Why Investors Shouldn't Touch These Companies With a 10-Foot Pole

By Markets Fool.com

Image source: Seadrill.

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Those that were investing in the energy sector when the BPMacondo well blew out remember that as a great time to invest in offshore companies.

While it wasBP and Transocean that were directly involved in the Macondo accident, the stock price of every company with significant offshore operations took a beating.The market's overreaction to the news created a tremendous buying opportunity, and most of those stocks had big rebounds from their post-Macondo lows.

Like most companies with exposure to oil, those same offshore operators have beaten-down stock prices again today. This time, though, investors would be wise to stay away.

How bad is it? Exxon just paid $150 million so it doesn't have to drill

ExxonMobil just last month paid Seadrill $125 million in cash so it could take an early exit from its contract to use Seadrill's West Capella drillship.

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Image source: Seadrill.

Seadrill getting paid to have someone not use its drillship might seem like a good thing, but it isn't.

The contract Exxon had on the Seadrill ship had an expiration date of April 2017. Exxon would have been paying Seadrill $627,500 per day to use the West Capella between now and then. With the $150 million buyout, Exxon will be paying the equivalent of $447,000 per day.

If Seadrill was able to take the Capella and contract it out to another user, this would be a great turn of events. Unfortunately, that is likely not the case, as there is virtually no demand for offshore drilling vessels at this time. Instead, the Capella is going to be sidelined until things improve.

The shale era has begun, and it's very bad for offshore operators

Just as companies are shutting down offshore drilling at a rapid pace, onshore operators are doing the same with their shale operations. The difference between the two is that shale drilling is likely to resume much faster when oil prices rebound.

A trend has emerged in the oil and gas industry in recent months. Companies are changing their long-term plans and moving away from long-lead-time projects such as offshore deepwater. The idea of committing huge sums of capital over several years to build out a multibillion-dollar offshore or oil sands project is completely unattractive in the this world of crimped cash. Companies that had been lulled into a false sense of security by several years of steady high oil prices are now very much aware that this is actually a very volatile commodity.

In the place of megaprojects with long lead times, oil and gas producers have learned to appreciate the characteristics of shale assets. While an offshore deepwater project takes several years to get from spudding an exploration well through to production, a shale well can only take weeks from spud to production. By focusing on shale, companies can quickly ramp up spending and production when commodity prices are high, and down if commodity prices drop. They are also fully able to remove exploration risk from the equation.

In recent months, we've seenMarathon Oilannounce that, other than for the completion of already-in-progress projects, all of 2016 will be directed toward resource (shale) plays.Conoco Phillipsannounced it will be exiting the offshore exploration game entirely, andChevron'sCEO just said the company is going to pivot away from megaprojects and toward short-cycle opportunities, particularly in the Permian Basin

Don't touch these stocks

The business has permanently changed for the worse for the companies that own the massive and crazily expensive offshore drilling fleets. These companies would include Transocean, Diamond Offshore, Seadrill, and Ensco PLC. Investors should not be tempted into buying these beaten-down stocks.

Shale is a massive new competitor for offshore oil projects, and shale has offshore beat on virtually every measure:

  • Shale has much less exploration risk.
  • Shale has very short cycle times.
  • Shale operates in an environment that has a much lower chance of high cost spills.
  • Shale's economics keep getting better and better.

If the threat from shale wasn't enough, these offshore operators also face the other risks all oil companies now must consider, such as alternative fuels, electric cars, and carbon taxes.

These offshore drillers -- with the billions of dollars they have tied up in floating steel, and future cash-flow-generating abilities that are uncertain at best -- don't belong in your portfolio.

The article Why Investors Shouldn't Touch These Companies With a 10-Foot Pole originally appeared on Fool.com.

Christopher Malcolmhas no position in any stocks mentioned. The Motley Fool owns shares of and recommends Chevron. The Motley Fool owns shares of ExxonMobil. The Motley Fool recommends Seadrill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.