Luke Davis, Peter Kiernan, Julian Callanan, and Dr. Roger Knight - Infield Systems Ltd.
The US is the largest consumer of oil in the world, with the US Energy Information Administration (EIA) expecting demand to be approximately 20 MMb/d in 2010.
While the EIA, in its Annual Energy Outlook 2010, states that US demand for petroleum-based liquids will remain relatively flat over the next two decades, the size of the US oil market is such that the requirement to boost domestic production to help prevent further growth in the share of oil imports is still substantial. Indeed, approximately 57% of the US’ petroleum needs are supplied by oil imports and reversing the trend of growing import dependence is a key priority for the Obama administration.
In this respect, the GoM is crucial to this policy objective as deepwater plays in the region are one of the few forecasted growth areas in terms of domestic production in the US. We therefore expect to see the GoM becoming increasingly important in meeting the US petroleum needs for the foreseeable future.
Nevertheless, as a possible outcome of the GoM oil spill, the Obama administration will face a delicate balancing act between seeking to reverse rising dependence on oil imports and meeting environmental concerns related to offshore oil and gas development.
Deepwater the key
Up until relatively recently, the GoM was mainly a shallow-water region, with the vast bulk of production stemming from waters of less than 200 m (656 ft). However, with improvements in drilling and production technology, the region’s majors have moved further offshore in search of more lucrative plays in the Lower Tertiary. The discovery of the Tiber prospect by BP in September 2009, located on Keathley Canyon block 102, is a case in point. Estimated to contain between 4-6 Bbbl of oil, Tiber has illustrated the potential of deepwater exploration, incentivizing operators to sustain their deepwater capex commitments in spite of a period of depressed oil prices and global recession.
Indeed, it is deepwater discoveries such as this that have enabled the GoM to reverse its production decline seen since the early part of the last decade, and, according to EIA data, output in the region reached a record monthly peak of 1.715 MMb/d in December 2009.
This new oil has been due in no small part to the impact of new deepwater production from fields such as Shenzi, Atlantis, Blind Faith, Tahiti, and Thunder Horse.
Given the production growth of deepwater oil regions in the GoM, there has been steadily rising pressure on the US government to end moratoria placed on offshore exploration and development of reserves located elsewhere in the US outer continental shelf (OCS).
This pressure was heightened by concerns over a rising reliance on crude imports and escalating oil prices that peaked at $147/bbl in the summer of 2008. As a result, in July 2008, President Bush lifted a presidential ban that prevented leasing on the OCS except for the Western GoM, parts of the Central and Eastern GoM, and Alaska.
Just two months later, the US Congress allowed its own ban on offshore drilling to expire.
Then in late March of this year, the Obama administration decided to open certain parts of the US OCS to offshore oil and gas exploration. According to a statement from Ken Salazar, Secretary of the Interior, the announcement of a new strategy for the OCS included opening up for development new areas in the Eastern GoM as well as increasing the potential for oil and gas exploration in frontier regions such as the Arctic Ocean and the Mid and South Atlantic seaboard.
Specifically, the strategy called for four more lease sales in the GoM by 2012, and after that year the opening up of two-thirds of the oil and gas resources in the Eastern Gulf for development. It also included plans for two further lease sales, one off the coast of Virginia and one in the Cook Inlet in Alaska.
But barely three weeks after the Obama administration announced its OCS Strategy, disaster struck in the GoM when the Transocean semisubmersible rigDeepwater Horizon, on contract to BP, experienced an explosion and subsequent fire. With the rig destroyed the resultant oil spill into GoM waters is estimated, at the time of writing, to be at a rate of 5,000 b/d.
Setback
An incident such as this is bound to have an impact on the debate concerning the direction of US energy policy. For now, the Obama administration has put a hold on new offshore oil drilling leases being awarded, and it also announced a pause on scheduled discussions to explore drilling offshore Virginia on the US East Coast. However, the OCS strategy in its entirety as announced in late March has not yet been revoked. Instead, Robert Gibbs, the White House press secretary, has been quoted as saying that the review of the Macondo incident could delay the next OCS lease round, the Western Gulf of Mexico Lease Sale 215, currently scheduled for Aug. 18, 2010.
It seems that the Obama administration’s response will not be clear until such a review has taken place. White House Senior Advisor David Axelrod also stated on the ABC Network’s Good Morning America that President Obama “Is not going to continue the moratorium on drilling [but that] no domestic drilling in new areas is going to go forward until there is an adequate review of what’s happened here and of what is being proposed elsewhere.”
