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Ensco plc (NYSE: ESV) is riding high today, with shares up as much as 10% in early-morning trading. While there is no specific company news fueing today's rally, the steady rise of oil prices and the dirt-cheap valuations of rig stocks have most companies in this industry moving lately.
The premise for an offshore rig stock rally is a pretty simple, if not direct, line from oil prices. As oil prices rise and stay above certain thresholds, oil and gas producers have a greater incentive to spend on exploration and development. When they do, it means more money for offshore projects that will employ the services of rig companies.
With the price of a barrel of Brent crude at $57 a barrel -- very far from the $35 per barrel this time last year -- the market seems to believe that this is a price point where producers will start to contract rigs. As a result, we're seeing shares of Ensco and others ride the good news to higher valuations.
There is another caveat to consider as well. Offshore rig stocks have been hammered over the past couple of years to the point that they are selling at very in expensive valuations. So the slightest bit of good news is going to cause some big jumps. For example, shares of Ensco currently trade at just 0.37 times tangible book value.
It's impossible to tell whether the rate at which oil prices have risen lately will continue. There are reasons to think that oil prices will increase (OPEC production cuts, less capital spending going on, etc.), but there are also reasons why we could stall out at this price (shale oil's quick ramp-up time could fill supply shortages very quickly). With that in mind, no one can say with certainty that this recent jump in offshore oil stock prices will hold.
What long-term investors should be on the lookout for are new rig contracts. If Ensco can put some of its idle fleet back to work, it will go a long way in improving the company's profitability.
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