High Returns Keep Some Energy Companies Faithful to Gulf

HOUSTON Aug 30, 2006 (Dow Jones Newswires)

Sometimes it pays off to go up against the storm.

Energy producers and investors shunned the shallower waters of the U.S. Gulf of Mexico following the devastating hurricanes of 2005. A year ago Tuesday, Hurricane Katrina made landfall in New Orleans, leaving a wreckage of oil rigs and pipelines in its wake.

But far from fleeing, some firms have increased their shelf presence in the Gulf Coast, attracted by the area's highly productive but quickly declining wells. A relatively benign 2006 storm season thus far - accompanied by near-record energy prices - has rewarded their stance. Although Tropical Storm Ernesto, formerly a hurricane, looked like it would pose a threat to oil and gas production in the Gulf last week, the system veered east into Florida. Weather forecasters have downgraded their hurricane predictions for this year, although most still expect it to be a season with above-average activity.

It's all only underscored the high returns energy companies can book in the Gulf of Mexico, even factoring in hurricane risk, at a time when access to attractive energy prospects elsewhere in the world is shrinking.

"Margins there are terrific," said Tony Lentini, a spokesman for Apache Corp. (APA). The Houston-based independent oil and gas producer recently acquired most of BP PLC's (BP) Gulf shelf assets, making it the largest leaseholder in the shallow-water area. The shelf is the part of the Gulf of Mexico that's closer to the coast, where production has been going on for decades.

While the shallow water Gulf, known for its rapidly depleting assets, "is not going to be an exploration play, it generates more cash than any other region for us," Lentini said.

Elliot Pew, executive vice president at Newfield Exploration Co.'s (NFX), said the company now has a flat production profile in the Gulf, but growth prospects elsewhere. The cash flow obtained from high commodity prices "has financed our diversification program," Pew told executives at a Houston meeting hosted by the Energy Forum.

Other big Gulf adepts include W&T Offshore Inc. (WTI) and ATP Oil and Gas Corp. (ATPG), all based in Houston. W&T, which has been entirely focused in the area since its inception in 1983, said last week that it had completed the acquisition of Kerr-McGee's shelf properties for $1 billion.

"The good thing about the Gulf of Mexico is that we have a huge cash flow," said W&T Chief Executive Tracy Krohn. "You get it out very quickly, have a nice profit and put it back in the ground again."

Scaring Away The Street

Wall Street investors don't favor the shallow waters of the Gulf. When long-time offshore operator Houston Exploration Co. (THX) said last November it would leave the region for more predictable North American onshore locations, the value of its shares jumped almost 10%.

The area's list of blemishes include low hydrocarbon reserve life and high operating costs for aging offshore fields, in addition to the extensive damage caused by hurricanes Rita and Katrina on old infrastructure. The storms destroyed 113 platforms and caused extensive damage at the other 72, said the U.S. Minerals Management Service, a Department of Interior Agency that oversees crude oil and natural gas production on federal territory. Most of the structures were in the shallow water, where the oldest platforms lie.

Since the 1990s, the Gulf shelf's importance has faded in contrast to the deepwater area, which has become one of the world's hottest energy investments as companies plunge billions of dollars in finding massive new fields.

But shallow-water production, although declining, still accounts for one-third of the Gulf's oil production and two-thirds of its gas output. The Gulf itself accounts for about a quarter of production in the Lower 48 States. Growth is still possible for companies focused in the area, W&T Offshore's Krohn said in an interview.

"Wall Street whispers in the ear of executives that it'd be nice to have a nice long production profile," said Krohn. "But we know we have the ability to replace our reserves."

After the purchase of Kerr-McGee's assets, W&T Offshore became the third-largest leaseholder in the shallow-water Gulf, behind Apache and Chevron Corp. (CVX). Krohn wants the company to become a "consolidator" of the region's assets, so he's fine with other companies abandoning the province.

"If my competitors want to be out of the Gulf because it's too scary in the summer, that's fine - it just means I'll have another rig at a cheaper price," he said.

Apache sees the Gulf as a cash cow that helps raise profits, and provides funds to invest in other, long-term areas in onshore North America or abroad, said Lentini. When hurricanes shut production in the Gulf, higher energy prices help even out the loss.

"Pretty much all our regions are running on all cylinders right now, so we're fortunate," Lentini said.

Confronting The Storm

For these companies, hurricanes remain a fact of life, but not as common as many think, said W&T Offshore's Krohn. "We're certainly prepared for it, but it is not unusual to have an active hurricane season and have the next one not be very active," Krohn said.

"Everybody is looking at the last war," said Apache's Lentini, referring to 2005's disastrous storm record. "We're not clairvoyant in predicting storms, we just know there's a certain number every year, and they're not all going to be Category five."

There are other risks in oil producing regions around the world, such as kidnappings, Lentini added.

Copyright (c) 2006 Dow Jones & Company, Inc.

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