An early indication that the Obama administration will likely take a more hands-on role in its response to the GoM spill is the announcement by Salazar that the Minerals Management Service (MMS) would be restructured. The US government now aims to:
Given the impact of theDeepwater Horizon incident, if there is still to be an expansion of offshore drilling in the US, it will likely come under a more stringent regulatory environment, something that would in turn increase the costs of offshore exploration and development, especially in deepwater plays.
As an example, Democrats in Congress are reported to be pushing for an increase in the corporate liability cap for oil companies for oil spills to $10 billion from $75 million. Additionally, further inspection and testing of equipment onboard rigs and new training initiatives designed to increase operational safety may also increase development costs.
In jeopardy of slow down?
Offshore drilling is an inherently risky business. Over the years, the industry has become better equipped to deal with the risks, but with such a rapid move into deeper waters, as witnessed over the last decade, operators have taken a step into an environment where the risks associated with exploration and production are magnified. The high-temperature, high-pressure fields that characterize deeper waters only serve to make operations more difficult. While at the time of writing we do not know exactly what caused the Macondo disaster, the challenges of mobilizing emergency and spill prevention measures over such extreme distances and into such extreme water depths has been demonstrated.
However, the importance of deepwater GoM to both the operators exploring and developing the region and to the US economy itself should not be underestimated. From the perspective of International Oil Companies (IOCs) the GoM region, and in particular the Lower Tertiary trend, offers the prospect of giant oil finds in a politically stable operating environment in which private investment is actively encouraged. Indeed, as reserves of easily recoverable oil become increasingly rare outside the domain of OPEC member states, IOCs have been forced into deeper and harsher operating environments in which to find opportunities for production growth. Consequently, the risks associated with that exploration have grown.
In the GoM, this has led to record-setting lease sales, as oil companies jostle for operatorship of the most promising blocks. The latest round, MMS Lease Sale 213 for the Central GoM, attracted $949 million in high bids for 468 blocks.
This total is greater than the figures recorded at last year’s Central Gulf sale which attracted $703 million in high bids. In the latest sale the highest bid was placed by Anadarko and Mariner Energy for the deepwater Walker Ridge block 793, while Keathley Canyon blocks 62, 76, and 77 attracted the highest number of individual bids. It is the now proven potential of these areas, particularly the Lower Tertiary and Lower Miocene trends, which have driven bidding competition in the GoM and made the region central to many IOC growth strategies.
A brief inspection of the deepwater capex figures directed toward the GoM reveals the emphasis operators place upon the region. On a global level, the deepwater region of the GoM is forecasted to attract 23% of total deepwater capex between 2010 and 2014 – equating to over $40 billion of investment on platforms, subsea infrastructure, pipelines, control lines, and single point moorings.
Moreover, when we look at spend by region, less national oil company (NOC) capex, we see that the GoM attracts almost a third of global total deepwater expenditure —highlighting the importance of the region to IOCs. Indeed, the US is forecast to attract more deepwater non-NOC capex than any other country, and as a region is second only to West Africa, where the majors have invested heavily in Angola, Nigeria, and Ghana.
Such heavy investment has paid off, and the discovery of new reserves located in deepwater has progressively increased since the turn of the millennium. A distinct trend toward deepwater has been exhibited for many years, and, as the accompanying graph shows, the larger fields have increasingly been found in areas where water is deeper than 1,000 m (3,281 ft) for some years now. At the same time, offshore capex has steadily increased in water depths of over 500 m (1,640 ft).
In light of the Macondo incident, and the knock-on effect this will likely have on the regulatory environment in the GoM and further afield, legitimate questions have arisen regarding the future development of deepwater reserves.
In the short term, the incident has the potential to slow exploration and appraisal (E&A) activity. Firstly, from a purely supply perspective, the region has lost an asset: Transocean’sDeepwater Horizon. Secondly, three other deepwater rigs, including the Discoverer Enterprise, Development Driller II, and Development Driller III have been earmarked for relief work at the Macondo spill site. In addition, Diamond Offshore’s semi Ocean Endeavour, currently working on ExxonMobil’s Mica field, was evacuated, although it is now operational again. This event has effectively taken four rigs out of action in the GoM, and, with an expected two- to three-month completion time for the Macondo interception well, the Development Driller III, currently drilling this relieving well, will be tied up for some time.
