Oil companies are "bristling at a six-month exploratory drilling ban and its probable effects on the industry and the U.S. economy," the Wall Street Journal reported Friday. -- "We believe responsible drilling should be allowed to continue," grumbled Chevron spokesman Mickey Driver, warning "that halting deepwater drilling will have lasting energy security and economic consequences for the U.S." -- But business columnists like David Bogoslaw, writing for Bloomberg Businessweek on Tuesday, are advising investors how to profit from likely new regulations. ...
OIL INDUSTRY STARTS TO HALT GULF DRILLING, RAISES CONCERNS
by Isabel Ordonez
Wall Street Journal
June 1, 2010 (posted May 28)
HOUSTON -- Oil and gas companies on Friday began halting exploratory drilling in the deepwater of the U.S. Gulf of Mexico following a federal government order. Meanwhile, they are bristling at a six-month exploratory drilling ban and its probable effects on the industry and the U.S. economy.
Exxon Mobil Corp. (XOM) and Marathon Oil Corp. (MRO) said they have stopped drilling two wells in the Gulf. Chevron Corp. (CVX), the second-largest publicly traded oil company after Exxon, warned that an offshore drilling moratorium extension will have a "lasting" negative impact in the U.S. economy and in the nation's efforts to enhance energy security. Royal Dutch Shell PLC (RDSA), Statoil ASA (STO), Eni Spa (E) and Anadarko Petroleum Corp. (APC), among others, are also seeing their drilling projects stalled.
Analysts say the ban isn't expected to hurt the short-term oil and gas output of the Gulf area, which produces about one quarter of U.S. hydrocarbons. But it will delay the massive, multi-billion-dollar projects major oil companies rely on for long-term growth. Deutsche Bank energy economist Adam Sieminski said Friday the pause on drilling ordered by President Barack Obama in the wake of a massive oil spill is expected to delay 160,000 barrels a day of oil in 2011, or about 8% of the Gulf's current production of crude.
The delayed production underscores the long-lasting impact the Deepwater Horizon incident, estimated to be the worst oil spill in U.S. history, will have on the global oil industry. Major oil companies consider the deepwater frontier Gulf of Mexico one of their prime areas for future growth, as it remained one of the last oil-rich areas of the globe still open to investment and subject to a stable tax regime.
The spill began more than a month ago after the explosion and sinking of Transocean Ltd.'s (RIG) Deepwater Horizon rig, which was leased by BP Plc (BP) to drill a deepwater well 40 miles off the Louisiana coast. On Thursday, Obama ordered 33 exploratory deepwater rigs currently operating in the deepwater Gulf to stop drilling and banned further exploration in the Gulf for six months. The president also put on hold the industry's foray into offshore Virginia and Alaska. The measures are perceived to be the first step towards an overhaul of offshore drilling laws.
The American Petroleum Institute, a lobbying group for the energy industry, said the drilling ban will hamper economic growth and job creation, especially in the Gulf states, and threaten U.S. energy supplies. "Deepwater development is a key component of domestic energy security," Jack Gerard, president of API, said in a prepared statement.
In 2007, the deepwater provided 70% of the oil and 36% of the natural gas from overall federal Gulf of Mexico production and the 20 most prolific producing blocks in the Gulf are located in deepwater, according to API.
Companies operating in the Gulf deepwater were still evaluating the impact of the government decision on their drilling plans, but they are expected to start moving rigs, which are leased at rates of around $500,000 a day, out of the region to keep them gainfully employed, according to a report by energy consultancy Wood Mackenzie.
Exxon said Thursday it has suspended drilling operations at the Hoover Diana well in the Gulf after the U.S. ordered a halt to current drilling in the area. It also delayed plans to drill a new exploration well at its Hadrian prospect. Marathon said it is in the process of temporarily abandoning the drilling of the Innsbruck well in the Gulf.
The drilling moratorium could be especially bad for Chevron, which is one of the largest oil and gas Gulf producers and whose future growth significantly depends on exploration in the area.
Chevron spokesman Mickey Driver said the company acknowledges the Obama administration's desire to fully understand the underlying cause of the oil spill, but that halting deepwater drilling will have lasting energy security and economic consequences for the U.S.
