Musings: Future of the Gulf of Mexico Oil & Gas Industry

The overriding topic of interest at the recent National Ocean Industries Association (NOIA) conference was the future of the offshore industry operating and depending on work in the Gulf of Mexico.  Several sessions of the conference were devoted to topics related to the question: When will we get back to work?  Besides a session with Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE) Director Michael Bromwich, there was a panel of four senior executives from producers and an oil service company discussing changes confronting the offshore industry.  Another session reviewed the activities of joint industry task forces set up to address various issues arising from the Deepwater Horizon disaster and the resulting oil spill.  There was also a session dealing with the future of oil spill management. 

The general consensus from these sessions was that the world of offshore oil and gas has changed and will never return to the way it was in the past.  As a result, industry participants will need to be open to making organizational and operational changes in how they conduct their business in the future. 

One presentation dealt with the establishment and operation of the Marine Well Containment Company, the joint venture of four major oil companies operating in the Gulf of Mexico, which will design, build and maintain ready for deployment equipment for capping and containing a spill from a deepwater well.  It was the absence of this capability that drew the greatest criticism from the Federal government, national and local politicians and the media.  The equipment being designed and built by this company will be able to handle a well blowout in 10,000 feet of water and oil spewing at a rate of as much as 100,000 barrels per day.  These capabilities comfortably exceeded the well depth and daily spill rate of BP’s (BP-NYSE) Macondo well. 

The four oil company partners in this venture have pledged an investment of $1 billion to create the non-profit company, design and build the equipment, contract additional spill clean-up equipment and provide for a permanent professional management team to maintain the equipment in a state of constant readiness.  This new company will be the Gulf of Mexico’s equivalent of your local “fire department” – always ready to respond but hoping never to be called upon. 

The presentation described various aspects of the equipment being designed and built, but that is not the thrust of this article.  The company will be open to all operators in the Gulf of Mexico who can become members and pay a pro-rata share of the investment and operating expense.  It will also provide a structure to accommodate the use of the equipment by non-members for a premium fee.  The non-profit company should be established before the end of the year, but it will take 18 months before all the well capping and spill containment equipment is built.  The company anticipates striking a deal, hopefully by January 1st, to assume control of some of the oil spill equipment and vessels currently under contract to BP. 

The establishment of the Marine Well Containment Company and the contracting of some of BP’s oil spill equipment may be critical in the determination of when permits will be issued to the oil and gas industry so it can resume working in the Gulf of Mexico.  Director Bromwich cited the growing availability of spill response equipment following the successful capping of the Macondo well as part of the reasoning behind lifting the government-imposed deepwater moratorium.  One of the issues with securing new deepwater drilling permits is detailing how the oil company will deal with a worse-case well discharge.  There is a huge difference between capping and containing an unconstrained well compared to a constrained one.  It is possible that an unconstrained deepwater well could generate a flow rate that would exceed the capability of the Marine Well Containment Company’s equipment.  On the other hand, it is most likely that well blowouts will involve constrained wells, ones that have a blowout preventer, albeit probably damaged.  The Marine Well Containment Company believes that the equipment and systems it is building could be readily expanded to deal with double the stated containment capacity.

While the spill response equipment is a critical part of satisfying the concerns of the BOEMRE with regards to granting new deepwater drilling permits, satisfying other aspects of the permitting process may become difficult hurdles for producers to overcome.  If the pace of permitting doesn’t accelerate soon, it is only a matter of time before operators and service companies reach the conclusion that the grass really is greener on the other side of the ocean and exit the Gulf of Mexico.  Among the panelists discussing how to get the offshore industry back to work, the issue of the lack of support from BOEMRE for extending deepwater leases that were subject to the deepwater moratorium was considered a significant disappointment, especially after Director Bromwich’s earlier comments. 

Another operator with both Gulf of Mexico and North Sea experience noted that the latter’s regulatory system often becomes quite bureaucratic, which slows down the permitting process.  Based on comments from other attendees who have secured well workover and plug and abandonment permits, the review process has become bureaucratic with all decision-making authority having been stripped from the regional offices of BOEMRE and consolidated in Washington, D.C.  There were also observations that questions asked during the permit review process stopped the review until the answer to the question was supplied.  This back and forth process clearly is slowing the permitting process and there is little producers can do to help speed it up.  There is also no understanding whether the questions being asked by BOEMRE inspectors are designed specifically to slow the permitting process (the conspiracy theory).

