US Gulf data indicates strong fourth quarter, year 2000

July 1, 1999
Permitting activity picking up

The turnaround in US Gulf of Mexico activity began in late April and preliminary permitting and drilling data from the first two quarters show the trend will continue through the remainder of 1999 and into year 2000, unless undercut by sharply lower oil and gas prices. If the global demand for oil products increases only slightly, the year 2000 will be an excellent one for the petroleum industry.

Discussions with oil and gas producers indicate that activity will pick up substantially by late in the third calendar quarter or early in the fourth quarter, when the drilling rate is expected to return to the 1,000 wells plus per year rate. The driver behind this turnaround is low drilling costs, largely due to low mobile drilling rig day rates. Indications that the turnaround has already begun are as follows:

  • In early June, drilling contractors reporting increasing interest from producers in re-negotiation of rig rates.
  • In May, turnkey drillers had the most active month for rebidding in the history of that business sector.
  • The number of wells requested under plans of exploration (POE) filed by oil and gas producers in the Gulf of Mexico during the second quarter, if extrapolated annually, would number 984, a very respectable drilling rate.
  • With $16-17/bbl oil prices and $2.00-2.25/Mcf gas prices, producers feel better off financially.

In the first five months of 1999, leasehold income at the wellhead, net of royalty, was running an an annual rate of $15.343 billion on 1.069 billion boe net of royalty. Gross annual production in 1999 is forecast to be 1.258 boe. Leasehold income net of royalty in 1998 is estimated to be $13.839 billion.

Drill sooner or later

Producers have been carrying profits garnered by higher oil prices right to the bottom line, but all that sunshine will not last much longer. The extra cash showing up on income statements will last only until production falls perceptibly, as a result of the low drilling contract rate, or when financial analysts begin querying producers as to how they plan to invest retained income.

As a result, the only investment choices producers have is whether to drill for reserves or buy them. There is little question they will have to do either - eventually. Buying reserves simply pushes back the drilling decision.

In both cases, many producers believe there will be a flurry of contracting by the fourth quarter of this year in order to fulfill drilling plans, with wells started before the end of the year.

Much of the recent permitting activity is a response to stronger oil prices and continuing weakness in day rates for drilling equipment. However, during the first and second quarters of 1999, drilling seriously lagged averages, so much so that if it had continued through all of 1999, only 717 wells would have been drilled. That changed as oil prices strengthened in April.

Fear overcoming greed

Abundant cash flow and profitability, coupled with low day rates for mobile drilling rigs, and thus low drilling costs, has producers perplexed. Should they continue to book profits, and hold off contracting for rigs until there is some permanence to oil prices, and a floor develops under oil demand?

Doing so might push them into a period where there are few mobile rigs left and the desired rigs will come only with longer contracts and higher day rates. If the lower day rates are necessary for commercial development of the field, then a producer could get into trouble waiting for firm oil prices, especially if leases are nearing expiration.

For example, a producer faced with the proposition of drilling for gas on the continental shelf with a $22,000/day rate rig, compared with a previous price of $60,000 (and a rate it could return to if there is a run on drilling units), has little choice but to guess when prices will begin firming, if in fact they have not already done so. Waiting too long renders the field uncommercial.

Apparently, gas producers on the continental shelf are already considering this dilemma. The evidence of this is the volume of rebidding requests received by drilling contractors in the past month.

POE, POD plans

Producers in the US Gulf of Mexico are required to file plans of exploration (POE) and plans of development (POD) with the MMS and obtain acceptance before commencing work on leases. Both POEs and PODs contain requests for a specified number of wells. Eventually, producers are required to file for permits to drill individual wells, when a decision is made as to how exploration and development are to be carried out.

Typically, producers POEs and PODs contain plans for more wells than the producers will need. On average, only 70-75% of the requested wells are drilled. But the filings are a strong indicator of producers' future plans in the Gulf of Mexico.

During the January-May months of 1999, when oil prices remained weak, producers filed 153 POEs containing plans for 410 wells, and 97 PODs with plans for 169 wells (see accompanying table). The well plans for both would annualize at 1,389. This compares with 1,548 wells contained in POEs and PODs filed in all of 1998; 2,040 wells in plans submitted in 1997; and 2,085 wells in plans submitted in 1996.

Exploration vs. development

In past years, there has been a rough parity in the number of POEs and PODs filed each year, although not so in wells planned. For example, 366 POEs were filed in 1998, against 356 PODs. Again in 1997, 457 POEs were filed, against 466 PODs. While the wells filed take precedence eventually, the balance in the number of plans is a reflector of future interest by producers.

Generally, producers don't want to over-commit budget to exploration drilling if they are not able to develop discoveries fairly quickly. It's a case of stranded assets. However, if there is a risk that there will be insufficient discoveries in portfolios to meet future delivery requirements, producers shift more budget into exploratory drilling.

Such is the case right now. Most of Gulf of Mexico upstream budgets had been dedicated to development drilling and recompletions during 1998 and early 1999. As oil and gas prices strengthened and there was a risk that producers would be unable to take advantage of higher prices later this year and next, exploration spending was raised to meet that perceived need. During the first five months of 1999, 58% (153) more POEs were filed than PODs (97), a parity that did not exist in previous years.

Wells filed under POE plans submitted through May 1999 amounted to 410, or 984 annualized, exceeding planned development wells of 169 through May, or 406 annualized.

Actual wells permitted

Actual wells permitted, versus wells planned in POEs and PODs, are an important indicator of future activities. Through the first five months of 1999, 236 wells were permitted for federal and state OCS areas of the Gulf of Mexico (see accompanying table). This annualizes to a total of 566, which shows just how weak drilling was during the first quarter and much of the second quarter of 1999.

Development drilling permits (130) continued to outrank exploration permits (106) over the five-month period. Only nine commercial discoveries were announced through that date.

One of the more interesting trends in wells permitted for the January-May 1999 period is that 135 (57%) of the 236 wells permitted were drilled, and 61 were spudded and drilling. Producers have six months to spud a well, once a well has been permitted. Historically, 90% of wells permitted are drilled within the six-month permit period.