Musings: Expanding Offshore Regulation - Flying Below Radar Screen

We recently attended the 40th annual meeting of the National Ocean Industries Association (NOIA) in Washington, D.C., which was focused on the current state of the offshore industry along with a heavy emphasis on current economic and political trends, with the latter being of great interest for the attendees. Attendees are always interested in the intersection between politics and regulation, which ultimately impacts the economic health of the domestic offshore oil and gas industry. One of the panels dove into a topic – offshore regulation – that has not received much attention from the energy industry press or from offshore producing and service company managements. This is a topic that should be receiving greater attention and, in fact, some worry that how regulation is currently being conducted, may alter the historical working relationship between offshore service companies and their clients.

The past few years have been a watershed for the domestic offshore energy industry. On April 20, 2010, when the Deepwater Horizon drilling rig, owned by Transocean Ltd. and working for BP plc, suffered a well blowout, caught fire and sank taking with it the lives of 11 offshore workers. BP's Macondo well blowout unleashed the largest oil spill in the history of the Gulf of Mexico and upended the workings of the entire offshore market. The offshore industry was engulfed in dealing with the well disaster while at the same time organizing a massive oil spill clean-up effort. The U.S. government sprang into action, but often found that the laws and procedures for dealing with a situation such as Macondo were not clear and in some cases inadequate.

The Deepwater Horizon and Macondo disasters ignited a festering anti-oil industry feeling among the American populace and a large segment of the U.S. political establishment. If the oil industry wasn't liked before Macondo, it was hated after! Not only were lives lost in the accident, but the continued spewing of ugly black oil that washed up on the beaches of the Gulf Coast was witnessed not only from onshore, but could be seen 24/7 on TV and computer screens globally, courtesy of underwater cameras held in place there by remotely operated vehicles operated by offshore service companies.

The three primary players in the disaster – BP, Transocean and Halliburton – represented elements of the petroleum industry people and politicians disliked. BP, a foreign oil company that had built its U.S. presence by buying up American oil companies, was run by British executives who seemed to be inept and more importantly, tone-deaf to the anger of Americans. Transocean, a leading offshore drilling contractor, had been one of the many oilfield service companies that abandoned the U.S. for lower-taxed jurisdictions around the world during the great wave of corporate inversions despite the criticism by Washington politicians. Lastly, Halliburton, which had once been led by former Vice President Dick Chaney, a man hated by the Left and many Americans who opposed the Iraqi war, completed the trifecta. This was an industry trifecta that even the most ardent opponent of the oil industry couldn't have dreamed up in a scenario of how an industry could self-destruct. More importantly, this was a trifecta that was at war with each other over who was at fault in causing the disaster.

The Deepwater Horizon accident ushered in a new environment of critical review and new regulation for the offshore oil and gas industry. Only weeks after embracing the idea of opening up parts of the U.S. East Coast for oil and gas development, the Obama administration was forced to reverse itself. Not knowing what to do, and frankly not possessing any expertise in how to deal with the offshore industry, the Obama administration used the disaster as an opportunity to expand the federal government's control over the industry. The long-standing problems at the Department of the Interior over its handling of Indian royalty income coupled with the sex, drug and payola scandals involving Minerals Management Service (MMS) inspectors just a few years earlier provided the impetus for a thorough examination into how the agency worked and whether it could be made to work better. To work better, in this case, meant providing stricter regulation.

On May 19, 2010, Secretary of the Interior Ken Salazar signed Secretarial Order 3299 that established the Bureau of Ocean Energy Management (BOEM), the Bureau of Safety and Environmental Enforcement (BSEE) and the Office of Natural Resources Revenue (ONRR). These three organizations were charged with carrying forward responsibilities that previously had been conducted by the MMS. According to Secretary Salazar, the purpose of the reorganization was to address "conflicting missions" carried out by the current MMS that necessitated they be separated in order to eliminate the conflicts. At the time of the announcement, Secretary Salazar said the reorganization is "not the first nor the last reform" of MMS, and subsequent actions support that statement.