A representative from Shell Oil (RDS-A-NYSE) pointed out that his company was preparing permit requests that comply with the new rules and that they hope will lead to the company returning to drilling before the end of the year.  But he pointed out a possibly serious impediment – the elimination of environmental exclusions.  Rather than being able to rely on a regional environmental impact statement, the oil company will have to go back to BOEMRE on a well or lease basis.  This will slow the process, and significantly retard the pace if the oil company has to prepare a supplemental environmental impact statement.  That process can consume up to a year of time.  All of these permitting issues could put at risk the timing of two Gulf of Mexico lease sales scheduled for 2011.  Ultimately, the combination of these issues could, according to Shell, put at risk as much as 400,000 barrels per day of future oil production planned to offset an equal volume that will be lost to depletion out of the 30% share of U.S. oil production that comes from the Gulf of Mexico.  That body of water also accounts for 10% of the nation’s natural gas production, but the success of onshore gas shales minimizes the risk of falling offshore gas production.

He also pointed out that Shell has been able to handle the costs related to the deepwater moratorium so far, but at some point if permits aren’t granted, the cost of idle rigs will become too great.  Another speaker pointed out that rig certification is an issue compounding rig contracting.  Getting a permit is one thing, but an operator can’t be assured the drilling rig under contract can be certified.  That risk will impact well timing and drilling costs.

The impact of these permitting problems will also fall on the offshore oil service industry.  As a speaker from Hornbeck Offshore (HOS-NYSE) put it, the future Gulf of Mexico market will be characterized by more risk, higher costs, a slower work tempo and a “compliance culture” that will drive regulatory costs much higher than the Federal government’s $183 million estimate.  In Hornbeck’s estimation, it will be 18 months before the Gulf of Mexico is back to normal permitting time and the industry is operating 33 drilling rigs as it was before the Deepwater Horizon accident.

He also said there will be other impacts on the offshore oil service industry.  The increased risk profile of producers is likely to drive them toward quality equipment and crews.  That means higher spec vessels, which will further drive up costs.  Oil service companies will need to focus on ethics and safety to an even greater extent than they do today.  Until better times drive increased activity offshore, there is a risk of mariner shortages as workers go abroad for work.  The shoreside and shipyard infrastructure in the Gulf of Mexico will be weakened as investment slows down.  How much of this capability might be lost and what will be the impact on future operating costs?  Lastly, he thinks the compliance culture will spread across the world raising costs everywhere; just one more example of how the oilfield service world has been changed by this disaster. 

We believe one of the great unknowns for the Gulf of Mexico is the impact of these regulatory changes on capital flows within the oil and gas industry.  If oil spill liability limits are eliminated, it will make it almost impossible for smaller producers to obtain insurance.  Many of these smaller companies will be forced to abandon the offshore.  What happens to their existing leases?  What about their participation in operating consortiums?  Will the larger remaining companies have to pick up the share of the exiting company?  If so, how will that impact oil company budgets and their willingness to accept an involuntary increase in spending in domestic waters.  For companies with global exploration portfolios, there is always a struggle in the annual budgeting process over allocating spending on a geographic basis.  If one region begins to see its share of the company’s total spending growing disproportionately, will management slow down spending on other planned projects?

Another issue that hasn’t been discussed much so far, but will also impact oil producer spending is the mandate to remove “idle iron.”  BOEMRE has mandated that the pace of plugging and abandoning existing but non-producing offshore wells, which usually means removing the platforms and well caissons, too.  This work has been underway for a number of years, but the pace has been modest.  The pressure to accelerate this abandonment work will strain the equipment and personnel situation along with consuming a greater share of producer budgets.  Unless budgets are increased, more abandonment spending will force cuts in exploration and development spending.  Until the rules for operating in the Gulf of Mexico are spelled out, the 2011 budgeting process that is well underway in oil and gas companies will have to err on the side of conservatism and that doesn’t bode well for any quick recovery in offshore operations.  Of course, if there aren’t any permits granted there won’t be any spending.

April 20, 2010, marks the date the offshore oil and gas industry’s world changed.  It will never go back to what it was before the Deepwater Horizon disaster.  The big question is whether when the industry does resume operations will it be anything like it was before that date?  We fear it won’t.

G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.


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