Speculating In The Energy Sector With Peabody Energy And Transocean (NYSE:BTU)

I haven’t made a ton of trades lately, but I have added a couple speculations on energy in recent weeks. I think energy prices will remain elevated, and I think oil will likely head higher into 2023 and beyond due to an imbalance and supply and demand. Today I’ll be discussing a couple options trades I made on Peabody Energy (NYSE:BTU), a coal company, and Transocean (NYSE:RIG), an offshore drilling company.

Investment Thesis

While major oil companies have had a good run in 2022, offshore drilling companies like RIG haven’t had their day in the sun yet. I think the company is undervalued at current prices and could be in for a couple of good years with higher oil prices and higher offshore drilling rates. BTU has already a big run since trading under $1.00 a share in 2020, but shares are still cheap and the company continues to reduce its outstanding debt. I chose options for these companies, but the shares could have impressive returns as well. I view both as speculations, so they are small positions, but I like the risk/reward profile for both investments.

Peabody Energy

BTU is set to report Q3 earnings this week on November 3^rd. Coal prices have remained elevated, but that hasn’t stopped the recent selloff in BTU shares. If the recent earnings report by Arch Resources (ARCH) is any indication, BTU should have a pretty good quarter on tap. I wrote an article on ARCH in August, and the company declared another special dividend this quarter, for a total payout of $10.75. BTU continues to pay down debt and trades at a dirt-cheap cash flow multiple below 4x.

I bought a January 20, 2023 $40 call when the underlying was around $27, so I’m underwater on this one for now. I’m considering adding another call at a lower strike price, especially if shares drop towards $20. I am curious to see what happens over the next couple months, as the company also has an investor day planned in November. Overall, I think the shares head higher from here, and I think there are a couple catalysts for investors in the near term. I like the risk/reward for BTU, and shares would be a solid play as well, but I like Transocean more at current levels.

Transocean

While BTU has already had a big run since 2020, shares of RIG haven’t had the same success (yet). Shares bottomed out around $0.70 two years ago, but there have been developments in the offshore market that are bullish for RIG and its shareholders. The offshore drilling rates continue to rise, and several executives have said that they expect rates to pass $500k a day by the end of the year.

RIG is set to report Q3 earnings on Wednesday, November 2^nd after the close. Besides rig utilization rates and debt levels, I’m curious to see what management has to say on the earnings call. To be clear, one of the reasons RIG is cheap is the elevated debt level (over $7B outstanding at the end of Q2). Over the next year, I expect that to come down significantly, but it is definitely something I will be monitoring with each quarterly report.

When you look at the company’s assets though, I think the company is undervalued at a $2.6B market cap. RIG also has the largest backlog among the offshore drillers ($7.4B based on a September investor presentation) and I’m curious to see what happens as rates for offshore drillers rise and the global available rigs continue to decline. The other thing that will be interesting to watch will be the oil price. The political strategic petroleum reserve releases should end after the midterms, OPEC is cutting production, and demand has remained relatively steady despite elevated prices. I don’t speculate directly on commodity prices, but I wouldn’t be surprised to see prices consistently above $100 in 2023.

I purchased several calls on RIG for January 2024 with a $5 strike when the underlying shares were around $3.50. I decided to go longer term on this one to give the bullish thesis more time to play out because deleveraging will take some time and I think oil prices will head higher in 2023. I’m up slightly on these calls, but if the thesis plays out, I think shares could head much higher than $5.

Conclusion

While I’m bullish on both of these companies over the next year, I want to be very clear about the risk of options trades like this. It’s entirely possible that I’m wrong and the share prices don’t reach the strike prices I picked. That is why I kept both trades as small positions and only risked what I can afford to lose. If your risk tolerance is lower (and/or you aren’t comfortable with options), a lower risk play would be to buy the shares directly. BTU has already had a significant run over the last couple years, which is why I don’t think it has the same upside as RIG. However, BTU is still cheap, the balance sheet is getting better, and coal prices have remained high as coal consumption continues to increase.

RIG has a lot of debt on the balance sheet, but that could mean significant upside for shares as deleveraging starts to happen next year. The global rigs available continue to trend down as the offshore drilling rates continue to rise. Oil prices will remain elevated in my opinion with a continued imbalance in supply and demand. Neither of these companies have a spotless operating history, but outsized returns for investors can be had by buying when something is cheap and out of favor. I think that’s the case with Peabody Energy and Transocean today.