For BP, theDeepwater Horizon tragedy is costing the company an estimated $6-8 million per day and is jeopardizing the major’s position as number one operator in the GoM. As the accompanying map shows, BP has a huge swathe of undeveloped deepwater blocks in the region and it is in precisely these areas that the company is seeking to expand its production portfolio. But with all of its GoM deepwater capable rigs now completing relief work at Macondo, BP’s 2010 E&P strategy is bound to be setback.
Looking further ahead, the disaster at the Macondo well could potentially delay the final investment decisions on many BP-operated interests through 2010-11. In the US alone, developments such as Tubular Bells, Mars B, Atlantis Phase 2, Galapagos, Na Kika Phase 2 and 3, and Horn Mountain Phase 2 – which were due for final investment decisions in 2010 – could all be at risk of delay. Furthermore, in 2011 two projects that BP planned to sanction – Mad Dog Phase 2 and Na Kika Phase 4 – could also be at risk of delay. Much of this will depend on the size of BP’s war chest after the cost of the spill cleanup has been deducted.
As one of the largest spenders in the GoM, with a forecast deepwater capex of $7.7 billion over the 2010-2014 period, a potential withdrawal or even slowdown of BP deepwater activity would have serious ramifications for the region. To date, operator comments suggest that project timings are unlikely to be affected. However, we remain conservative.
Away from BP, other deepwater projects around the GoM also could be adversely impacted. Petrobras, for example, has already come out to say that it intends the development timeline for Cascade Chinook to be unaltered. However, the Brazilian national oil company is working on the assumption that the current pause on further development drilling will have been lifted by August 2010. Looking more broadly, with the prospects of increasing legislation and restrictive measures on drilling activity, the GoM deepwater market may see some price inflation, and this in turn may render more marginal fields uneconomical.
Much of the media spotlight that has identified long-term impacts of the spill on the GoM has focused on the US fisheries or coastal industries. However, we need to be acutely aware of the potential impacts of this unfortunate accident on the development prospects of the GoM. Here we may see deadlock develop between the oil companies, which have invested so much in deepwater acreage and technology, and the legislators, whose job it is to prevent accidents similar to Macondo from occurring again.
Turning attention back again to BP, which, understandably, is likely to be the most affected of the majors operating in the GoM, delays, deferrals, and cancellations could have a major impact on total deepwater production.
As detailed by the holdings graphic, BP looks to be one of the key players going forward. Should any BP-operated fields be canceled, a significant drop in production should be expected. Furthermore, if ongoing deepwater development was severely affected, such as in our worst case scenario, we would expect production growth to erode dramatically. This would have a substantial impact on how achievable the Obama administration’s plans are to make the US less reliant on imported hydrocarbons.
The eventual impact that the Macondo incident has on BP will depend on the outcome of the myriad of investigations and lawsuits that are under way, not to mention the policy and legislative response from the Obama administration and US Congress.
While the US policy response to theDeepwater Horizon incident may slow the pace of growth of the deepwater sector in the US, we believe that a prolonged ban on new drilling activity is unlikely. The GoM is one of the major O&G basins in North America and it now accounts for 28% of total US oil production. The push to open up more offshore regions to exploration and development may be delayed as the regulatory environment tightens and project costs rise, and this in turn may slow the rate of any production growth in deepwater regions.
The Macondo incident highlights the fact that deepwater operations involve considerable technological risk. While we believe it is possible that short-term delays in exploration and development may occur in order to facilitate a safer offshore operating environment, we also expect that in the GoM, as well as offshore Brazil and West Africa, efforts to develop deepwater prospects will still be made given the size and importance of these regions’ reserves.
In the meantime, all efforts will naturally focus on stemming the flow of oil from the Macondo well and on the cleanup operation across the GoM. Ascertaining the exact cause of the accident will be a priority over the next few months as governing bodies, oil companies, and rig managers alike seek to learn from this tragic incident so that the deepwater industry can move forward in a safer operating environment.
Reversing the growth in dependence on imported oil is a major objective that underpins the Obama administration’s emerging energy strategy. Achieving this objective has potentially become more complicated by the recent Deepwater Horizon incident on the BP operated Mississippi Canyon block 252 in the US Gulf of Mexico (GoM). Although the seriousness of the incident in the Gulf should not be underestimated, the fact remains that oil sourced from deepwater production has been playing an increasingly significant role in supplying the US, the world’s largest oil market, with its energy needs.
Luke Davis, Peter Kiernan, Julian Callanan, and Dr. Roger Knight of Infield Systems Ltd. discuss the impact of the Macondo disaster on US energy policy, and also on the near-term investment decisions relating to deepwater oil and gas (O&G) projects in the United States.