Initially, the MMS was renamed the Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE). Michael Bromwich, formerly a partner and head of the internal investigations, compliance and monitoring practice with the law firm of Fried, Frank, Shriver & Jacobson LLP, and before that the Inspector General in the U.S. Department of Justice, was appointed the director of the agency. In revising the regulation of the offshore oil and gas industry, Mr. Bromwich set in motion a policy that is quite radical based on the nearly 65-year history of regulation of offshore drilling in U.S. waters. The new policy was revealed in a speech Director Bromwich delivered at the 2011 Offshore Technology Conference in Houston. In that speech, he said he wanted to announce two new major developments being initiated by his agency. One dealt with how information about well permitting would be conducted in the future and the other dealt with regulations about entities that operate offshore. It is this latter development that provides the substance of concern for oilfield service companies operating offshore.

Quoting from Director Bromwich's prepared remarks we can see both the substance of the regulation, but just as importantly the inherent danger in how this regulation is being handled – what is and should be of great concern to offshore oilfield service company managements. Director Bromwich stated:

"Second, I have mentioned several times in recent weeks my interest in exercising regulatory authority over not only offshore operators but contractors as well. It has struck me as inappropriate to limit our authority to operators if in fact we had legal authority that reached more broadly to the activities of all entities involved in developing offshore leases. We have completed our review of the issue and have concluded that in fact we have broad legal authority over all activities relating to offshore leases, whether engaged in by lessees, operators, or contractors. We can exercise such authority as we deem appropriate. The reason for our historical practice that has focused solely on regulating operator was that it served to preserve clarity and the singular responsibility of the operator. I am convinced that we can fully preserve the principle of holding operators fully responsible -- and in most cases solely responsible -- without sacrificing the ability to pursue regulatory actions against contractors for serious violations of agency rules and regulations. We will be careful and measured in extending our regulatory authority to contractors." (Emphasis added.)

The current regulatory blanket that has been thrown over the offshore service industry hasn't stirred much discussion or apparent concern among company managements, but the fact that the federal government has made this determination without citing any statutory authority should give pause. This policy was reiterated in a response to a question following a presentation to the NOIA meeting by James Watson the current director of BSEE. Quite possibly company managements do not understand that they are now subject to regulation. It is possible they do not know because there haven't been any actions by BSEE other than to issue "Incidents of Non-Compliance" (INC) to Halliburton and Transocean relating to the Deepwater Horizon accident. Since those INCs were related to that disaster, other offshore service company managements may not appreciate their new regulatory status.

In a presentation dealing with this issue, attorneys Paul Smyth and Robert Thibault with Perkins Coie, LLP pointed out some of the problems with the way in which BSEE is conducting offshore service company regulation. Besides there being no identified statutory authority for the regulation, there are no definitions of exactly who is covered, nor are there standards for performance set forth. As they pointed out, and even highlighted by Director Bromwich in his OTC speech, the historical regulatory process involves legal arrangements agreed to between Lessees (oil companies who hold the offshore lease) and the federal government. Under that arrangement, the standards for performance are spelled out and the process allowing the government to bring a claim for non-compliance is set forth.

In this case, the lack of authority and definition of performance standards can lead to revisionary interpretation of actions. We all understand how perfect hindsight is. Additionally, there is no process for dealing with the government's claims and thus there are no limits as to the nature or source of a company's possible exposure or to the extent of the government's reach in extending its jurisdiction. This regulatory situation is the equivalent of driving your car around a town with no speed or warning signs and then being subjected to the judgment and interpretation of rules by the traffic officer writing you a ticket.

Messrs. Smyth and Thibault warned their audience that until either this regulatory scheme is rescinded by BSEE or overturned by the courts, the managements of offshore service companies should consider the potential impact this regulation could have on their businesses. That means understanding the impact on operations, insurance coverage and even corporate governance, including regulatory filings for public companies. Companies should consider implementing, or at least reviewing, regulatory compliance programs. Existing service contracts should be reviewed for clarity over risk-sharing and indemnification terms and even pricing arrangements. Public companies also need to consider the adequacy of their business risk disclosure in their filings with the Securities and Exchange Commission. All of this is good advice, but the better solution would be for the government to follow the correct legal process and either establish authority for this regulation and its rules, or abandon the regulatory over-reach. On the other hand, the offshore service industry needs to acknowledge its potential regulatory exposure and prepare to deal with it, or be willing to face the consequences should an issue develop.