As we explained in Going Deep and Here’s the Drill: Buy the Pullback, we remain bullish on the tightening supply-demand balance in the market for ultra-deepwater drilling rigs and high-specification deepwater units.

With customers contacting contract drillers about extending contracts a year or two before they expire, we expect the day rates that these vessels earn to remain elevated. Management teams agree that the market for ultra-deepwater drilling vessels should remain tight through at least 2014, while many argue that a bevy of new offshore discoveries should ensure that the market will absorb coming capacity additions.

However, investors shouldn’t overlook the turnaround that’s under way in the notoriously cyclical market for offshore seismic services and data.

Drilling deepwater wells is extraordinarily expensive. Day rates for the rig alone can top $600,000 per day, and a single well can take 90 or more days to drill. In addition to the rig and crew, producers must pay services firms to handle a host of tasks, including drilling, logging and testing the well and managing the drilling fluid. Drilling alone can cost well north of $1 million per day.

Given this expense, it’s no surprise that seismic services account for roughly one-quarter of all spending on exploration; high-quality seismic information enables producers to identify the areas in a basin that are most prospective for hydrocarbons, limiting the risk of drilling a dry hole.

And the need for seismic work doesn’t disappear the minute a new field is identified and drilled. Companies increasingly rely on seismic data to determine the best strategy for developing a field over time and ideal well locations. Modern seismic data offers a three-dimensional (3-D) image of the formations in a particular field.

Historically, the market for marine seismic services has proved highly cyclical; when energy prices or the economy tanks, oil and gas companies tend to focus on existing production and axe funding for new exploration.

Spending on marine geophysical services usually accelerates in advance of offshore licensing rounds, when producers purchase data from multi-client surveys (MCS) to assess the commercial potential and market value of available blocks. Oil and gas companies also procure seismic services, usually under short-term contracts of three weeks to three months, to identify drilling sites and better understand the reservoir characteristics of new discoveries.

In addition to exposure to the economic cycle and major fluctuations in commodity prices, the industry’s concentrated nature–five operators account for about 70 percent of capacity–can also lead to “arms races” when the supply-demand balance for marine seismic services tightens. If these capacity additions are accompanied by vessel retirements or conversions, the effect on pricing is negligible; however, prices can take a hit when operators seek to extend the economic life of older vessels by keeping them on the seas.

These factors came to a head in 2009-10, a challenging period for the industry.

In 2006 and 2007, marine geophysical companies rushed to take advantage of robust demand and rising day rates, ordering significant additional capacity. Unfortunately, these newly built vessels arrived just in time for the Great Recession and collapsing oil prices, a killer combination that prompted producers to slash spending on exploration and saddled the seismic-services market with a huge supply overhang.

The dislocations associated with the Macondo oil spill in the Gulf of Mexico exacerbated this oversupply, as idled capacity shifted from the Gulf to other offshore markets, forcing operators to shoulder relocation expenses and further depressing day rates on contract work. Surging fuel costs in 2011 likewise eroded the industry’s profitability.

Aggressive Portfolio holding Petroleum Geo-Services (Oslo: STL, OTC: PGSVY) earns points for the way its management team moved decisively during these dark days to prepare the company for the eventual turnaround.

First, the company aggressively retired older vessels or converted them to other purposes, slashing the average age of its fleet. The firm also shifted its focus from lower-margin contract work to MCS acquisition, a business that’s usually prefunded by prospective clients and has a longer sales life. To shore up the balance sheet, Petroleum Geo-Services sold its onshore seismic-services division to Geokinetics (AMEX: GOK) for USD205 million, transforming the company into a pure play on the offshore market and enabling the company to reduce its leverage.

Besides the defensive moves, management in 2010 had the foresight to order two titan-class vessels that are slated for delivery in 2013; these high-specification ships should have no problem achieving high day rates when they leave the shipyard.

We’ve owned Petroleum Geo-Services since November 2010, when Growth Portfolio stalwart Schlumberger (NYSE: SLB) first indicated that the market for marine seismic services had troughed.

