Analysis: Moratorium In Gulf Gets Graver

The recent decisions by President Obama and his administration to extend the moratorium on new deepwater drilling in the Gulf of Mexico (GOM) by six months, to recapitulate on activities in the Arctic, to cancel the upcoming lease sale originally scheduled for August 2010, and to lengthen the shallow water permitting process beyond 30 days will collectively take their toll on offshore operators and drillers.

Rigs currently contracted in GOM include 41 jackups and 34 deepwater units. From an employment perspective, the International Association of Drilling Contractors (IADC) estimates that the GOM offshore industry employs approximately 75,000. Activities levels for both employment and wells drilled offshore may be trimmed as operators react to the economic dynamics imposed by the President's decisions. Specifically, all deepwater rigs will suspend drilling operations in the Gulf of Mexico for the next six months (see attached report - PDF - from Interior Secretary, Ken Salazar for more details).

While it may be too early to draw conclusions from recent trends in permitting activities, given the relative newness of all the changes at hand; we have nonetheless pulled some data together that will provide a backdrop for looking at these trends going forward.

Past experiences dictates that plans filed with the Minerals Management Service (MMS) do not always lead to actual drilling offshore. Based on activity reported between 2008 and 2009, we found that 95 out of 237 leases or approximately 40% had a wellbores spudded. What is interesting to note is that activity diminished versus actual plans as time elapsed (i.e. three-quarters of drilling activity occurred within 90 days of planned drilling start date). The chart below provides the likelihood of a well being drilled on a lease based upon actual results from 2008 and 2009.

GRAPH: Drilling Plants THat Lead to Wellbore

MMS records indicate that 58 pending plans for the months of May through July 2010 were filed prior to the moratorium's extension. Using these statistics would imply that as many as 20 current drilling plans in the Gulf of Mexico would likely to dry on the vine even if moratorium is lifted in six months as proposed.

Of the 34 rigs that are currently contracted for the GOM's deeper waters, nine are drillships and 25 are semisubmersibles. Half of the total are controlled by Shell, Anadarko, ENI, Chevron, and BP. The moratorium extension for new drilling leaves these operators in quite a pickle considering that the average rates are $445k/day. Obviously, the nine drillships would be the easiest to move out of the region if work is sought elsewhere in the mean time. All seven operators with contracted drillships have international drilling activities that could lend themselves to mitigating the impact of the moratorium. Only two of the operators with contracts, Taylor and Walter Oil & Gas, do not have international operations that could provide some buffer. Additionally, Cobalt International Energy is subletting a rig from Anadarko which we doubt would get moved internationally.

GRAPH: Deepwater rigs under contract

The elephant in the room is the question of whether operators will claim force majeure. With over 40% of the rigs in the Gulf of Mexico currently contracted at dayrates above $500k, the risk that pricing here will decline significantly from current levels is a stark possibility. Operators will look to drillers for some relief to mitigate some cost hemorrhaging caused by the suspension of deepwater drilling in the region. The most recent fixtures for ultra-deepwater rigs like the majority of those found in the Gulf of Mexico were already starting to taper prior to the DW Horizon incident. In fact the last three fixtures were for less than $450k/day (excluding exceptional environmental conditions).

Approximately 71% or 29 (of the 41 jackups currently contracted in the GOM) complete their existing contracts by summer's end. While drilling operations for shallow water operators are now excluded from the moratorium, they still face some pain in the near-term as the permitting process going forward may now take up to 90 days. Besides the timing delays that could sideline a few rigs, the upcoming hurricane season presents its own challenges. Parts of the Gulf of Mexico become restricted as the summer wears on because of the risks posed by storm winds. Thus, the delays in permitting that are likely to occur for rigs that would work in these regions prior to being restricted may result in no drilling here until after hurricane threats subside (i.e. next winter).

GRAPH: Jackups Rolling off contract

Combining 100-150 rig hands with another 200-250 individuals providing ancillary support; you are looking at between 300-400 jobs lost per rig. From an oil demand standpoint, nearly one-third of U.S. consumption comes from Gulf of Mexico production. While the moratorium applies to exploration efforts, clearly both jobs and future production are put in jeopardy by the decision to suspend deepwater drilling and extend the permitting process for shallow water operations. Time will tell if the enhanced safety and security measures that are under construction mitigate the immeasurable costs they impose. The most salient quote we have heard recently on the matter was by Amy Myers Jaffe, a research fellow at Rice University's Baker Institute, to the Christian Science Monitor. "What the president's announcement has accentuated for the industry in a very concrete way, is that the industry is only as safe as the practice standards of the weakest link."

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