And with the Macondo blowout still fresh in the industry's memory, E&Ps are placing a premium on safety. Companies operating in these exotic offshore deepwater locations are working harder than ever to make sure they don't get slapped with massive penalties for leaks, blowouts, and equipment failures. This means that older equipment, which fails to meet new safety standards, is on the chopping block for being dismantled.

2 companies to keep on your radar
With more than half of the global rig fleet more than 25 years old, oil companies are increasingly demanding newer-generation rigs with improved safety features. This has prompted a flood of new orders, with more operators requesting items like additional blowout preventers and better well-control systems. This is one major reason to like Ensco (NYS: ESV) and Seadrill (NYS: SDRL) , which both own some of the newest deepwater and ultra-deepwater fleets in the industry.

Ensco is a winner in terms of overall fleet quality, boasting the world's largest offshore drilling fleet, as well as one of the industry's youngest ultra-deepwater fleets. It also has a strong history of effective capital allocation and a shareholder friendly-management.

Seadrill is also a standout in terms of overall fleet quality. It has some of the newest and best rigs out there and has got companies clamoring for contracts even years out into the future. And these companies are more than willing to pay up for Seadrill's services, as reflected by the company's superior day rates. Last but not least, Seadrill has a history of passing through the bulk of its cash flow as dividends to shareholders, with a current yield of 8.5%, easily the highest in the industry.

In fact, both companies offer some of the best dividends in the space. While Ensco's 2.6% dividend yield is tiny in comparison with that of Seadrill, it's notably higher than competitors Noble (NYS: NE) and Diamond Offshore (NYS: DO) , whose yields come in at 1.5% and 0.8%, respectively. Meanwhile, the largest offshore driller in the world, Transocean (NYS: RIG) , recently announced that it's halting its dividend for this year.

Digging deeper

Though it has the youngest fleet of all its competitors, Seadrill isn't a sure thing for investors. To learn more about the strengths and weaknesses of the offshore driller, as well as what to expect from the company going forward, be sure to check out this brand-new premium report our analysts have put together. Get started.

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Fool contributorArjun Sreekumarowns no shares of any companies listed above. The Motley Fool owns shares of Transocean and Seadrill.Motley Fool newsletter serviceshave recommended buying shares of Seadrill. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days. The Motley Fool has adisclosure policy.

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