All Eyes on the Gulf of Mexico, but How about Beyond??
As failure to control the Macondo oil spill passes the six week and, possibly, half million barrel mark, frustration grows, similarly, on many fronts – with the apparent, negligence or very poor judgment which led to the explosion, with the failure of Modern Technology to stem the leak or adequately limit the surface damage, the powerless position of government agencies to address a multitude of challenges, and the surprising (sic) expansion of finger-pointing in both industry and government as every party looks for another scapegoat. Unfortunately, one of my previous comments, that this could be ‘Three Mile Island’ for the oil industry, is coming to pass, right or wrong. Stepping back, a few points.
First, from the perspective of the most established hydrocarbon industry leaders, one of the most fundamental strategic (and differentiating) tenets of successful oil and gas companies is risk management. Risk Management takes many forms – resource and fiscal diversity, financial conservatism, cycle management, and, of course, operational focus. Former ExxonMobil CEO Lee Raymond loved to talk about oil and gas investments as a ‘thirty year decision,’ reinforcing the high volatility and uncontrollable events that can ‘come at you’ from any direction. From the information disclosed to date, I can only conclude that for the sake of a multi-million dollar budget overrun, BP and, possibly partners/subcontractors may face a multi billion dollar ‘ Black Swan’ event, to the economic detriment of a local economy, energy service industry and domestic trade balance.
Second, it goes without saying that deepwater and offshore activities face risk/reward issues which are as different as night and day. Increasing opportunities to extract gas and, now, oil, from North American onshore reservoirs, while less prolific (reserves per well), are significantly easier to execute and regulate. The regional, and likely global time out for offshore activity can only benefit onshore E&P everywhere. With the most likely need for increasing energy resources over the next decade, too soon for economic substitution, oil and gas development cannot come to a halt.
Third, through a year of conversation with policy wonks closer to the “new” US administration, it has become clear that the subliminal energy strategy is to accept/allow (but not quite encourage) higher prices over time. Higher royalties, more onerous permitting, reduced tax benefits, and preferential cap and trade all seemed poised to increase the price umbrella, encourage efficiency, innovation, and substitution, and set the US on a path to a more efficient and diversified energy/power portfolio. In this respect, the Three Mile Island analogy, though ironically hypocritical (here comes Nuclear Power?), is apt. Most intermediate term supply/demand forecasts now look alike for Europe (flat since the mid 1990s) and the US. ChIndia and the Middle East are the two fastest growth demand markets, and, coincidentally, have been the most subsidized. Removal of subsidies is consistent with improved efficiency. The politics are difficult, but the path, to me, is clear, especially post Horizon.
In my view, the nearterm investment (not trading) investment opportunity continues to favor onshore E&P, not only in the US, but worldwide. Offshore costs, including the cost of capital, will rise significantly except where best controlled or already high, such as Brazil and Norway. The current events will increase operator interest in onshore projects, especially in the US, but also China and possibly Europe. The start-stop transition to green, renewable, low carbon energy options, faces numerous headwinds – economic pressure on subsidies, adverse currency shifts, reduced electricity demand, and ongoing transmission woes. However, it does not take much of a shift to drive significant growth, especially at ‘grid parity’ (whatever that means), which IS on the way.
Meanwhile, absent ongoing investment, the current oil production capacity, worldwide, deteriorates at about 5-6%/year (over 10% in the US offshore), or over 4 million barrels/day. It would take a LOT of additional onshore exploitation to offset much more than a US GOM moratorium. Higher prices are on the way.