tenaris

A Pipeline to Profits
They say the best way to hit the mother lode in a gold rush isn't by digging -- it's by selling picks and shovels to the miners. That's fortunate for Foolish investors, because there's a massive gold rush taking place the world over. Black gold, that is.

Don't let the recent oil headlines scare you: While the price of oil is ever slippery, long-run demand is heading in just one direction -- up. That leaves Tenaris (NYSE: TS), a global supplier of essential oil field equipment, lined up to profit handsomely.

About the Company
Everyone uses oil, and somewhere along the way, that oil comes through a tube. And Tenaris makes those tubes.

If you're drilling a well, Tenaris almost certainly sells lots of the parts you find handy, even necessary. Specifically, it sells steel pipes -- and lots of them -- as well as casings to support well walls and tubes to transport crude oil and natural gas to the surface and on to refineries or storage locations. There's nothing flashy about Tenaris' business, but there's a simple beauty to it. And barring the development of "Beam me up, Scotty" technology, these pipes and tubes will remain essential to drilling and transporting oil and natural gas.

Because your basic steel pipe is pretty ordinary, standing out and earning extraordinary profits becomes, well, extraordinarily difficult. A company needs the right product mix, good geographic breadth, and battle-tested management. Tenaris has each in spades.

Tenaris differentiates itself in a crowded industry by emphasizing premium pipes. These pipes -- including the deepwater drilling line Tenaris makes for Petrobras and a special cold-resistant pipe for Russia's Rosneft -- can better withstand extreme temperatures and pressures during drilling and garner more profitable margins than conventional steel pipe can.

Domiciled in Luxembourg to take advantage of corporate-friendly taxes, Tenaris is listed on stock exchanges in New York, Buenos Aires, Italy, and Mexico, and has manufacturing facilities in 15 countries. This global footprint adds value in three ways. First, Tenaris' geographic manufacturing breadth puts it close to key production basins and gives it a leg up on its competition by lowering shipping costs. (Think your Amazon.com shipping fees are expensive? Try moving a thousand feet of steel pipe.) Second, that breadth allows Tenaris to develop broad and deep relationships with global oil giants -- companies with deep pockets that are best positioned to ride out recessions. And third, a global revenue base helps defend against the regional ebb and flow of capital budgets for oil and gas exploration and production.



But despite its global reach, the company hasn't strayed from its roots. Argentina remains the country with the largest portion of Tenaris' 23,000 employees, and Chairman and CEO Paolo Rocca is a grandson of the company's founder. The Rocca family, which has a controlling ownership stake in Tenaris, has guided the company through thick and thin over the decades, and Paolo Rocca himself has overseen Tenaris' dramatic recent growth since becoming CEO in 2002. Tenaris is still 60% controlled by the founding Rocca family. We love that high figure. Although the family's controlling stake could seem intimidating to minority shareholders, we like that the family's interests are so closely aligned with us Main Street investors.

More Oil... Please
At the heart of the case for Tenaris is our belief that worldwide oil and gas drilling will stay robust for years to come. The recent slowing of the global economy has some industry observers predicting that short-term global oil demand could slip a tad from the current level of around 86 million barrels a day. But Fools should keep their eyes on the ball: The long-run trend of oil demand is unquestionably on the rise, and producers will need to scramble to keep pace.



Where is this massive demand growth coming from? China, of course. And even though China's oil consumption has risen from 3.5 million barrels per day in 1997 to 8 million today, there's still plenty of room to run. The average Chinese citizen uses only 2.3 barrels per person a year, compared with 7.5 in Mexico and 24 in the United States. Simmons & Company estimates that if India and China saw their demand rise to that of just Mexico, it would add another 49 million barrels per day of oil demand.

But enough about demand. Let's talk supply -- or the lack of it, anyway. Long gone are the days when a poor mountaineer would chance upon an oil field while shooting for some food. Most large, relatively easy-to-tap fields such as Mexico's Cantarell and Alaska's Prudhoe Bay are either peaking or have seen better days.

To make up for fading production from traditional sources, oil companies are increasingly turning to more expensive, technically challenging reserves, such as the deepwater fields off the coast of Brazil, the frozen tundra of Russia and Kazakhstan, and the oil sands of Canada. Even extracting natural gas has grown trickier and costlier, with the latest U.S. finds requiring unconventional horizontal drilling. These sources require more and pricier equipment -- including pipes and tubes -- than traditional reserves do. Combine tight, hard-to-reach supply with steadily rising demand, and you have a recipe for sustained high energy prices. That's bad news for just about everyone, except for investors in companies such as Tenaris that make it all possible -- and that will profit from this bonanza.

Investment Thesis
Though the steel tubing industry is intensely competitive and affected by outside commodity costs such as the prices of steel, oil, and natural gas, Tenaris still boasts a competitive advantage, thanks to its global manufacturing presence. Tenaris' close proximity to key production basins allows it to deliver its tubes more quickly and cheaply than more distant competition. Tenaris offers just-in-time delivery to rigs, and as you might expect, the incremental shipping costs for large steel pipes run a pretty penny, so the manufacturer with a closer facility can offer a better relative value. Indeed, Tenaris' holdings in Mexico, Venezuela, Brazil, and Canada are the sole or leading producers of steel pipes in those countries. Tenaris' global presence also reduces exposure to a slowdown in any one drilling basin -- an especially valuable advantage, given the boom-and-bust nature of the industry and the intense geopolitical risks associated in some oil-producing regions.

The proof of Tenaris' value proposition and its high regard in the industry shows up in its client list. Tenaris supplies the biggest of Big Oil names the world over: Saudi Aramco, Rosneft, StatoilHydro, Pemex, and many, many more.

The world's growing thirst for energy seems to be taking a respite, but this breather in oil and gas exploration is only a blip on the radar. Worldwide drilling activity is likely to stay robust in the years to come, and oil field service providers and equipment manufacturers should profit handsomely. Among them, Tenaris stands out.