Will Gulf of Mexico producers spend budgets in 2002 - or just sit it out?

Despite an abundance of drilling rigs and leases to be drilled, early data indicates oil and gas producers in the Gulf of Mexico might just sleep through 2002 - meaning minimal exploration and dwindling production and workover activity similar to the latter half of 2001. d

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By Jim Dodson,
Ted Dodson
James K. Dodson Co.

Leonard Le Blanc

Despite an abundance of drilling rigs and leases to be drilled, early data indicates oil and gas producers in the Gulf of Mexico might just sleep through 2002 - meaning minimal exploration and dwindling production and workover activity similar to the latter half of 2001. Actually, producer exploration budgets for larger producers in the Gulf of Mexico in 2002 are optimistically similar to that of 2001, but the key question is whether they will spend the appropriated funds. In the case of many independents: Do they actually have the cash to expand activities?

Despite the potential of a disappointing short term, the bottom line for US oil and gas productivity in the years to come, as well as the continuing viability of non-deepwater operations in the Gulf of Mexico, resides with the action producers take in 2002. The one bright spot in the 2002 outlook is that there are plenty of leases ready to drill, and many jackup drilling rigs are "hot-stacked."

Royalty relief

And that leads to the second question. Is this the year that US exploration and production activities - or lack thereof - become tightly latched to oil and gas prices? Maybe. To answer this it would be necessary to see a recovery in US product demand. If demand does not recover, the question becomes difficult to answer.

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Another key driver may be royalty relief. Would shelf action pick up if the US Minerals Management Service (MMS) threw the royalty relief door open for all shelf wells - regardless of depth? Continued leasing of shelf tracts indicates that smaller producers may be hoping such measures reach fruition in the near term, 1-3 years.

With so much attention lavished on deep-water tracts, what is driving this continuing interest in shelf drilling? Despite the flurry of excitement over large Gulf of Mexico deepwater discoveries, the hard fact is that 92% of all current oil and gas production still comes from the US continental shelf. These are wells located in less than 350 ft water depths. Beyond that depth the contribution numbers drop suddenly and dramatically. Even water depths between 600 ft and 1,500 ft in the Gulf of Mexico actually contribute little to oil and gas productivity. Looking at things from this point of view, it is clear that production in all water depths beyond 1,500 ft, however lucrative in appearance, cannot rise fast enough to replace oil output lost in shallower water in the near term. At the same time, gas production throughput continues to languish in both deep and shallow water.

Remaining shelf reserves

Before MMS comes to the rescue it has to evaluate some tough questions. Principal among these is: Is there enough shelf gas left to make further royalty relief feasible? There are modest pools remaining at current drilling depths, and producer studies continue to evaluate the potential of costly, yet lucrative, gas in sediments beyond 15,000 ft water depth.

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Royalty relief provided for deeper wells on the shelf thus far has failed to interest producers, even during higher oil and gas price conditions. Part of the problem is that royalty relief is only offered on a sale-by-sale basis, and there is no assurance of it being available in the future. Also, royalty relief does not exist for shallow gas, and producers are slowly exhausting lateral drill-out and deepening efforts to produce surrounding and deeper pools. Only new shelf exploration can reverse the slide in production.

Continued erosion

So, what's left for the industry in 2002? Without a change in market prices or tax or royalty relief policy, all signs point to exploration and development activities continuing to erode further. More jackup drilling units will continue to move overseas to pursue work, which is one reason many such units are currently "hot stacked," (ready for contract).

Generally, the remaining on shelf gas (and some oil) accumulations are small. Even when inexpensively acc-essed, they deplete quickly (see accompanying production tables by water depth). Gas reserves have only a 2-3 year production life and show a rapid collapse with just one year's drilling fall-off.

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Royalty relief, such as it exists today for gas, will continue to widen the gap between the Gulf's continental shelf and deepwater development.

Undrilled leases

The lack of drilling activity, coupled with continued interest in acquiring leases, has left an overhang of quality leases to be drilled in the coming years - both short and long term. If demand should surge or royalty relief expand, this pool of leases would offer a convenient take-off point for a quick rebound in the Gulf of Mexico.

The question that must be asked at this point is whether the majors and independent operators, after two years of acquisitions, debt pay-down, and a cool-down in oil and gas prices, have sufficient money left to expand drilling. Many major producers who dominated Gulf shelf drilling activity in the early and mid-1990s have dropped down on the shelf drilling charts for 2001. Independents now dominate this drilling sector of the business. ChevronTexaco is virtually the lone exception.

While it is common to think of the independent operators as moving aggressively into shelf drilling the facts do not bear this out. A number of large independents that managed to climb to the top of the Top 40 Producers chart actually did so without increasing production (an example is Unocal). This is an indicator of how weak production is on the shelf.

That said the independent producers do have an unprecedented influence in this region of the Gulf. Another reason that the industry will experience further weakness in 2002, before strength returns either later in the year or 2003, is that independent producers now dictate the volume of activity in the Gulf of Mexico. Most of these producers, for the reasons just cited, are short of the capital needed to expand drilling above a minimum.

Does this lack of exploration capital mean that the MMS shouldn't offer an expanded royalty relief? It is a risk, especially considering that the US could not respond adequately to a surge in demand, and oil and gas prices would rise accordingly.

Widening gulf

The independents now dominate the shelf by default. The majors chose to leave the security of shelf production for the high risk and high reward of searching for deepwater reserves. Unless royalty relief for the shelf is expanded to all oil and gas produced deeper than 15,000 ft TVD, the majors will continue to dominate this region. There will be no incentive for the independents to explore for deep reserves on the shelf. While it is too soon to close the books on the Gulf of Mexico, it is this type scenario, that could usher in a new "dead sea" era for the Gulf's shelf region.

Wells in the Gulf of Mexico are projected to number 1,101 by yearend 2001. Projections of wells to be drilled for 2002 show a significant drop to 900 total wells. Of these wells 200 are forecasted to be in >1,500 ft water depths. This drop in drilling activity translates into a substantial decline in finding new shelf reserves and a major delay in developing the reserves for market.

The widening gulf bet-ween the shelf and deepwater is a serious crisis. It can be resolved, but this will require the intervention of the MMS in the form of royalty relief for deep exploration of the shelf. Royalty relief that covers all leases.

Click here to view Federal OCS-US Gulf Gas (BCF)

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