Higher costs, consolidation expected in Gulf of Mexico

Paula Dittrick
OGJ Senior Staff Writer

HOUSTON, Aug. 28 -- Drilling costs and operating expenses in the Gulf of Mexico are apt to escalate in the aftermath of the explosion on Transocean Ltd.’s Deepwater Horizon semisubmersible and the subsequent oil spill from BP PLC’s Macondo well off Louisiana.

This anticipated rise in costs stems from proposed regulatory changes. Proposals include higher civil and criminal penalties for an oil spill, greater redundancy in drilling safety equipment, additional federal inspectors, and more-stringent requirements for deepwater drilling permits.

Grant Thornton LLP’s Corporate Advisory & Restructuring Services (CARS) released a white paper examining how exploration and production companies are going to have to reconsider their deepwater strategies because of proposed regulations aimed at reducing the chance of another oil spill.

Separately, Deloitte LLP senior advisors discussed what they called “the game-changing implications of the oil spill” in an Aug. 25 webcast.

Regulatory proposals also include increasing the federal cap on economic liability for an oil spill to $10 billion or possibly removing the cap altogether. That change alone is likely to prompt consolidation because only large integrated oil and gas companies could afford to operate in the deepwater gulf.

Loretta Cross, managing partner of Grant Thornton CARS practice and a coauthor of the white paper, said fewer independents operating in the gulf could significantly lower gulf production because independents excel at maximizing production of mature and declining fields.

“A number of companies have got to address whether the risk profile and the cost profile really fits their strategy,” Cross said. “For some of these companies, the largest piece of their cost is insurance.” Separately, Moody’s Investors Service estimated offshore insurance premiums could jump by up to 50%.

Higher insurance rates means higher day rates for deepwater rigs. It also could translate into a higher capital costs for gulf operators if investors and creditors demand higher returns in exchange for a perceived higher risk level, the Grant Thornton paper said.

“As all of the costs associated with operating the gulf continue to rise, deepwater drilling will increasingly become the province of only the largest, most well-capitalized companies,” said Rob Moore, director of Grant Thornton’s CARS.

The cost of obtaining insurance coverage will be prohibitively expensive for smaller independents unable to self-insure against an oil spill. Large integrated oil and gas companies could acquire such independents or could acquire their deepwater properties.

“Some independents will find they don’t have a big-enough balance sheet to operate in the gulf,” Cross said. “It’s already started.”

Houston independent Plains Exploration & Production Co. has said it plans to sell its gulf assets and expand onshore. Plains E&P hired Barclays Capital and Jefferies & Co. to assist in the planned divestitures.

Cross believes activity in the gulf will remain slow for 18-24 months given the certainty of a change regulatory framework. “Large companies could find that it’s easier to acquire other companies than to drill.”

US lawmakers trying to reduce the probability of another oil spill also must consider the long-term economic ramification of deepwater regulations, she said. Excessively stringent regulation could result in higher operating costs to the point that some companies find it uneconomic to drill in the deepwater gulf.

“Policymakers need a balanced outlook. They should consider a number of factors when making long-term regulatory changes affecting the oil and gas industry,” Cross said, encouraging them to avoid making decisions solely out of a desire to satisfy the public’s appetite for swift retribution on the energy industry.

Long-term consequences
“Eliminating or significantly reducing gulf production would increase US reliance on foreign oil,” leaving the US more dependent on the Organization of Petroleum Exporting Countries and national oil companies (NOCs), Grant Thornton’s paper said.

Peter J. Robertson, Deloitte LLP independent senior advisor for oil and gas and a former vice-chairman of Chevron Corp., said deepwater drilling is crucial to the US and world energy supply. Deepwater drilling accounts for 30% of US oil production and is forecast to grow to more than 10% of global oil production by 2015, he said during an Aug. 25 webcast by the Deloitte Center for Energy Solutions.

Robertson noted that the liability reported by BP, operator of the Macondo blowout well, is larger than the market capitalizations of most companies operating in the gulf. BP estimated its spill liability at $32.2 billion and its spill costs as of early August were more than $6 billion (OGJ, Aug. 2, 2010, p. 34).

“Uncertainty will reduce capital investment in the Gulf of Mexico,” which could increase US dependence on foreign oil, result in higher US trade deficits, and result in the movement of US jobs to other regions of the world, Robertson said.

He also questioned whether large oil companies and NOCs will be able to operate in the gulf in the future, adding companies typically like to find partners for deepwater projects so that they can share the costs and the risks.

Corporate boards will reexamine their health, safety, and environment strategies, he said, adding that the value attributed by investors to strong HSE performance is likely to increase.

“Leaders in government need to make it clear that deepwater production is something that we need to do,” Robertson said. “We also need to make it clear that high standards will be enforced.”

US Department of Energy records show more than 36,000 oil wells were drilled in the gulf since the 1950s. Only one other well blowout resulted in an oil spill comparable with the BP Macondo well blowout. Mexico state oil firm Petroleos Mexicanos’ Ixtoc well blew out on June 3, 1979, in the Mexican side of the gulf.

Contact Paula Dittrick at paulad@ogjonline.com.

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