Musings: Obama -- New Wildcatter or Bait 'n Switcher?



On the last day of March, President Obama went to Andrews Air Force Base in Maryland to stand in front of an F-18 jet fighter called the Green Hornet, which is scheduled to fly powered by biofuel later this year, and announce he was recommending lifting offshore drilling curbs. The symbolism of pushing for more offshore drilling while highlighting biofuel for military jets was not lost on all observers. The announcement, when fully dissected, showed the administration made concessions in areas where they were destined to lose court cases, but they may actually be slowing down future offshore drilling. Yes, President Obama says he wants to open the East Coast waters from Delaware south to central Florida for offshore exploration, but ultimately it all depends on Congress signing on to the plan.

The administration made concessions in areas where they were destined to lose court cases, but they may actually be slowing down future offshore drilling
Exhibit1"

The staging symbolism was highlighted by the president's comments. In talking about his decision to open new coastal regions to offshore exploration, he said, "The bottom line is this: given our energy needs, in order to sustain economic growth we are going to need to harness traditional sources of fuel even as we ramp up production of new sources of renewable, homegrown energy." In reality, the offshore drilling announcement was designed to win a few Republican senate votes for the potential energy bill being drafted by Senators John Kerry (D-MA), Lindsay Graham (R-SC) and Joseph Lieberman (I-CT). The legislation they are writing is designed to attack carbon emissions through cap-and-trade on a sector by sector basis rather than economy-wide. That means the utility industry will have one set of regulations implemented on a certain date while refiners would have a slightly different set of regulations and a different date and manufacturers would have yet another set of regulations and implementation date. 

The legislation they are writing is designed to attack carbon emissions through cap-and-trade on a sector by sector basis rather than economy-wide

Under the draft legislation, the utility regulations would start in 2012 and the manufacturers in 2016. This approach, some Democrats argue, would hamper the bill's ability to reduce emissions. "This approach is likely to make the system more complex and less cost-effective," said Robert Stavins an environmental economics professor at Harvard. But as Fred Krupp, president of the Environmental Defense Fund, a U.S. "green" group said, "cap-and-trade is certainly our preference, but it's a policy approach, not orthodoxy."

On the offshore drilling front, the administration has proposed to allow the oil companies holding leases in the Chukchi Sea off Alaska to go ahead and drill, but all future lease sales in that region have been delayed until another round of environmental studies is done for it and the Beaufort Sea. Bristol Bay, an area off Alaska the Bush administration had opened to drilling, has also been placed off-limits. As well, the entire Pacific coast will not be open for drilling, despite its prospective geology, along with the Atlantic coast from New Jersey northward to Maine.

Exhibit2"

In deciding to open the southern portion of the Atlantic coast, the Obama administration is only proposing allowing environmental and seismic studies. Plans for any lease sales in the area would not begin until a new five-year plan is approved for 2012-2017. Public hearings are scheduled to begin on the plan shortly. At the end of the day, it is entirely possible that the Democratic-controlled Congress will not go along with Obama and leave the East Coast drilling moratorium in place. The Obama proposal also would delay the sale planned off of Virginia's coast that was initially driven by Republican state legislators. 

It is entirely possible that the Democratic-controlled Congress will not go along with Obama and leave the East Coast drilling moratorium in place

President Obama is proposing to allow Gulf of Mexico drilling off Florida in the area that extends beyond 125 miles off the coastline.  While this is a positive for the oil and gas industry, the decision raises questions of whether people should believe President Obama or Candidate Obama who campaigned hard in Florida on a pledge to keep all its waters off limits to drilling. 

The politics of this offshore drilling moratorium are very interesting. About five years ago, while attending an annual meeting of the National Ocean Industries Association (NOIA), I had the occasion to talk to a senior E&P executive who was involved in the 1970s East Coast drilling effort. At the time of our discussion, natural gas prices were in the $8 per thousand cubic feet (Mcf) range. He told me that if the East Coast area was opened for leasing again he wouldn't drill a well but rather would start laying a pipeline because he already knew there was natural gas in the area. He was referring to the 1977 drilling that took place in Baltimore Canyon some 50 to 90 miles off Atlantic City, New Jersey.

The gathering of seismic data off the East Coast began in the early 1960s but picked up steam in 1969 when the concept of group shoots developed. We find this timing curious as it coincides with the time period when people believed the U.S. was running out of natural gas supplies from the Gulf of Mexico. In order to encourage increased exploration for gas, the Federal Power Commission, which regulated the market for natural gas sold to pipelines engaged in interstate commerce due to the Supreme Court decision in the 1954 Phillips Petroleum case, allowed gas buyers to make advance payments for gas supplies to help fund the exploration effort. Under the regulatory scheme, monies advanced to E&P companies could be included in the "regulatory rate base" that was used for determining the earnings allowed for pipeline companies. These pipeline advance payments would be offset against future gas supplies delivered by the E&P companies, but if there were no new gas supplies, the advance payments were forgiven. The payment did remain in the pipeline company's rate base earning the allowed rate of return. 

