Halt in Gulf Drilling Begins, Raises Concerns

HOUSTON (Dow Jones Newswires), May 28, 2010

Oil and gas companies on Friday began halting exploratory drilling in the deepwater of the U.S. Gulf of Mexico following a federal government order. Meanwhile, they are bristling at a six-month exploratory drilling ban and its probable effects on the industry and the U.S. economy.

ExxonMobil and Marathon Oil said they have stopped drilling two wells in the Gulf. Chevron, the second-largest publicly traded oil company after Exxon, warned that an offshore drilling moratorium extension will have a "lasting" negative impact in the U.S. economy and in the nation's efforts to enhance energy security. Shell, Statoil, Eni Spa and Anadarko Petroleum, among others, are also seeing their drilling projects stalled.

Analysts say the ban isn't expected to hurt the short-term oil and gas output of the Gulf area, which produces about one quarter of U.S. hydrocarbons. But it will delay the massive, multi-billion-dollar projects major oil companies rely on for long-term growth. Deutsche Bank energy economist Adam Sieminski said Friday the pause on drilling ordered by President Barack Obama in the wake of a massive oil spill is expected to delay 160,000 barrels a day of oil in 2011, or about 8% of the Gulf's current production of crude.

The delayed production underscores the long-lasting impact the Deepwater Horizon incident, estimated to be the worst oil spill in U.S. history, will have on the global oil industry. Major oil companies consider the deepwater frontier Gulf of Mexico one of their prime areas for future growth, as it remained one of the last oil-rich areas of the globe still open to investment and subject to a stable tax regime.

The spill began more than a month ago after the explosion and sinking of Transocean's Deepwater Horizon rig, which was leased by BP to drill a deepwater well 40 miles off the Louisiana coast. On Thursday, Obama ordered 33 exploratory deepwater rigs currently operating in the deepwater Gulf to stop drilling and banned further exploration in the Gulf for six months. The president also put on hold the industry's foray into offshore Virginia and Alaska. The measures are perceived to be the first step towards an overhaul of offshore drilling laws.

The American Petroleum Institute, a lobbying group for the energy industry, said the drilling ban will hamper economic growth and job creation, especially in the Gulf states, and threaten U.S. energy supplies. "Deepwater development is a key component of domestic energy security," Jack Gerard, president of API, said in a prepared statement.

In 2007, the deepwater provided 70% of the oil and 36% of the natural gas from overall federal Gulf of Mexico production and the 20 most prolific producing blocks in the Gulf are located in deepwater, according to API.

Companies operating in the Gulf deepwater were still evaluating the impact of the government decision on their drilling plans, but they are expected to start moving rigs, which are leased at rates of around $500,000 a day, out of the region to keep them gainfully employed, according to a report by energy consultancy Wood Mackenzie.

Exxon said Thursday it has suspended drilling operations at the Hoover Diana well in the Gulf after the U.S. ordered a halt to current drilling in the area. It also delayed plans to drill a new exploration well at its Hadrian prospect. Marathon said it is in the process of temporarily abandoning the drilling of the Innsbruck well in the Gulf.

The drilling moratorium could be especially bad for Chevron, which is one of the largest oil and gas Gulf producers and whose future growth significantly depends on exploration in the area.

Chevron spokesman Mickey Driver said the company acknowledges the Obama administration's desire to fully understand the underlying cause of the oil spill, but that halting deepwater drilling will have lasting energy security and economic consequences for the U.S.

"We believe responsible drilling should be allowed to continue," Driver said. Exxon, Chevron and other companies are helping BP deal with the spill.

Offshore drilling contractors, which managed to weather most of the downturn in drilling that followed the recession, also stand to suffer. Switzerland-based Transocean, the world's largest offshore driller, gets 25% of its revenue from the U.S. Gulf, where it operates 14 rigs. Those rigs will receive a reduced "force majeure" rate because of the drilling ban, the company said Friday. Transocean shares have lost more than a third of their value, or about 38%, since the April 20 blast and recently traded at $57.11 apiece. Noble Corp., another large offshore driller, has seen its shares come down 30% since the incident, each trading at $29.19 on Friday.

Wood Mackenzie said the development of several existing oil discoveries in the area could also be jeopardized by delays and substantial cost increases resulting from new, stricter safety regulations. These delays and higher costs could defer as much as 19%, or 350,000 barrels of oil equivalent a day, of projected deepwater Gulf production in 2015 and 2016.

Wood Mackenzie said that a 10% increase in overall capital expenditure would drop the internal rate of return--a measure used by companies to compare profitability of investments--of deepwater Gulf of Mexico oil discoveries to 15% or less. This would put several of them close to, or below, the profitability rates required to proceed with a project, according to the report.

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