"We believe responsible drilling should be allowed to continue," Driver said. Exxon, Chevron and other companies are helping BP deal with the spill.
Offshore drilling contractors, which managed to weather most of the downturn in drilling that followed the recession, also stand to suffer. Switzerland-based Transocean, the world's largest offshore driller, gets 25% of its revenue from the U.S. Gulf, where it operates 14 rigs. Those rigs will receive a reduced "force majeure" rate because of the drilling ban, the company said Friday. Transocean shares have lost more than a third of their value, or about 38%, since the April 20 blast and recently traded at $57.11 apiece. Noble Corp. (NE), another large offshore driller, has seen its shares come down 30% since the incident, each trading at $29.19 on Friday.
Wood Mackenzie said the development of several existing oil discoveries in the area could also be jeopardized by delays and substantial cost increases resulting from new, stricter safety regulations. These delays and higher costs could defer as much as 19%, or 350,000 barrels of oil equivalent a day, of projected deepwater Gulf production in 2015 and 2016.
Wood Mackenzie said that a 10% increase in overall capital expenditure would drop the internal rate of return -- a measure used by companies to compare profitability of investments -- of deepwater Gulf of Mexico oil discoveries to 15% or less. This would put several of them close to, or below, the profitability rates required to proceed with a project, according to the report.
AFTER DISASTER, OIL SERVICE BARGAINS FOR LONG-TERM INVESTORS
By David Bogoslaw
** The BP rig blowout has hammered the oil services companies that work in the Gulf of Mexico. But analysts say, in the long run, companies can benefit from new rules **
June 1, 2010
Less than a year ago, when low oil prices and uncertainty about the timing of an economic recovery made investors nervous about energy bets, the oilfield services industry was the place to be, since oil producers couldn't afford not to continue drilling. Now, in the wake of what's said to be the biggest environmental disaster in U.S. history, the near-term outlook for oilfield services companies doesn't look nearly as bright. But for investors willing to stick with battered stocks such as Cameron International (CAM) or Halliburton (HAL) -- for a year or two -- stiffer regulations on drilling in the Gulf of Mexico could mean enhanced opportunities. And while the sector remains risky, there could be some bargains.
The near-term impact of the blowout of BP's (BP) Deepwater Horizon rig has been rough on companies working in the Gulf. On May 27, President Obama declared a six-month moratorium on all deepwater drilling in the Gulf of Mexico, which affects all wells drilled in waters deeper than 500 feet. The following day, Interior Secretary Ken Salazar announced tough safety and control regulations on rigs working in the Gulf. And on June 1, the Obama Administration said it was investigating whether any criminal or civil laws were violated in the rig disaster.
But since about 30 percent of the oil the U.S. consumes comes from the Gulf, it's unlikely the Obama Administration would choose to permanently ban drilling there, say some analysts. The fact that minerals royalties are a major source of federal revenue makes that option even more unlikely, according to Tim Parker, an energy analyst at T. Rowe Price (TROW).
The ban on deepwater drilling is sure to hurt oil services companies' earnings for the second half of 2010 and for the full year. Parker expects earnings to be reduced by 5 percent to 10 percent on the low end and 10 percent to 15 percent on the upper end. The impact might be worse if companies don't trim their cost structures, says Parker, who expects them to move personnel around to manage expenses.
Still, Parker sees this as a short-term money issue. "If you have a one-year time horizon, you'll be very happy owning these stocks," he says. "You could own these things for the next two years and get them cheap for the next six months."
In a research note for FBR Capital Markets (FBCM) on May 27, Rob MacKenzie estimated that Transocean's (RIG) earnings before interest, taxes, depreciation, and amortization (EBITDA) for 2010 would drop by up to 14 percent if the deepwater permit moratorium were extended by six months and all its deepwater rigs working in the Gulf of Mexico went idle after its current wells for roughly another five months of downtime. Diamond Offshore's (DO) 2010 EBITDA would decrease by up to 28 percent under the same scenario. The financial impact of the drilling ban could be reduced if the rigs were hired to drill sidetrack wells, or secondary wellbores drilled away from the original hole, which are exempted from the drilling permit moratorium, or if rigs were moved to projects in other geographic regions, he wrote. MacKenzie reaffirmed his outperform rating on Transocean and market perform rating for Diamond Offshore.
