The Gulf of Mexico – One Year Later

By the Casey Research Energy Team

It has been a year since the Deepwater Horizon drilling rig exploded and sank, sparking a 3.5-month-long battle to cap a gushing oil well in the Gulf of Mexico. And gushing is the word – the well spewed 50,000 barrels of oil each day at its peak.

The Transocean rig that drilled the Deepwater well had just finished drilling the deepest well in history, pushing through more than 35,000 feet of water and rock in another part of the Gulf. With that feat under its belt, the Deepwater Rig moved to the Macondo prospect. We all know what happened next.

After months of investigation, the National Commission on the BP Deepwater Horizon Oil Spill and Offshore Drilling determined the accident occurred because of a combination of failures by all of the companies and contractors at work on the well, as well as the government regulators who should have been overseeing them. Led by BP, everyone in charge of the Deepwater Horizon rig had, to some degree, chosen efficiency and cost savings over safety and security. The accident was man-made, through and through.

The oil spill commission’s report included a laundry list of suggestions to better regulate deepwater drilling, including the creation of an industry-sponsored safety organization modeled after the Nuclear Safety Institute and the creation of an independent safety agency within the Interior Department. But with the spill receding from people’s minds, the oil and gas industry lobbying hard for fewer restrictions and more drilling acreage, and domestic oil production a national priority, how much of that will transpire?

A year later, the waters are still murky, but a few things are starting to become clear.

For energy investors, the most important aspect of the disaster was the moratorium on deepwater drilling in the Gulf. That ban was lifted in late February, but new safety requirements have slowed restarts on the 33 rigs that were halted, and Washington has so far issued only a handful of new permits for Gulf oil exploration.

So what impact does an almost year-long stoppage in drilling have on oil production? New data from the U.S. Energy Information Administration (EIA) is starting to answer that question. Offshore oil production in the U.S., most of which comes from the Gulf, is expected to average 1.55 million barrels a day this year, down 13% from 2010. The EIA estimates the drilling suspension and new, slower permitting process will erase 375,000 barrels of oil a day for the rest of the year.

The setback illustrates how important development wells are in maintaining oil production. Development wells are drilled in already discovered reservoirs to extract more oil and gas, stemming output declines. With the moratorium in place, none of those wells were brought on line.

Companies across the board have seen their Gulf production numbers fall in the wake of the spill. The Deepwater disaster hit BP on the heels of a series of major discoveries in the Gulf, on which it had only just started to capitalize. The company is now producing roughly 300,000 barrels a day from the Gulf, down from more than 400,000 a day before the spill. Chevron says the drilling pause cost it 10,000 to 15,000 barrels of oil a day; Shell quotes similar numbers and says it will produce 50,000 fewer barrels a day through 2011 than it had originally projected because of the spill.

Despite the difficulties, though, few companies have abandoned their offshore positions a year after the biggest marine oil spill in U.S. history. And that includes smaller players.

Investors and analysts alike predicted the staggering costs of the BP spill would scare small companies away from the Gulf. But that does not seem to have occurred. And that is important, because small companies have played a big role in making the Gulf of Mexico one of the world’s most productive oil and natural gas basins. In the 1990s, as production started to decline in the Gulf’s heavily explored shallow waters, scrappy independent companies were among the first to venture out to the continental shelf and prove up the Gulf’s deepwater potential.

According to Deloitte LLP, only 10 of the roughly 300 companies operating in the Gulf have market capitalizations of more than $30 billion, and 40% of the Gulf’s companies are worth less than $5 billion.

The Deepwater Horizon spill, however, raised what were already high stakes for these juniors, as no small company could possibly absorb the $40+ billion cleanup cost that BP is shouldering. Luckily for them, BP was self-insured, so insurance rates have not skyrocketed. And the industry has developed a pair of spill-containment cooperatives that have allowed small producers to show regulators they could control a large spill.

Speaking of paying for the cleanup, the question of who will eventually take legal responsibility for the spill is still unclear – in fact, this is one area where things are actually getting more confusing. Companies involved in the Deepwater disaster had one year following the accident to lay claims against each other, and the final days of that year-long period saw a barrage of court claims pitting BP against its partners.

