It was one of the worst drilling disasters in U.S. history...
Three years ago, the world watched in real time as 5 million barrels of oil poured into the Gulf of Mexico. The Deepwater Horizon accident killed 11 workers. The spill lasted 87 days. The U.S. government stopped issuing new offshore drilling leases for six months. And it was a disaster for oil drillers...
Transocean, which owned the rig, dropped more than 50% in less than two months. Noble, a big driller that didn't have anything to do with the Deepwater, lost nearly 40% of its market cap. And even after a sharp recovery later that summer, many offshore oil drillers have underperformed the market.
But this is about to change. And investors have a great opportunity to buy several potential growth names in this sector at a huge discount.
Let me explain...
The largest oil producers – like Saudi Aramco, Gazprom, PetroChina, and Pemex – are having trouble keeping their reserve replacement ratios (RRR) above 100%.
The RRR is an important barometer used in the oil industry. It measures the amount of proven reserves added to a company's base relative to the amount of oil produced each year. A ratio above 100% means current production is growing. Below 100% means a company is having trouble replacing its reserves – and could eventually run out of oil.
In an effort to find new deposits, oil companies around the world are looking offshore...
Brazil, for example, is exploring untapped reserves in the Santos Basin, located more than 180 miles off the coast of Sao Paulo. The water in this area has depths of almost one mile (5,280 feet).
China is planning to produce 1 million barrels of oil equivalent per day by 2020 by drilling offshore. Oil companies in Japan, Africa, Thailand, and India are ramping up spending to drill for oil off their coasts.
And with the Deepwater disaster three years past, the U.S. government is actually expanding offshore areas for oil companies to drill.
It just opened up areas along the Alaska Arctic and deepwater areas in the Gulf of Mexico to oil and gas drilling. These areas are estimated to have huge resource potential based on independent seismic studies. This drilling will take place through 2017.
Based on these massive new projects, investment firm Goldman Sachs predicts spending on ultra-deepwater projects (like offshore drilling) will grow 40% annually through 2016.
That's a huge number considering most large-cap companies are struggling to grow sales more than 2% year over year. Plus, most offshore oil rigs cost in excess of $1 billion to build.
Platforms on these rigs can weigh over 40,000 tons. Some extend 1,500 feet into the water so they can drill 5,000-plus feet below the surface. And these structures can stand at over 1,500 feet tall. To put that in perspective, the Empire State Building in New York City stands at 1,454 feet tall.
These are massive, expensive projects. But most offshore drilling projects are economical as long as oil stays above $75 a barrel. (Right now, the benchmark U.S. crude is trading at nearly $110.) And even a billion-dollar investment is a drop in the bucket for most major oil companies.
In fact, investment firm Barclays predicts oil companies will spend a record $640 billion in 2013 to find oil. That's enough cash to buy every Major League Baseball team nearly 30 times over.
This spending spree will benefit companies like Transocean (NYSE: RIG, Stock Forum) and Noble Corp (NYSE: NE, Stock Forum). They provide the biggest mobile offshore drilling fleets to help customers like ExxonMobil Corp. (NYSE: XOM, Stock Forum) and Chevron (NYSE: CVX, Stock Forum) find and develop oil.
These companies are trading below nine times forward earnings and just slightly above book value. (The average S&P 500 company is trading at 15 times earnings and over two times book value.)
Other beneficiaries are infrastructure plays like Fluor Corp. (NYSE: FLR, Stock Forum) and Foster Wheeler AG (NASDAQ: FWLT, Stock Forum). These companies build the massive offshore platforms that look like spaceships coming out of the water. They also receive money on the services end to help operate these rigs once they're built.
These infrastructure companies are also trading at a discount to the average S&P 500 company. And they're expected to grow earnings much faster than the overall market.
I suggest getting exposure to some of these names today. They're still cheap. And the offshore oil industry may be one of the biggest growth markets in the energy sector.