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Deepwater Services Firm Going Strong

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The end of easy oil means it takes a lot of effort to find and extract the next generation of "elephant" wells, and this firm is leveraged to that trend.

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My firm remains bullish on the tightening supply-demand balance in the market for ultra-deepwater drilling rigs and high-specification deepwater units.

With customers contacting contract drillers about extending contracts a year or two before they expire, we expect the day rates these vessels earn to remain elevated. Management teams agree that the market for ultra-deepwater drilling vessels would remain tight through at least 2014, while many argue that a bevy of new offshore discoveries should ensure that the market will absorb coming capacity additions.

However, investors shouldn't overlook the turnaround that's underway in the notoriously cyclical market for offshore seismic services and data.

Drilling deepwater wells is extraordinarily expensive. Day rates for the rig alone can top $600,000 per day, and a single well can take 90 or more days to drill. In addition to the rig and crew, producers must pay services firms to handle a host of tasks, including drilling, logging, and testing the well and managing the drilling fluid. Drilling alone can cost well north of $1 million per day.

Given this expense, it's no surprise that seismic services account for roughly one-quarter of all spending on exploration. High-quality seismic information enables producers to identify the areas in a basin that are most prospective for hydrocarbons, limiting the risk of drilling a dry hole.

And the need for seismic work doesn't disappear the minute a new field is identified and drilled. Companies increasingly rely on seismic data to determine the best strategy for developing a field over time and ideal well locations. Modern seismic data offers a three-dimensional (3D) image of the formations in a particular field.

Historically, the market for marine seismic services has proved highly cyclical. When energy prices or the economy tanks, oil and gas companies tend to focus on existing production and axe funding for new exploration.

Spending on marine geophysical services usually accelerates in advance of offshore licensing rounds, when producers purchase data from multi-client surveys (MCSs) to assess the commercial potential and market value of available blocks. Oil and gas companies also procure seismic services, usually under short-term contracts of three weeks to three months, to identify drilling sites and better understand the reservoir characteristics of new discoveries.

In addition to exposure to the economic cycle and major fluctuations in commodity prices, the industry's concentrated nature-five operators account for about 70% of capacity-can also lead to "arms races" when the supply-demand balance for marine seismic services tightens.

If these capacity additions are accompanied by vessel retirements or conversions, the effect on pricing is negligible. However, prices can take a hit when operators seek to extend the economic life of older vessels by keeping them on the seas.

These factors came to a head in 2009-10, a challenging period for the industry. The dislocations associated with the Macondo oil spill in the Gulf of Mexico exacerbated this oversupply, as idled capacity shifted from the Gulf to other offshore markets, forcing operators to shoulder relocation expenses and further depressing day rates on contract work. Surging fuel costs in 2011 likewise eroded the industry's profitability.

Petroleum Geo Services (PGSVY) earns points for the way its management team moved decisively during these dark days to prepare the company for the eventual turnaround.

First, the company aggressively retired older vessels or converted them to other purposes, slashing the average age of its fleet. The firm also shifted its focus from lower-margin contract work to MCS acquisition, a business that's usually prefunded by prospective clients and has a longer sales life.

To shore up the balance sheet, Petroleum Geo Services sold its onshore seismic-services division to Geokinetics (GOK) for $205 million, transforming the company into a pure play on the offshore market and enabling the company to reduce its leverage.

Besides the defensive moves, management in 2010 had the foresight to order two titan-class vessels that are slated for delivery in 2013. These high-specification ships should have no problem achieving high day rates when they leave the shipyard.

Petroleum Geo Services' proprietary ramform ship design and GeoStreamer platform differentiate the company from the pack.

Traditionally, marine geophysical companies gather data by towing streamers up to 6.25 miles in length and use advanced air guns to discharge sound and pressure waves. These emissions, which bounce off formations under the seafloor, are received by hydrophones attached to the streamers. From this data, powerful software extrapolates an image of these formations. In general, the more streamers attached to a ship, the more data it can collect and the faster it can perform surveys.

Petroleum Geo Services unique vessel design features a wider stern that can accommodate a higher number of streamers than comparable ships. Moreover, the firm's GeoStreamerGS technology acts as a ghostbuster, filtering out distortion caused by reflected waves.

By towing these advanced streamers further beneath the surface, the firm reduces noise and weather-related disruptions, providing a sharper image and deeper penetration than conventional techniques. This technology is particularly useful in the North Sea and other harsh environments. The company continues to hone this technology to improve accuracy and efficiency.

Not only are the firm's oldest ramform vessels still among the most efficient ships in the industry, but its S-class units also set a world record by acquiring seismic data covering 3,056 square kilometers in one month. The firm's titan-class vessels, which are slated for delivery in 2013, will operate even more efficiently. These capabilities give Petroleum Geo Services a huge leg up on the competition on large jobs in harsh environments where data collection is limited to the summer season.

Management estimates that the company earns a price premium of about 10% when clients opt for GeoStreamer-based solutions rather than conventional products. And this price premium appears to be growing. Customers are willing to pay up for high-quality data, boosting Petroleum Geo Services' profit margins. Consider buying Petroleum Geo Services up to $17.50.

Editor's Note: This article was written by Elliott Gue of The Energy Strategist.

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