Schlumberger’s optimism ultimately proved somewhat premature. Shares of marine geophysical companies limped along for quarters, as profit margins have been slow to recover and results fell short of Wall Street’s expectations. Falling oil prices and concerns about economic growth have also weighed on stock prices.

But the group enjoyed a sharp rally on July 17, after Petroleum Geo-Services announced second-quarter results that blew away analysts’ consensus estimates.

Based on preliminary consolidated numbers, Petroleum Geo-Services’ revenue last quarter exceeded USD395 million, up 20.7 percent increase from a year ago. This sales growth fueled a 40.2 percent year-over-year upsurge in earnings before interest, taxes, depreciation and amortization (EBITDA).

Management also increased its full-year EBITDA guidance to more than USD750 million from USD700 million. At the end of March, the Bloomberg consensus estimate called for Petroleum Geo-Services to generate EBITDA of USD719 million on the year; after the announcement, Wall Street’s average forecast jumped to USD752 million.

We remain bullish on pricing in the marine seismic market through at least 2014. Not only are oil and gas companies stepping up offshore exploratory efforts in established markets such as the North Sea and West Africa, but major discoveries off Africa’s east coast also promises to yield a great deal of work. Meanwhile, activity in the Gulf of Mexico should continue to accelerate as licensing and permitting normalize, further tightening the global supply-demand balance. Management teams also cited increased demand for marine seismic services in frontier markets such as India, Uruguay and the Russian Arctic.

Conditions on the supply side are equally bullish in the near term, with only four vessels slates to join the fleet in the next two years. However, analysts have expressed concerns that a recovery in pricing could prompt the five leading marine geophysical companies to overbuild once again.

Although these concerns have some merit, we suspect that operators will be far more aggressive with ship retirements this time around; oil and gas companies increasingly prefer high-specification vessels that offer superior image resolution and accuracy, especially for MCS work.

At present, Dolphin Group (Oslo: DOLP) has ordered one new ship for delivery in the first quarter of 2014, while Petroleum Geo-Services recently extended a free option to purchase two additional vessels for delivery in 2015. CGG Veritas’ (Paris: GA, NYSE: CGV) management has also expressed interest in upgrading the company’s fleet.

Regardless of the duration of the current up-cycle, Petroleum Geo-Services remains our favorite bet on the ongoing recovery in the market for offshore seismic services. Not only is the Norway-based firm a pure play on this business, but the company’s titan-class vessels slated for delivery in 2013 also give the firm exposure to improving margins on contract work.

More important, Petroleum Geo-Services’ proprietary ramform ship design and GeoStreamer platform differentiate the company from the pack.

Traditionally, marine geophysical companies gather data by towing streamers up to 6.25 miles in length and use advanced air guns to discharge sound and pressure waves. These emissions, which bounce off formations under the seafloor, are received by hydrophones attached to the streamers. From this data, powerful software extrapolates an image of these formations. In general, the more streamers attached to a ship, the more data it can collect and the faster it can perform surveys.

Petroleum Geo-Services unique vessel design features a wider stern that can accommodate a higher number of streamers than comparable ships. Moreover, the firm’s GeoStreamerGS technology acts as a ghostbuster, filtering out distortion caused by reflected waves.

By towing these advanced streamers further beneath the surface, the firm reduces noise and weather-related disruptions, providing a sharper image and deeper penetration than conventional techniques. This technology is particularly useful in the North Sea and other harsh environments. The company continues to hone this technology to improve accuracy and efficiency.

Not only are the firm’s oldest ramform vessels still among the most efficient ships in the industry, but its S-class units also set a world record by acquiring seismic data covering 3,056 square kilometers in one month. The firm’s titan-class vessels, which are slated for delivery in 2013, will operate even more efficiently. These capabilities give Petroleum Geo-Services a huge leg up on the competition on large jobs in harsh environments where data collection is limited to the summer season.

Management estimates that the company earns a price premium of about 10 percent when clients opt for GeoStreamer-based solutions rather than conventional products. And this price premium appears to be growing. Customers are willing to pay up for high-quality data, boosting Petroleum Geo-Services’ profit margins. Buy Petroleum Geo-Services up to USD17.50.