Monday, May 3, 2010

Lousiana Oil Spill Threatens Future U.S. Oil Supply

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

As the easy to get to oil on land has become scarcer, the industry has increasingly been forced to develop offshore wells in deeper and deeper water. This strategy is not without its risks, as the recent explosion of the Deepwater Horizon drill rig off Louisiana last week made evident. The event is rapidly turning in to one of the worst environmental disasters of all time and may surpass the Exxon Valdez spill in Alaska. The opening of new offshore wells is likely to be suspended for some time and consequently long-term projections for oil production should be lowered.

The Gulf of Mexico is a prime source of offshore oil and gas production, but it is by no means the only one in the world. Major offshore production also exists in the North Sea and even the Middle East. New discoveries off the west coast of Africa and the waters off Brazil have gotten the media's attention as the great hope for oil production in the future. When I first read the hype about the large deep-water deposits east of Brazil (which are also under a lot of earth as well as water), I noted a brief comment that stated the technology doesn't currently exist to tap these deposits. The recent disaster off Louisiana demonstrates that the technology also doesn't exist to fix a blow out or spill from currently existing offshore wells.

The description of the size of the oil spill varies considerably from one report to another. At first it was just a few thousand barrels a day, then some sources stated 42,000 gallons a day were leaking, while higher estimates have now reached 210,000. There is a device called a blowout preventer that was supposed to have kept the explosion and leak from happening, but it failed. Working around it is now something that is a major factor in trying to fix the problem. There are actually three leaks and there are now plans to cap the biggest one with a dome that is currently being constructed for this purpose. This has never been attempted in a well 5,000 feet under water. It has worked in shallow water. The U.S. Coast Guard is also planning a controlled burn of the oil slick, as it is nears coastal Louisiana  and is heads toward the beaches of Florida. Burning has been done in rivers, but this would be a first attempt in the ocean. The oil industry is in clearly in uncharted territory in trying to deal with this disaster. Perhaps we should ask ourselves how reliable are their other deep-water wells?

There was a spill in a Gulf of Mexico well, the IXOT 1, in 1979, but it was in 150 feet of water, not 5000 feet below the water's surface as is currently the case. It leaked up to 30,000 barrels of oil a day for nine months. Attempts to cap the well, more easily done considering the more favorable circumstances, failed at first. Two relief wells had to be drilled and only then could the leak be stopped. It would take months to drill a relief well now in the offshore Louisiana location.

Needless to say, oil service stocks have taken a hit because of the Louisiana disaster. ETF OIH has declined more than ETF XES though. British Petroleum (BP) has been down as much as 13% so far. Anadarko (APC) also has a 25% stake in the well and Mitsui a 10% stake. President Obama has declared that they are fully responsible for all clean up costs. The first class action suit relating to the spill has already been filed and claims for damages to fishing and related industries could be enormous. Trans Ocean Ltd (RIG) owned the rig and its stock has dropped 21% so far, Halliburton (HAL) was in charge of the drilling and Cameron International (CAM) supplied the failed blowout preventer.

Ironically, president Obama just announced the expansion of offshore drilling one month ago. There is going to be considerable blow back from this oil spill that is likely to put any future U.S. offshore drilling on hold for some time to come. And that is going to have serious consequences. The Gulf of Mexico is the only place in the U.S. where oil production has grown in the last 15 to 20 years. Unfortunately, it is a region fraught with problems. Only five years ago, BP's Thunderhorse platform was supposed to start producing 250,000 barrels of oil a day (under three miles of water). It never happened. Before Rita and even before Katrina came along, the fairly minor hurricane Dennis blew past it and wiped it out. As if there aren't already enough problems in the Gulf, hurricane seasons starts next month.

Disclosure: Long oil.

Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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