Sheila McNulty Small Gulf operators could be barred by higher cost risk

As Congress debates how to prevent another gulf spill like that impacting an ever-growing portion of America’s coastline, it is looking at the possiblity of imposing a significantly higher liability cap for operators in the gulf. PFC Energy says this will limit the ability of smaller companies that had making their way ever deeper into the Gulf to compete. Indeed, the consultancy notes, the implication of changes to liability levels and also liquidity tests being considered could reduce the number of qualified operators in the Gulf of Mexico from over 100 down to three – BP, ExxonMobil and Royal Dutch Shell.

Some bullet points from the report:

  • An increase of the $75m liability cap to $10bn, as currently proposed, will limit the availability of offshore energy industry insurance.
  • Despite some early opposition on anti-competition grounds, Congressional action raising the cap to at least $10bn appears inevitable.
  • As smaller operators are priced out by higher insurance rates and impractical bond options to establish coverage in the US Gulf of Mexico, they may be forced to exit positions.
  • Under current regulations, operators with large shareholder equity can establish self-insurance to continue operating in the US Gulf of Mexico. Companies like Shell and ExxonMobil could benefit as smaller operators exit.
  • To maintain their ability to compete and operate in the US Gulf of Mexico, smaller operators may need to band together under a form of group insurance.

In short, there will become an even bigger barrier to entering the deepwaters of the Gulf. This may be good for the big players, as they will eventually lay claim to much of the production there, but it will not be good for US oil production overall. Less players means slower development and less innovations to spur technology improvements. The majors are more risk averse than the independents. One only need look at the shale gas boom in the US, which was led by the independents, after the majors abandoned US gas supplies as uneconomic to develop. The independents found a way to make it work.

This loss of the independents from the Gulf will hurt US energy security, which had been growing with the move into ever deeper waters, reversing the decline in US oil and gas production, which has been dropping since the 1970s. Jim Burkhard, managing director of the global oil group at IHS Cera, the consultancy, noted in an interview before the moratorium on new drilling in the deepwater Gulf was imposed that US production capacity was on the rise in a reversal of a long-term trend.

He explained that in 2009, net oil imports as a share of consumption was 52 per cent, the lowest per centage since 1999. That was down from 60 per cent in 2006, as US oil demand declined and domestic production rose. On top of that, the US produced 18 per cent more natural gas than in 2005, meeting 91 per cent of demand. Rayola Dougher, senior economic advisor at the American Petroleum Institute, the industry trade association, said the US would not have even imagined this a few years ago. There has been a real shift in how the US looks at our energy future. The US government forecast 200,000 more barrels of crude oil and liquid fuels per day in production in 2010, with the country representing the largest source of non-Opec supply growth in the world, followed by Brazil, Azerbaijan and Kazakhstan. But those forecasts may have to be modified to account for delayed production from the moratorium.

Moody’s Investors Service says offshore Gulf of Mexico crude production – which is primarily deepwater – averaged about 1.6m barrels per day in 2009. Various industry studies have estimated it could increase by more than 40 per cent by 2013. But the moratorium will have an impact, it says in the report:

We believe the moratorium will not only cause near-term production declines for both oil and natural gas, but also slow production growth thereafter, pushing any peak assumptions back by several years.

PFC goes into detail about the impact of potential regulatory changes in its report:

Under the current system, there are two key regulations addressing the liability of offshore operators. First, a $75 m liability cap for economic damages, which excludes actual cleanup costs and can be waived for negligence or regulatory violations. Second, companies must “maintain evidence of financial responsibility” of an amount up to $150m in order to operate offshore. This $150m of financial responsibility essentially serves as pre-disaster risk insurance. Lawmakers have been debating an increase to the liability cap, from $75 mn to $10 bn. But despite Congress’ quick reaction, a bill has yet to pass. One thing is certain: an increase-of any amount-to the liability cap could have game-changing repercussions on the financial responsibly requirements for offshore operators.

It is clear that raising the costs and regulations to operating in the Gulf will slow production from the gulf. That does not mean it should not be done. Safe operation and responsible plans for dealing with accidents are crucial. It is just important to note that too many barriers to operating out there will limit what the country gets from one of its most promising oil producing regions.