Musings: Outlook for The US Offshore Industry Is Darkening

Musings: Outlook for The US Offshore Industry Is Darkening
More government regulations are impacting the offshore sector's outlook, possibly hampering the recovery. G. Allen Brooks' examines several of the recent Obama administration actions.

This opinion piece presents the opinions of the author.
It does not necessarily reflect the views of Rigzone.

After enunciating an energy policy in March 2012 that was based on the concept of an “all of the above” resource strategy, President Barack Obama has abandoned it in his recent energy policy actions. First, he rejected the construction application for the Keystone XL pipeline, and now he is ditching the Atlantic Lease 260 sale from the proposed five-year offshore oil and gas lease sale program for 2017-2022. Even more recently, President Obama has directed that the government tighten air pollution standards for offshore drilling. The removal of Atlantic Lease 260 is a reversal of President Obama’s previous policy calling for opening up the East Coast offshore to oil and gas exploration. This is the second time that acreage in the Atlantic Ocean has been bumped from proposed five-year lease sale programs. The first time was in 2010 when President Obama was siding with including an Atlantic lease sale in the 2012-2017 sale program, only to withdraw his support after the Macondo accident and resulting oil spill.

In President Obama’s March 15, 2012, speech about energy policy, he stated, “We can’t have an energy strategy for the last century that traps us in the past. We need an energy strategy for the future – an all-of-the-above strategy for the 21st century that develops every source of American-made energy.” As explained in a report of the President’s Council of Economic Advisors a little over two years following the speech, entitled “The All-of-the-Above Energy Strategy as a Path to Sustainable Economic Growth,” the advantages of President Obama’s policy were set forth. The report pointed out that the United States is producing more oil and natural gas, is generating more electricity from renewables such as wind and solar, and is consuming less petroleum while holding electricity consumption constant. Importantly, as the report pointed out, these developments have produced substantial economic and energy security benefits, while at the same time helping to reduce carbon emissions in the energy sector and thereby tackling the challenge posed by climate change.

The President’s energy policy was based on three tenets: 1) To support economic growth and job creation; 2) To enhance energy security; and 3) To deploy low-carbon energy technologies and lay the foundation for a clean energy future. Exploring the offshore oil and gas resources off the East Coast would certainly go toward fulfilling two of those critical tenets. The decision to abandon the Atlantic lease sale was in keeping with President Obama’s abandonment of his all-of-the-above energy policy and substituting instead an all-of-the-environmentally-acceptable energy policies.

When the Department of the Interior released its proposed 2017-2022 Outer Continental Shelf Oil & Gas Leasing Program, as required by the Outer Continental Shelf Lands Act, for 60 days of public comment, an email from an environmental organization arrived in our inbox declaring the success of its effort to fight the oil and gas industry. After claiming victory over the rejection of the Atlantic lease sale, the organization turned its attention to trying to get the five Arctic lease sales excluded from the plan. As a media report on the Atlantic Ocean sale rejection pointed out, it was the revolt of environmentalists and coastal communities concerned with threats to marine life, fishing and tourism along the East Coast that won the day in getting President Obama to remove the lease sale, even when the governors of most of the coastal states were in favor of the sale. The government’s decision was also impacted by concern about offshore operations disrupting U.S. military and commercial shipping interests. Interestingly, the Department of the Interior sees no problem with those interests when considering offering lease sales for offshore wind energy resources, especially as we know the structures will sit above the ocean surface, however, after drilling wells, oil and gas production and transportation equipment will rest on the ocean floor.

It should be noted that many of the media stories about the proposed Atlantic lease sale reported that the previous drilling off the East Coast some 40 years ago resulted in no successes. The reality is, as one story we read pointed out accurately, there were 51 wells drilled and hydrocarbon resources discovered, but they were not in sufficient quantities to be developed commercially. The key in conducting more exploration would be as an aid in determining if there were sufficient resources that could be developed commercially.

While we watch the evolution of our offshore oil and gas leasing program, it is important to understand that there are other ways the offshore oil and gas business is being attacked in an effort to hamper operations and boost operating costs in U.S. waters. If successful, the efforts will reduce offshore activity and resource development. That outcome would go against two of President Obama’s key energy policy tenets – to produce economic and employment growth while also boosting U.S. energy security.

