More Companies May Dig Deeper in Search for Oil

Sep 19, 2006 (Dow Jones Newswires from the Wall Street Journal) The successful production of oil from the five-mile-deep Jack well in the Gulf of Mexico is likely to spur more deep-water exploration around the world -- and that prospect is helping calm overheated crude-oil markets anxious about future supplies.

Chevron Corp. and partners Devon Energy Corp. and Statoil ASA announced earlier this month that they had flowed oil out of an ancient rock formation about 175 miles south of the Louisiana coast. The development could herald a vast energy-producing region in the U.S.'s backyard. Similar cutting-edge technology could be used to find oil in a number of other regions around the world, including Mexico, Mauritania and Malaysia.

Until recently, oil prices have been rising, lifted by geopolitical tensions in oil-producing countries like Iran and broader concerns that world oil production won't be able to keep up with increasing world demand.

The successful Jack test underscores what a group of economists and oil-industry executives have been arguing for a while: High prices will encourage energy companies to find and pump oil in deep, dark places around the world that otherwise would have been uneconomical. However, the scarcity of deep-water drilling rigs may slow the industry's push into this frontier.

Since hitting $77 a barrel in mid-July, oil prices have been sliding. Yesterday, crude-oil futures were up 47 cents at $63.80 a barrel in New York Mercantile Exchange trading. Several factors are at play. Hurricanes have disrupted Gulf of Mexico production the past two years, but the outlook this year -- though midway through the hurricane season -- appears more benign. The Jack discovery seems to be weighing on oil prices, even though it won't produce oil for several years.

At the same time, the discovery has had a salutary effect on the stock prices of companies that have leased prime acreage in the Gulf of Mexico. Devon, a relatively small company by energy-company standards, saw its stock price shoot up 13% the day the development was announced, though it has since fallen with drooping commodity prices. Chevron and Statoil enjoyed smaller bumps, but their shares have since fallen.

Around the world, deep-water exploration is accelerating and offering some tantalizing new sources of oil. Many of the companies involved in deep-water exploration are oil behemoths that have enormous cash stockpiles with relatively few places to invest that money in a world where the best prospects, such as the Middle East, are largely closed to Western investment.

In addition to companies involved in the Jack well, deep-water oil is poised to play a larger role in the portfolios of Exxon Mobil Corp., BP PLC, Royal Dutch Shell PLC and Brazil's Petroleo Brasileiro SA. In the Gulf of Mexico, midsize companies such as Devon and Anadarko Petroleum Corp. are participating.

As the successful test of the Jack well demonstrates, the industry is quickly overcoming technical hurdles in deep water. Outside the Gulf of Mexico, the industry has racked up oil discoveries off the coasts of Brazil, Nigeria and Angola. There is mounting excitement as well in the South China Sea and off the coasts of India, Pakistan, Mauritania, Egypt, Malaysia and Mexico.

Deep-water oil "is a major source of new production as it expands more in the Gulf of Mexico and Brazil and especially in West Africa," says Robert Esser, director of global oil-and-gas resources for Cambridge Energy Research Associates, a consulting firm. He says deep-water wells produced about two million barrels a day in 2000, but are expected to produce more than 10 million barrels a day by 2015.

Nearly half the largest oil fields due to start up in the next four years are in deep water, usually considered anything deeper than 2,500 feet.

The rush into deep waters is stretching the industry's drilling resources perilously thin -- raising exploration costs and slowing down the ability to explore regions. Robert Long, chief executive of deep-water drilling contractor Transocean Inc., told a Lehman Brothers conference this month that off the coast of West Africa "I could name six or seven different customers right now who are looking for deep-water capacity as soon as they could get it."

Companies are responding by building drilling rigs as quickly as possible. According to Deutsche Bank, there are 140 floating rigs with an additional 23 under construction. There are 33 drill ships in the world, which can sink a well in 10,000 feet of water, and an additional six are under construction. Rates for existing ships have skyrocketed.

While the cost of drilling these wells can top $50 million per well and sometimes exceed $100 million, the fields tend to be very large. This keeps the cost of producing oil competitive on a per-barrel basis.

"Oil prices could get cut in half and the economics of these projects would still be attractive," says A.G. Edwards & Sons analyst C.K. Poe Fratt, who follows many of the companies that own deep-water drilling rigs and could benefit from the increased deep-water activity. These include Transocean, Diamond Offshore Drilling Inc., GlobalSantaFe Corp. and Noble Corp.

The industry's expanding deep-water capabilities are opening the door for exploration. Officials at Mexican state oil company Pemex said they intended to bid for two drilling rigs capable of working in 3,000 feet. Pemex has never before tried to tap its deep-water oil reserves, in part because historically it hasn't wanted to form a partnership with Western oil companies experienced at such risky exploration.

India also is stepping up deep-water exploration. Last year the state-run Gujarat State Petroleum Corp. said it made a substantial gas discovery off its eastern coast and is seeking an international oil company as a partner.

The deep-water finds include some substantial natural-gas accumulations as well as oil. This summer Canada's Husky Energy Inc. and its partner, China National Offshore Oil Corp., or Cnooc, said they made a major natural-gas discovery in nearly 5,000 feet of water in the South China Sea, about 150 miles south of Hong Kong. The reservoir is estimated to contain about five trillion cubic feet of gas -- about one-quarter of annual U.S. consumption.

Copyright (c) 2006 Dow Jones & Company, Inc. Southeast Asia is also attracting more deep-water exploration. Wells off Malaysia and Indonesia have been drilled, and there is interest in geologic formation off the coast of Vietnam, according to industry officials.

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

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