The Rude Awakening
Wall Street, New York
Wednesday, June 1, 2005
------------------------- The Rude Awakening PRESENTS: "A couple years ago, lowly
valued oil-drilling stocks couldn't seem to find any investors. Today,
investors can't seem to find any lowly valued drilling stocks…
except maybe in Canada…" --- Advertisement ---
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*A $5.32 pump price for gas
*More than 2 million jobs lost
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A BIT ABOUT DRILLING
By Eric J. Fry "Ten years ago, a geologist couldn't find a job," recalls
Dan Sarnecki, from the Alberta Energy & Utilities Board in
Calgary, "Now, you can't find a geologist." But if you DO
find a geologist, you don't find one cheap. Finding
drilling rigs isn't easy either…or cheap, which should be
very good news for oil-drilling companies. "Rig day rates are rapidly escalating to record or near-
record levels, taking even the largest offshore drilling
contractors by surprise," the Petroleum News reports. "Three months ago, Transocean chief executive Robert Long
reported that rates for the company's second and third
generation offshore drilling rigs, for example, had moved
from $50,000 per day in 2004 to around $100,000 per
day…Since then, rig rates for second and third generation
offshore rigs have moved as high as $160,000 a day." Not surprisingly, therefore, the cost of finding and
pumping a barrel of oil -- including labor, equipment and
seismic testing - cost a record $17.12 last year, up 43
percent from a year earlier, based on data compiled by
Bloomberg News. But one company's expense is another
company's revenue. And in this case, the rising costs of
extracting oil from its geologic hiding places are
appearing as rising revenues on the top lines of many oil
services companies. First-quarter profits quadrupled, for
example, at Transocean and GlobalSanteFe, two of the
world's largest offshore drilling companies. Of course, anyone can see that rig rates are very high
right now. The question is whether they will remain
high…and for how long. And since there aren't any 2008
issues of the Petroleum News lying around our office, we
cannot say for certain how high rig rates might be in three
years' time, or even in three months' time. But based on
the evidence contained in the dog-eared pages of a couple
of recent 2005 issues, the outlook for the oil-drilling
industry seems promising. The current boom seems likely to have staying power, mostly
because the bust that preceded it persisted for so many
years. During the dark decade of sub-$20 oil, oil-drilling
activity seized up like an overmatched drill bit. Very few
souls dared to invest in an industry that offered such
dismal economic prospects. The many years of under-
investment set the stage for today's rising rig rates. Therefore, GlobalSantaFe chief executive Jon Marshall
predicts, "We may have entered a longer and more robust
drilling cycle than we've seen in many years." Marshall's
optimistic outlook finds sample anecdotal support. For
starters, rig utilization rates have been climbing sharply.
88.4 percent of the worldwide fleet is being used today, up
from 81.7 percent a year ago and 80.9 percent five years
ago, according to ODS-Petrodata figures. ``We have virtually everything that we own booked for the
summer,'' says Hank Swartout, CEO of Precision Drilling
Corp., Canada's largest oilfield-services company. As should be expected, rig-builders are scrambling to meet
the new demand. But that effort seems unlikely to pressure
rig rates any time soon. "Rowan, whose fleet consists
almost entirely of jack-ups, believes that it's unlikely
that construction of new offshore jack-up rigs over the
next decade can keep pace with the expected world-wide
demand for shallow-water drilling," Bloomberg News relates.
"Rowan's conclusion is based on the average number of new
rigs expected to be delivered into the market each year vs.
the attrition rate of older rigs, plus the relatively small
number of shipyards around the world willing to build new
jack-ups. The company noted that by 2010 more than 93
percent of today's world-wide jack-up fleet will be over 20
years old." And even if shipyards supply the oil industry with lots of
new rigs, the new rigs might go begging for qualified rig
personnel. There are about 15,000 Canadian pipe fitters and other
tradesmen available to fill 25,000 jobs over the next five
years as Shell, Suncor Energy Inc. and other producers
expand, according to Neil Camarta, a senior vice president
with Shell's Canadian unit, "The oil and gas industry is booming, and that's made it
harder to find qualified people because they can command
bigger bucks now,'' says Alberta's Sarnecki. ``We're having
to offer people more money because demand for their
services is so much bigger than what it was.'' Happily for oil services companies, the rising costs of
providing their services are rising slower than the
revenues they've been receiving. Entry-level geologists at
U.S. oil companies may be earning a hefty average salary of
$65,600, but that's only 24 percent more than these "petro-
nerds" earned in 1999. For perspective, rig rates have more
than tripled over the same time frame. In short, we suspect that oil-drillers will continue to
enjoy brisk demand for their services for the next few
years, exactly as many industry insiders predict. In which
case, the shares of oil-drillers and oil-services stocks
should continue performing well, especially the relatively
cheap Canadian stocks. Faithful Rude Awakening readers may recall the column of
April 7… http://www.dailyreckoning.com/RudeAwake/Articles/RA040605a.
html …in which we observed, "Canadian contract oil-drillers
and oil service companies sell for very steep discounts to
their American counterparts." Two months later, they still
do…although not as steep as before. 