One of the recent moves impacting offshore operations that is flying below the radar screen of the industry, and Americans in general, is the effort to change bonding requirements for companies operating offshore. The Bureau of Ocean Energy Management (BOEM), under its responsibilities to oversee the Outer Continental Shelf law, has stepped forward with proposals to revise its current financial responsibility determination of operators, largely related to the costs for plugging, abandoning and decommissioning offshore wells. BOEM’s actions are described as primarily a modernization of the agency’s financial assurance regulations to more closely match current industry practices.
In August 2014, BOEM published an Advance Notice of Proposed Rulemaking seeking input on “risk management, financial assurance, and loss prevention.” The input desired was to assist the agency in overhauling how it determines how much money a company must pledge to tie up to ensure compliance with financial and performance obligations arising from an offshore lease. Behind this modernization effort is the explicit intent to ensure that U.S. taxpayers never have to pay to decommission an offshore facility and to protect the environment.

As the process moved forward, BOEM elected not to pursue the regulatory changes through the rulemaking procedure but rather to make the changes known through Notice to Lessees (NTL), which is the traditional way for notifying lessees of violations of offshore operating rules and policies. The new NTL increased the list of entities to which the revised policy would apply. The list was expanded to include not only the lessees and operators but now also pipeline rights-of-way holders, right-of-use and easement holders, along with geological and geophysical test well permit holders. The NTL also removed restrictions that the Gulf of Mexico regional manager previously considered unacceptable such as letters of credit or production escrow accounts in lieu of surety bonds from the United States Department of the Treasury or U.S. Treasury securities.

Now the Regional Director would be able to determine whether additional security is necessary to secure compliance with lease obligations. The financial evaluation would now be based on 1) financial capability; 2) projected strength; 3) business stability; 4) reliability; and 5) record of compliance with laws and lease terms. BOEM also eliminated the eligibility for an exemption from this security review and has now established one set of criteria for determination of financial strength for independent exploration and production companies and another set of financial criteria for integrated companies.

The financial responsibility issue revolves around the determination of the estimated cost of decommissioning efforts. The key for the offshore industry is that BOEM will no longer consider the combined financial strength and reliability of co-lessees and operating rights holders when determining an individual lessees’ decommissioning liability. The net result of these changes is that each co-lessee in an offshore project will be required to maintain sufficient cash or surety bonds to cover the total costs of a decommissioning obligation. The net effect will be an explosion in offshore bonding requirements to the point that there may be insufficient bonding capacity available. That condition will drive the cost of bonding up sharply. For smaller operators who do not have the balance sheet strength (cash) to support their decommissioning costs nor are able to secure the necessary bonds, they may have to exit the Gulf of Mexico market.

While quite possibility not a conscious effort to shut down offshore exploration, development and production activities, the impact of a bonding capacity shortage could force small operators out of the market. This will increase the cost of offshore operations for integrated companies since they will need to assume a greater proportion of the total decommissioning cost of offshore projects. Less capital, which is certainly a condition of the current petroleum market, will hurt the growth of the industry. A recent example of this problem was shown in a March 8, 2016, press release reporting 2015 year-end financial results for W&T Offshore (WTI-NYSE), an exploration and production company operating in the Gulf of Mexico. In the press release, management commented on the challenge they face in meeting bonding requirements.

W&T Offshore stated, “In February and March, 2016, the Company received several letters from the U.S. Department of the Interior's Bureau of Ocean Energy Management (‘BOEM’) ordering the Company to provide additional supplemental bonding on or before March 29, 2016, in the aggregate amount of $260.8 million to cover its obligations under certain Federal offshore oil and gas leases operated by the Company. The issuance of any additional surety bonds to satisfy the BOEM order or any future orders may require the posting of cash collateral, which could be substantial. We plan to continue our discussions with BOEM regarding satisfying their requests for additional financial assurances.”

We cannot speculate on how this particular issue will be resolved, especially since we are not completely familiar with the company’s financial position. What we do know, however, is that for this issue to be reported in the year-end financial results press release, it is a serious issue.

In addition to the bonding rule changes, the extension of offshore regulation by the Bureau of Safety and Environmental Enforcement (BSEE) to offshore service companies will also alter the economics of working offshore besides elevating the regulations to potentially criminal status. We have written about these changes in the past so we won’t dwell on it, but offshore service contractors are subject to being charged for violations of rules and regulations that are still being determined by BSEE. Moreover, offshore service companies are now liable for the actions of all the other companies working on the project meaning they will need greater insurance coverage than needed prior to the regulatory change.

What we conclude from President Obama’s rejection of Atlantic Lease 260 and his administration’s actions with respect to the new offshore bonding requirement, new air quality regulations and offshore service company regulation, whether all coordinated or not, is that the domestic oil and gas industry is under increased economic pressure. These actions reflect new and different considerations that petroleum company management teams must consider when evaluating their corporate strategy. We wonder how many offshore petroleum company management teams are considering these issues now, let alone are even aware of them?


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