Moving a rig to Brazil, the drilling region closest to the Gulf, would result in the loss of a month's worth of revenue for an operator, while a move to West Africa would cause an even longer disruption in revenue, says Geoff Kieburtz, an analyst at Weedon & Co. in Greenwich, Conn.
There's additional uncertainty for contractors if other operators take a cue from Cobalt International Energy (CIE), which on June 1 invoked the force majeure provision under its drilling contract with Diamond Offshore for a rig that was ready to start drilling an exploratory well in the Gulf. That means that revenues which contractors believed were locked in may not be if the operators refuse to pay, citing events beyond their control.
Of the big four multi-service companies, Baker Hughes (BHI) is most exposed to the Gulf of Mexico, where it generates a bigger portion of its total revenues relative to other regions, says Will Riley, co-manager of the Guinness Atkinson Global Energy Fund (GAGEX). "If you can get over the fact that earnings will be weak this year, the outlook for next year looks good," he says.
These companies' balance sheets are generally strong, so they can withstand short-term earnings pressure, Riley says. His fund, which manages $95 million in assets, has maintained both its direct and indirect exposure to the Gulf. While he doesn't own shares of Noble Group (NE) or Ensco International (ESV), two other companies that are active in the Gulf, he believes both would be good bargains fairly soon.
More risk-averse investors might want to avoid companies directly exposed to the Gulf of Mexico, but most stocks in the multi-services group have potentially fallen too far and will "require serious attention" fairly soon, says Riley.
Ironically, the stricter safety regulations the Interior Dept. is calling for will likely increase oil services companies' revenues in the long term as some of the services they aren't currently required to provide will be mandated in the future, says Parker of T. Rowe Price. Enhanced safety procedures could include stronger control systems such as a cement bond log, which gauges the quality of a cement bond on a well's exterior casing by measuring variations in the acoustic signal traveling down the casing wall between a transmitter and receiver. "[Currently], you don't have to do that for every job." Halliburton is one of the leading providers of this service.
Another gainer from new rules might be Cameron International, which made the blowout preventer, or BOP, installed on the Deepwater Horizon rig. The company probably won't be held liable for the Apr. 20 explosion, since the various problems with the blowout preventer that may have caused its malfunction aren't the result of a product defect or design flaw, Gabelli & Co. said in a May 25 research note. Cameron, with about a 40 percent share of the BOP market, "will be a beneficiary of a new equipment cycle to increase safety standards" for offshore drilling. Blowout preventers represent an estimated 10 percent to 15 percent of Cameron's annual revenue, the note said.
One recommendation from the Interior Dept. is that every floating rig in the Gulf would have to have redundant shear rams -- the part of the blowout preventer that cuts through drill pipe and forms a seal against well pressure -- as a backup safety measure. Although the Deepwater Horizon rig did have two shear rams, that isn't a typical configuration, says Weedon's Kieburtz. Multiple shear rams would boost equipment sales for Cameron and the other leading BOP manufacturer, National Oilwell Varco (NOV), he adds.
Cameron and National Oilwell would also benefit from increased aftermarket activity if new regulations require the original blowout preventer manufacturers to have a hand in maintenance after sales to contractors. Transocean had done all the maintenance on the blowout preventer involved in the Deepwater Horizon incident since buying it from Cameron in 2001.
Shares of other drilling equipment manufacturers, such as FMC Technologies (FTI) and Dril-Quip (DRQ), have dropped considerably since the oil spill, making them more attractive to investors willing to take a risk. Riley says he's always believed they were relatively expensive stocks to own, but for investors who can get comfortable with valuations, the new regulatory environment should boost these companies' sales.
Two other names in the industry, Oceaneering International (OII) and Subsea 7 (S8J:GR), which manufacture underwater remotely operated vehicles, or ROVs -- the tethered robots that function as oil producers' eyes and hands on the ocean floor -- stand to gain from improved operating capabilities in ROVs that may be required as a result of the BP disaster, says Parker at T. Rowe Price.
--Bogoslaw is a reporter for Bloomberg Businessweek's Finance channel.