NORTH AMERICA US Gulf operators bracing for heavy lease expirations in 1998-2000

Shell's Mars tension leg platform is part of the new thrust into deepwater.

US Gulf of Mexico drilling activity will remain level through 1996 and 1997, and experience a surge through the remaining three years of this century. In essence, the 1996-1997 period could be the "calm before the storm." By 1998, lease expirations will be increasing dramatically, and the industry will begin drilling the shallow and deep water leases added this year. The year 1996 could be the record year for leases awarded in a single year.

Drilling data analysis indicates four emerging trends in the US Gulf of Mexico.

• Flat 1997: The industry in 1997 may pay a penalty for a weak leasing year five years ago (1992). The small number of tracts leased in 1992 coincides with a very weak drilling year, and both were a product of very low natural gas prices. Only 437 wells were drilled in 1992, the fewest since the 434 drilled in 1961. The large number of leases added to portfolios by the April US Gulf lease sale should help mitigate a slowdown in 1997.

• 1998-2000 expansion: Excluding the April sale results, there were 1,730 leases undrilled as of May, 1996 which have expiration dates in the 1998-2000 period. These leases represent 34% of the 5,138 leases currently in effect before lease awards from Sale 157. If oil and gas prices remain relatively high, operators will put maximum utilization pressure on rig contractors and suppliers. Since rig utilization is already at the 90% mark, rig day rates in the US Gulf will tend to attract more rigs from offshore waters around the world.

• Larger drilling window: About 40% of the leases bid on in the April sale were for tracts with 10-year periods. The tendency of most operators is to drill the most prospective acreage early on, and leave the larger number of less promising leases for later in the leasing period. In the case of 10-year leases, this means as much as eight to ten years later. There are a number of reasons for doing so. Not only does it take the pressure off post-sale rig contracting day rates, but new technological development during the later years of the lease will improve the economics of less attractive prospects.

• Gas reaching maximum: Unless deepwater gas reserves can be brought onstream soon, gas production is essentially reaching maximum elsewhere in the Gulf of Mexico. Gas production is not responding to higher gas prices, and virtually all wells are producing at maximum efficient recovery. Mobile Bay production was the main support behind US Gulf gas output, and production there has peaked. The only relief may come from the utilization of more drilling units working on gas prospects at the edge of the continental shelf, but this isn't likely because net inflow of rigs into the US Gulf has slowed and most qualified units already there are working on oil prospects.

Given the huge expiration levels of 1998-2000, will operators take advantage of the expiration slowdown in 1997 and actually keep rig use rates higher than what would be expected historically? Will the large number of 10-year leases stemming from the April outer continental shelf lease sale result in a postponement of drilling into the next century? Both are possible. In any case, 1997 will be a period of lease assessment and preparation.

Calm before storm

In contrast to a generally strong drilling pace in 1996, where there are a large number of undrilled leases expiring, 1997 may be just the opposite. Jackup drilling rigs, in particular, could take the brunt of any drilling slowdown in 1997.

Whereas 348 leases will expire this year, of which 243 are in water depths of less than 351 ft, 1997 will see only 272 leases expiring, the lowest number in many years. Of the 272 leases expiring, 98 are in water depths under 350 and 136 are in depths over 2,700 ft. Since activity on deepwater leases is already constrained by both rig availability and high day rates, the slowdown there may not be as prominent.

In contrast to this steep dip in lease expirations, a total of 414 leases will expire in 1998. Of these, 180 are in water depths beyond 2,700 ft. These expirations will be followed by 614 more in 1999 and 702 in the year 2000.

A total of 778 shallow water leases will expire in the years the 1999-2000 period. This is the period that may stretch the availability of shallow water drilling units, particularly jackups.

If all of the leases won in the OCS lease sale held earlier this year were awarded, a total of 556 leases would be added to the 148 already scheduled for expiration in the year 2001. Of this number, 406 of the leases bid upon are in depths under 350 ft. In the year 2001 alone, this means that nearly 700 leases will be expiring, close to the combined total scheduled to expire in the years 1999 and 2000.

In effect, the maximum rig activity period would be extended from 1998-2000 into the year 2001.

Deepwater frontier

The deepwater US Gulf of Mexico play is becoming a model for other mature producing areas of the world. Drilling and production aren't over with for any region or maritime nation until deepwater has been thoroughly explored.

The 40% of leases bid on in the April lease sale in water depths beyond 2,700 ft are an indicator of the huge popularity of the deepwater play. The large oil flows - 8,000-15,000 b/d - from single wells make the deepwater gulf a world-class play. It also means that fewer wells are needed to develop a reservoir, important because 60% of the cost of a deepwater development is the drilling phase.

However, ultra-deepwater is still a major operator's game for the most part. There are only nine leaseholders presently in water depths beyond 2,700 ft, and only 15 leaseholders participated in bidding for acreage in depths greater than 2,700 ft in OCS Lease Sale 157.

The few developments in deepwater so far are making a major contribution in turning around oil production in the US Gulf. The 327 million bbl produced in 1995 will be the largest volume output in eight years. The turnaround follows a long period of steady decline in oil reserves. As deepwater development continues, oil production will rise further, providing the US with the only opportunity to increase domestic production. This opportunity was what the Minerals Management Service was looking at when it recommended royalty postponement to encourage prompt development in the deepwater US Gulf.

