Drilling Challenges Reshape Oil Exploration
More than six months after the Deepwater Horizon drilling rig sank, resulting in an estimated release of nearly 5 million barrels of crude oil into the Gulf of Mexico, regulations have tightened and the industry is just getting a taste of the potential changes and challenges ahead.
For a while, the U.S. government's temporary halt on new deepwater drilling seemed to be among the industry's biggest long-term worries in the wake of the big oil spill at the site of BP PLC's (BP, BP.LN) Macondo well in April.
The Obama administration implemented a six-month moratorium on deepwater oil drilling immediately after the spill, and then lifted that ban on Oct. 12, several weeks ahead of schedule.
Even so, 'recovery of deepwater drilling in U.S. waters will be very slow and will take several years,' said Beth Sewell, a managing partner at Quantum Power & Gas Services.
Randy Stilley, chief executive of Seahawk Drilling Inc. (HAWK), told MarketWatch on Tuesday that 'it's anyone's guess when the first new deepwater drilling permit will be issued, and ... it would seem likely that new permits for deepwater drilling will be very slow in coming.'
Before the blowout on April 20, there were 33 deepwater rigs and 45 shallow-water rigs working in the U.S. Gulf of Mexico, he said.
Most of the deepwater rigs are currently idle and some have already left for work in other regions. Among the shallow-water drillers, where there has been no official moratorium, the working rig count has dropped to 27 rigs, he said.
'Without a significant increase in the pace of drilling permits being issued for both shallow and deepwater drilling in the Gulf of Mexico, more rigs will go idle between now and the end of the year,' Stilley said.
Oil drillers have obviously suffered in the wake of the oil spill and it could very well be a pain that lasts.
'There will likely be some big changes within the industry, some of which will spill over to other areas and countries,' said Lew Watts, CEO of global energy advisers Lew Watts & Associates.
Among those changes, the contractual relationship model between operators and service companies will move to shift more liabilities to service companies, creating 'upward pressure on costs of products and services,' he said.
Also, the scale of liabilities at risk overall 'could prove problematic' for the smaller independent drillers, with only those with large balance sheets able to afford to play, said Watts.
Stilley said that 'from a profitability standpoint, every driller in the Gulf of Mexico has seen their profits drop and this will likely escalate during the fourth quarter of 2010.'
For BP, the cost of the spill, so far, is a bit more transparent. The oil giant saw pre-tax charges related to the spill of $7.7 billion in the third quarter and $32.2 billion in the second quarter.
'As for other companies operating in the Gulf, there is definitely a voluntary 'belt tightening' going on as far as their internal drilling procedures are concerned, and that will intensify for some time to come,' said Sewell. 'These companies will take every step necessary to be sure they do not encounter a major spill in the future.'
Shallow offshore drilling--drilling in less than 500 feet of water depth--will be hurt as well.
'Even though new regulations may be planned for deep drilling, they spill over and impact on shallow drilling too,' said Sewell, noting that about four new shallow offshore drilling permits have been issued since the spill, down from about 10 per month.
Still, there are a couple of potential offsets to losses in deepwater drilling.
In the Gulf of Mexico, drillers have moved several deepwater rigs overseas to such offshore locations as Brazil, the Middle East and Southeast Asia, said Charles Perry, president of energy consulting firm Perry Management.
'This migration of deep rigs overseas will continue,' he said. 'These rigs cost too much to allow them to sit idle when there is still demand for them elsewhere in the world.'
The fallout from the BP spill has also highlighted the opportunities in the new onshore energy sources that producers have found in both crude oil and natural gas, said Libby Toudouze, portfolio manager for the Cushing MLP Funds.
Energy infrastructure companies, specifically those referred to as master limited partnerships or MLPs, 'continue to be in high demand as we will need over $200 billion of oil and natural-gas infrastructure to be built in North America over the next two decades to service these new onshore energy supply areas,' she said.
Regulatory Red Tape
Safety regulations have tightened, however, and any added costs absorbed by the drilling industry may find their way to consumers and increase the processing time for permits.
Of course there are those who believe that regulations didn't need to be changed at all.
'The oil industry has drilled offshore for 40-plus years and this was the first major disaster, which was certainly bad but part of that was clearly not due to lack of regulations,' said Toudouze.
Stilley points out that over the past 15 years alone in the U.S. Gulf of Mexico, 'we have drilled over 11,000 wells in shallow water and spilled only 15 barrels of oil,' and in the deepwater segment, before the Macondo incident, there had been no such events.
Oil majors already have a great many safety measures in place and they will further and fortify those precautions, said Anthony Sabino, a professor of law at St. John's University whose legal practice includes oil and gas law.
'It will be an incremental increase in drilling expenses, but that will be passed onto consumers,' he said. 'In fact, it already [has] since the market has factored that in.'
New restrictions so far in the wake of the oil spill lean more toward enforcing the rules in place, he said. 'Even though the rules call for heightened safety, the emphasis has been on more oversight, more inspections and more [of the] government saying 'no' to the industry,' Sabino said.
So really, the 'underlying rules haven't changed much, but the new regime is one of more robust enforcement,' he said.
Striving For Normalcy
And even if the industry meets these new regulations, Stilley warned that the amount of time required for processing a drilling permit, or an exploration or development plan, has 'greatly increased.'
The Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE) has said that it will need to hire at least another 200 people to deal with the additional work flow, but they are not allowed to hire people from the industry, due to potential conflict of interest, he said. There are also few new hires due to lack of qualified candidates and lack of funding, he explained.
'This will take some time to work out and in the meantime, the offshore drilling industry will continue to suffer,' Stilley said.
Michael Lynch, president of Strategic Energy & Economic Research, said that 'new regulations will mean that project lead times will be longer, and therefore costs higher, for years to come.
'The long-term impact on Gulf production will be to suppress the expected production curve somewhat, but should not be disastrous,' he said. 'The big projects will be pushed through, but the little producers/projects may find it hard to get the attention of regulators and inspectors to approve their developments in an expeditious manner.'
The oil majors, on the other hand, are 'still cash rich from the last run-up, so they are well able to weather the increased costs and will adapt to more expensive deepwater drilling,' said Sabino.
'Just the way the airlines returned to the skies after 9/11, drilling will resume in the Gulf, but with even more emphasis on safety,' he said.