Over the last few weeks, the discount between the two has
been narrowing recently. Perhaps that's a fluke, perhaps
not. Either way, Canadian oil services companies have
advanced about 4% since early April, while American oil
service companies have DROPPED about 4%. We cannot be sure that this recent trend is indicative of
future trends, but we wouldn't rule it out. The valuation
gap between the Canadian and American oil service stocks
should continue closing, as no significant fundamental
distinction between the two would seem to validate the
"Canadian discount." Stocks like Precision Drilling (TSE:
PD) and Ensign Resource Service Group (TSE: ESI) need not
continue to sell for much lower valuations than their
American peers. A couple years ago, lowly valued oil-drilling stocks
couldn't seem to find any investors. Today, investors can't
seem to find any lowly valued drilling stocks…but they
can still find a few reasonably valued stocks, especially
up in Canada. [Ed. Note: If you are the type who loves getting in on the
ground floor with undervalued companies, Chris Mayer,
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obligations. http://www1.youreletters.com/t/151821/1380489/775934/0 ------------------------- Did You Notice…?
By Eric J. Fry In March, foreign central banks became net sellers of U.S.
Treasury bonds and notes for the first time in almost three
years. And they sold quite a bit. One month does not make a
trend, of course. But it does seem a curious moment to
unload Treasury securities. Hasn't the dollar been
rallying? And haven't competing assets, like stock been,
falling? Perhaps the sellers distrust the dollar rally. After
suffering a falling dollar for three straight years, the
recent mini-rally might seem like a gift from above. 
Or maybe the central banks are selling Treasuries just
because they are "stretching for yield," just like ordinary
bond-fund managers might. "Foreign central banks are buying fewer Treasuries,"
observes James Grant, editor of Grant's Interest Rate
Observer. "Over the past three months, growth in Treasury
securities held in custody by the Fed for the account of
foreign central banks rose at an annual rate of just 3.3%. But over the same three months, Fannies, Freddies and
Ginnies [i.e. government agency bonds] held in custody for
their non-American owners registered growth of 59.8?"
Why might this be so? Grant suspects the central banks are
selling low-yielding Treasuries to invest in higher-
yielding securities. State Street Global Advisors, which manages $57 billion in
assets for 33 central banks, lends support to Grant's
suspicion. "The great majority of our clients are looking
to push their investment boundary out along the risk
spectrum," reports the head of State Street's central-bank
advisory division. We don't begrudge our foreign lenders the right to "shop
for yield," but we do fear it. If foreign central banks are
shunning our low-yielding Treasury securities, these
securities won't remain "low-yielding" for long. Interest
rates will rise…until the banks become eager buyers once
again. We'll be watching… [Ed. Note: Dan Denning, editor of Strategic Investment,
will also be watching. Dan knows better than most the
potentially catastrophic effects of a sharp rise in
interest rates, especially for homeowners. He explains
here… Strategic Investment
------------------------- And the Markets… | Tuesday | Friday | This week | Year-to-Date | DOW | 10,467 | 10,543 | 327 | -2.9% | S&P | 1,192 | 1,199 | 38 | -1.7% | NASDAQ | 2,068 | 2,076 | 91 | -4.9% | 10-year Treasury | 4.00% | 4.07% | -0.12 | -0.22 | 30-year Treasury | 4.33% | 4.43% | -0.15 | -0.49 | Russell 2000 | 617 | 617 | 35 | -5.3% | Gold | $417.40 | $420.25 | -$3.00 | -4.6% | Silver | $7.40 | $7.25 | $0.48 | 8.6% | CRB | 300.83 | 300.89 | 6.98 | 6.0% | WTI NYMEX CRUDE | $51.97 | $51.85 | $3.30 | 19.6% | Yen (YEN/USD) | JPY 108.55 | JPY 108.00 | -1.23 | -5.8% | Dollar (USD/EUR) | $1.2305 | $1.2580 | 328 | 9.2% | Dollar (USD/GBP) | $1.8173 | $1.8242 | 333 | 5.3% |
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