The Federal Power Commission, which regulated the market for natural gas sold to pipelines engaged in interstate commerce due to the Supreme Court decision in the 1954 Phillips Petroleum case, allowed gas buyers to make advance payments for gas supplies to help fund the exploration effort
Exhibit3"

On August 17, 1976, the Minerals Management Service held an auction of 154 leases off the East Coast raising $1.17 billion in lease bonuses. Drilling on these leases commenced in 1977. A total of 35 wells were drilled in Baltimore Canyon. Eight of the 35 wells were drilled in Hudson Canyon, which is part of the greater Baltimore Canyon, and five of them tested natural gas at flow rates ranging between 5.9 million cubic feet per day (mmcf/d) and 18.9 mmcf/d. One of the wells also tested oil from a shallower formation at a flow rate of 630 barrels per day of 48.4° API-quality crude oil. The oil was found in a Texaco well that tested 18.9 mmcf/d of gas.

Drilling of the Texaco well was performed by Ocean Drilling & Exploration Company (ODECO) whose offshore drilling rig fleet today forms the core of Diamond Offshore's (DO-NYSE) fleet. ODECO was founded by drilling pioneer Doc Laborde, who helped create the offshore drilling and supply vessel industries. The drilling operations were supported by two supply vessels using Atlantic City, New Jersey and Davisville, Rhode Island for bases. Wells generally took 100-150 days to drill, although the length of time was impacted by the amount of well testing and coring that was undertaken to gain intelligence about the formations. We have seen one well cost an estimated $8.9 million.

As analysts go back and look at Baltimore Canyon, they will find it sits on a trend extending from offshore Nova Scotia to Maryland.  The 1999 Deep Panuke discovery by EnCana (ECA-NYSE) near Sable Island offshore Nova Scotia provides encouragement that Baltimore Canyon could equally be as promising an oil and gas bearing region. What we have found, however, is that the offshore leasing program is a vote-getting effort aimed at various senators -- keeping certain ones on the reservation by banning offshore leasing off their state's coast and winning others by appearing to modify the offshore drilling moratorium. 

The drilling operations were supported by two supply vessels using Atlantic City, New Jersey and Davisville, Rhode Island for bases
Exhibit4"

New Jersey Senator Robert Menendez (D-NJ) came out opposed to President Obama lifting the offshore drilling moratorium. In a release issued by his office on the day of the announcement, Sen. Menendez is quoted as saying, "I have let the administration know that if they do not protect New Jersey from the effects of coastal drilling in the climate change bill, then my vote is in question. I am deeply concerned about the threat coastline drilling poses to the Jersey Shore's economy and to the potential for new jobs and energy savings that can be harnessed in a clean energy economy. If issues like coastline drilling are being promoted to gain Republican votes and support from oil companies, then we need to know exactly how much support it will actually deliver -- this can't be a case of giving up something for nothing." So how to protect the New Jersey shores? Let's close the doors and discuss the situation!

Exhibit5"

A critic of the proposed offshore leasing expansion is Michael Lynch, a Massachusetts energy consultant. In an op-ed in The New York Times, he opined that easing the offshore leasing ban would do little to impact the U.S. oil supply picture. He also doesn't believe the change will have any impact on gasoline pump prices in the foreseeable future. In his view, the country would be better served if the offshore drilling ban along the Pacific Coast were lifted as we are certain that there are substantial oil reserves along with an oil and gas producing infrastructure to help process and transport the oil. What a strange thought -- an economist from Massachusetts recommending drilling offshore California!

In order to get any climate/energy bill through the Senate, even with a 59 Democratic majority, President Obama needs the votes of at least one Republican. But he actually may need more as it appears that he can't keep the votes of Blanche Lincoln (D-AR) and Ben Nelson (D-ND). So how to win crossover votes? Give them something they want -- offshore drilling -- or prevent something they don't want -- offshore drilling.  The one thing President Obama is desperately trying to avoid is a debate about blocking his authority to regulate carbon emissions via the Environmental Protection Agency, his Plan B if the energy/climate bill fails. 

The Obama administration has probably done more harm than good in relation to developing the nation’s potential oil and gas reserves and edging us closer to self-sufficiency

At the end of the day, this offshore drilling proposal is largely a public relations exercise designed to try to sway senators to vote for the upcoming energy/climate change legislation. It may also become one of the all-time bait 'n switch events.  All the proposed changes to the offshore drilling moratorium will require Congressional approvals and we know where most of their sentiments lie. Additionally, the potential high-profile drilling that was scheduled for offshore Virginia will not happen until at least 2012. Drilling in Alaska's Chukchi Sea will go forward, but based on the court cases it was likely to happen anyway. By delaying other lease sales in the Chukchi Sea and Beaufort Sea and putting Bristol Bay off limits along with the entire Pacific Coast, the Obama administration has probably done more harm than good in relation to developing the nation's potential oil and gas reserves and edging us closer to self-sufficiency. 



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