Oil markets and energy stocks often get painted with a broad brush. But within the sector, offshore drilling stocks offer upside that many investors are overlooking. Despite cries of peak oil demand, fundamentals for rig owners point to gains ahead.
The oil services sector has rocketed over 50% higher in the last year, soundly beating the S&P 500. Yet offshore drilling stocks remain unloved. This creates an opportunity for investors willing to take a contrarian bet.
The bull case lies in constrained supply and rapidly rising prices. ESG considerations have limited capital investment in new oil production. But robust demand has returned as pandemic impacts recede. This supply/demand imbalance has sent oil above $80 per barrel.
Day rates for offshore rigs are soaring as utilization rates stick near 90%. However, shipyards are focused on liquefied natural gas, not building fresh drilling ships. That means supply can’t catch up to growing demand in a hurry.
This grants pricing power to rig owners. Valaris, Noble, and Weatherford have emerged from bankruptcy with pristine balance sheets. Meanwhile Transocean boasts the most high-specification rigs, positioning it to profit from climbing day rates.
Yet valuations look disconnected from fundamentals. Offshore drillers trade at up to an 80% discount to replacement value, signaling the market doubts their potential. But conditions point to further gains.
Why Energy Could Shine for Investors
Beyond compelling fundamentals, two key reasons make energy stocks stand out right now:
- Inflation hedge – Energy equities have historically held up well during inflationary periods. With prices still running hot, oil stocks may offer protection if high inflation persists.
- Contrarian bet – Energy is the most hated sector this year, with heavy net outflows from funds. That sets up a chance to buy low while others are selling.
To be clear, the long-term peak oil argument holds merits. The global energy transition will likely constrain fossil fuel demand over time. But that shift will take decades to play out.
In the meantime, diminished investment and stiff demand creates room for shares like offshore drillers to run higher. For investors willing to make a contrarian bet, the neglected energy space offers rare value.
ESG Sours Sentiment But Oil Remains Key
What about the ESG push away from fossil fuels? Shift is clearly underway. But hydrocarbons still supply 80% of global energy needs. Realistically, oil and gas will remain vital to powering the world for years to come.
Market sentiment has soured on all things oil. But investors should remember that supply/demand, not narrative, ultimately drives commodity prices. Offshore drillers look primed to benefit from that dynamic.
While oil markets face uncertainty beyond the next decade, conditions now point to upside in left-behind niches like offshore drilling stocks. For investors who see value where others only see headwinds, forgotten energy corners may hold diamonds in the rough.