Seahawk Drilling (NSDQ: HAWK) is a contract drilling firm spun off from Pride International (NYSE: PDE) on August 24, 2009. Seahawk owns a fleet of 20 mat-supported jackup drilling rigs that operate in the Gulf of Mexico.

I highlighted the contract drilling business at some length in the June 17 issue, The Drilling Dozen. To review, jackup rigs are bottom-supported rigs used to drill in shallow waters up to roughly 300 feet deep. For waters deeper than that, producers would use floating rigs such as those owned by Portfolio recommendations Noble Energy (NYSE: NE) and Seadrill (OTC: SDRLF).

The term mat-supported relates to the way that the rig rests on the sea-floor; this type of rig is considered less capable than independent leg rigs. In other words, Seahawk’s rigs are fairly simple jackups often called “commodity” rigs; such rigs are suitable primarily for use in the Gulf of Mexico and aren’t capable of doing much work internationally. 

Longtime readers will recognize that Seahawk’s Gulf-focused jackup business is similar to that of Hercules Offshore (NSDQ: HERO), a company I profiled at some length in the June 17 issue. In fact, Hercules and Seahawk together are more or less a duopoly and control almost three-quarters of the Gulf market.

Drilling activity in the shallow-water Gulf of Mexico is highly leveraged to natural gas prices because most drillers in the region target gas, not crude oil. In addition, production from the area tends to be higher cost; drilling activity in the shallow-water Gulf has been particularly hard hit by the decline in gas prices over the past year.

Rig utilizations in the region are near record-lows; Seahawk currently has 6 of its 20 rigs contracted, 4 are available for contracting and 10 are cold stacked. The term cold stacked refers to rigs that are in long-term storage and would take some time and significant investment to bring to a state of readiness.

But weakness in the Gulf of Mexico is widely recognized and is entirely a function of weak gas prices. As I will explain in this Wednesday’s issue of The Energy Strategist, the most relevant measure of gas prices is the 12-month calendar strip, which recently broke to its highest level since January.

Economic news suggests that industrial demand for gas troughed over the past few months and will recover into 2010. Meanwhile, the massive decline in drilling activity spells falling gas production. As I noted in the September 23 issue, Top Three Energy Themes, I expect falling supply and reviving demand to push gas prices significantly higher in coming months.

This means that drilling activity in the Gulf of Mexico will likely hit its nadir in the third quarter; news is likely to improve steadily as we move into 2010. Seahawk Drilling is a leveraged play on a 2010 rally in natural gas and a accelerating drilling activity in the Gulf of Mexico.

I continue to like Hercules Offshore (NSDQ: HERO) as a play on the same theme but prefer Seahawk at present. Unlike Hercules, Seahawk has no debt; this superior financial position gives the firm more room to maneuver even though debt market conditions are improving. In addition, Seahawk is slightly cheaper than Hercules on several valuation metrics I follow. And finally, Seahawk has an extremely limited float and stands to really soar as investors pile into the stock as a play on a gas recovery.

I would note that Seahawk is thinly traded and typically trades around 100,000 shares a day.  If liquidity is a concern for you, you might consider trading Hercules instead. 

This recommendation is also a trade, not a long-term investment; I look to hold Seahawk through year-end or into early 2010 as a play on a gas rally. And because of liquidity and volatility this trade involves some risk–do not be tempted to bet the farm. Nonetheless, I believe the heightened risk is worthwhile; I can see the stock trading above 50 over the next three months on improving gas prices and/or signs of an uptick of drilling in the Gulf of Mexico.

Buy Seahawk Drilling (NSDQ: HAWK) under 33 with a stop-loss order at 24.35.