We have upgraded offshore driller Transocean Inc. (RIG) shares to Neutral from Underperform, reflecting our belief that the market is overestimating the company’s legal liability associated with the Gulf of Mexico (“GoM”) oil spill.
As a reminder, on April 20, Transocean’s ultra-deepwater Horizon drilling platform, contracted to British major BP plc (BP – Analyst Report), sank following an explosion while operating in the U.S. GoM off the coast of Louisiana. The incident killed 11 workers and spewed more than 200 million gallons of crude in what is touted as the worst oil spill in U.S. history. Subsequently, a six-month moratorium (which is in place till November 30) was imposed on offshore drilling in the region at water depths of more than 500 feet.
We believe Transocean’s contract with BP apparently indemnifies Transocean from the economic liability of the GoM oil spill. Even if negligence is proved on Transocean’s part, we believe these direct liabilities (in the form of legal fees and payouts) will be much lower than the $5 billion – $6 billion discounted in the stock price.
However, the Deepwater Horizon incident is bound to create some overhang on the stock because of Transocean’s active involvement in the disaster and the ensuing government-imposed deepwater drilling moratorium in the region. We do not expect the deepwater drilling market to balance itself before a year, thereby adversely affecting the likes of Transocean.
Consequently, we see the stock performing in line with the broader market.