Another interesting aspect of the US Gulf lease sale in April is that operators have decided to focus either on the very shallow or very deep water. The edge of the continental shelf and the upper slope are getting less attention.

Of the four million acres receiving bids, two million were for acreage in water depths of 200 meters or less. Only 70 tracts in the 200-800 meter water depth range. The rest were in water depths over 800 meters. The deepest tract bid on was in 9,280 ft in the Walker Ridge area.

Lease brokering

Another trend in the US Gulf - lease brokering - may be just emerging for tracts on the outer continental shelf. As the gap between oil and gas supply and demand tightens and the value of smaller reserve accumulations increases, is lease brokership a worthwhile pursuit? Several independents and a small number of major operators apparently think so.

Lease brokers are qualified operators that bid for or buy large and small working interest positions on a number of leases but don't expect to or cannot drill but a small portion of the leases they acquire.

For example, the largest primary term acreage leaseholder in the US Gulf in water depths under 600 ft is Zilkha Energy. As of April 15, Zilkha held 533,280 acres in primary term, over 90% of the operator's 590,059 acres in total. In addition, the company has only 37,083 in production, a little over 6%. Zilkha is certainly the exception, but could be the leader in this game if gas prices remain high. Virtually all of Zilkha's holdings are in water depths of less than 350 ft.

Other independent producers with most of their acreage in primary term are CXY Energy (97%), Hardy (85%), King Ranch (81%), Senaca (79%), Ashland (77%), BHP (77%), but none of these have such large holdings as Zilkha. In contrast, many majors are in the 20-60% range.

The largest leaseholders in the US Gulf are major operators or large independents, and most of their acreage is the producing or producible category. However, a number of major operators are picking up working interest positions on a large number of tracts, sensing a risk sharing opportunity and a method of boosting collective cash flow in the future while minimizing operatorship.

Remainder of 1996

The pace of drilling in the US Gulf probably will remain high this year, since purchases of oil and gas are exceeding seasonal demand in order to replenish low stocks and heavy drawdown last winter. In addition, the drilling rate for gas prospects is much more price sensitive than oil, and the dropoff in gas production will make an impression on commodity markets and prices.

Due to limits on the number of available qualified rigs, and the lengthening periods required to drill, operators are maintaining the pace of 920-950 wells per year. At that pace, higher per-well output in deepwater and ongoing sidetrack drilling on the shelf for gas should be sufficient for most operators to replace produced reserves.

Reserve replacement, which can fluctuate negatively and positively from year to year for major operators without undue concern, is becoming a critical measure of an independent's equity market value and source of future investment and growth capital. Without consistent reserve replacement, investors are likely to put the under-valued company in play for its remaining reserves.

Rig utilization rates across the US Gulf reached the 90% mark in May and will likely go higher as the year progresses. Semisubmersible leasing rates have been close to 100% for some time, but jackup drilling rates began to surge after the April lease sale as operators moved quickly in anticipation of growing pressure on rig availability. A few rigs have been ordered, but more are in the discussion stage, possibly awaiting drilling plans for 1997.

Most operators and contractors would like to see more drilling units in the US Gulf to relieve tight scheduling, but long-term leases in other parts of the world are likely to constrain further trans-ocean mobilization of rigs.

Finally, there is one other economic trend affecting drilling in the US Gulf. Natural gas reserves offered for sale are becoming increasingly expensive, and there is a finite economic limit to the pursuit of behind-the-pipe or outlying reserves with sidetracks (261 sidetracts out of 958 total wells in 1995). There is an increasing realization that operators will have to book reserves the old fashioned way - drill the wildcats.

Will 1996 be a normal hurricane year for US Gulf?

Leonard LeBlanc

Weather trend forecasters are generally correct in predicting greater or lesser hurricane seasons in the Western Hemisphere, but where they truly have problems is predicting where the storms are likely to hit landfall.

Along the equator off Africa where the Western Hemisphere's tropical storms develop, steering currents generally blow toward the west. Once they leave the equator for higher latitudes, unpredictable tropical jet streams steer the storms in many directions.

For example, 1995 was predicted to be an active storm year, and it was. However, steeply dipping U-shaped tropical jets formed in the late summer, forced storms in the central Atlantic to turn north early, keeping them east of the Gulf of Mexico and frequently out of the Caribbean Sea. Some swept along the US Eastern Seaboard and others churned harmlessly in the North Atlantic, eventually dumping more rain on Europe than the US.

The Weather Research Center in Houston is forecasting 10 tropical storms, of which five will evolve into hurricanes. This predicted number is half that occurring in 1995. In 1995, there were 19 named storms, of which 11 developed into hurricanes.

Theoretically, with the end of El Nio, there is a greater chance hurricanes will track farther to the west before turning North, unlike 1995. This could mean more hurricanes will enter the US Gulf of Mexico in 1996.

However, the Weather Research Center predicts the greatest chance of landfall in 1996 is on the coast of Georgia and North Carolina (90% probability), followed by West Florida (70% probability). Of course, in 1995, the Center predicted the greatest risk of landfall was Texas and West Florida (both 75% probability), followed by Georgia and North Carolina 65% probability).

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