BP has sued Transocean, Halliburton and Cameron International, seeking the full $42 billion cost of the disaster as well as costs, interest and punitive damages from each of the companies that helped it drill the doomed well. In court papers, BP said Halliburton concealed critical information that could have prevented the disaster. The partner companies promptly turned around and sued BP in return, accusing the British company of failing to accept responsibility for the disaster as called for in its contracts. (Service providers’ contracts with operators usually provide indemnity against any environmental damage that may result from their work.)

Transocean owned and operated the rig. Cameron was the maker of the blowout preventer, the "fail-safe" device that failed to automatically shut the well down. Halliburton handled the cementing work on the well. So far, BP has met the cost of the cleanup effort alone, including paying compensation to fishermen and property owners.

Odds are the suits – which include very serious allegations ranging from negligence to faulty planning – will never see a courtroom, as the companies will almost certainly divide up responsibility and reach a settlement. For one, even though these companies are battling over the Deepwater spill, they remain committed business partners in multiple other endeavors across the globe.

Transocean is the world’s largest deepwater drilling contractor. Cameron built 43% of the blowout preventers currently installed offshore. Halliburton is the world’s second-largest oil field services company. As such, they are all players in a market that is straining to keep up with demand from producers, who are looking to ramp up output to take advantage of high oil prices. So, for example, even while BP and Transocean point accusatory fingers at one another, they are locked into years-long drilling contracts valued at more than $3 billion.

There just aren’t many alternatives to Transocean and Halliburton. Even the handling of the Deepwater incident showed how linked these companies are: BP used Transocean to drill the relief well that eventually killed the gusher and hired Halliburton to cement it shut. So look forward to lots of posturing, but little in the way of real action against one another.

And even while it tries to wrest admissions of fault from its partners, BP remains committed to funding restoration work in the Gulf. The major agreed this week to provide $1 billion for an array of cleanup projects. BP did not have to provide an upfront payment of this kind, as the in-depth damage assessment that ultimately determines how much a polluter pays for a spill is far from concluded. (For a spill of this size, the process could take a decade or more.) But BP decided a down payment towards the final settlement would help kick-start restoration projects.

In another facet of the disaster, researchers are now trying to assess whether the 1.8 million gallons of oil-dispersing chemicals that BP poured into the Gulf during the spill added to the environmental damage.

During the spill, BP and the EPA fought over dispersant use, with the EPA at one point ordering BP to use a different kind of dispersant and BP refusing. Scientists say the shoving match shows how little regulators understood about dispersants, which are soap-like chemical mixtures that break up oil and help it dissolve. In general, scientists agree that the chemicals were effective in completing that task. But the most important questions still remain unanswered: what long-term effects will the dispersant chemicals and the dispersed oil have on the Gulf of Mexico ecosystem? And is it better to sink oil with dispersants, at possible risk to deepwater marine ecosystems, or should it have been left to surface and float into beaches and marshes?

On the second question, most agree that dispersing the oil was less harmful than allowing it to migrate into the coastal wetlands and marshes along the Louisiana coast. But we really don’t know how the dispersed oil will impact deep ecosystems. And as dolphins and sea turtles continue to wash up mysteriously along the Gulf Coast, the question only becomes more pressing.

U.S. energy regulators now face a very difficult task. After the Deepwater explosion, they were charged with ensuring a similar calamity could never happen again. At the same time, they face a mandate from President Obama to help reduce U.S. oil imports by one-third within a decade by boosting domestic production. Much of the oil that could enable the country to meet that goal is in the deepwater Gulf. Oil and gas companies say the accident was a one-off and that they can drill safely in the deep Gulf. Critics say the industry has got way ahead of itself in challenging the deeps and regulators are far too lax, in many cases relying on the companies to prove the safety of a new piece of equipment.

We don’t know what will happen next. But we do know that the Deepwater disaster shook up an industry that had probably gotten a bit slack, that oil production has gone down because of it, and that the way forward is as murky as the waters of the Gulf.

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