Prepare for Washington’s “Heavy Hand,” Thanks to BP

by | published June 2nd, 2010

Living in New Orleans years ago, I would often spend weekends down on Grand Isle, a beautiful sliver of land jutting out into the Gulf. I checked on Sunday – the most recent count is over 350 vacation homes there on the market. You can get them cheap… and BP will soon provide the oil at no extra charge.

If this column sounds bitter, it is intentional. Actually, I am pretty angry, and BP (NYSE: BP) is the focus of that ire.

The company has guaranteed that the drilling environment in the U.S. will undergo significant change. There will now be government overreaction, but leaving the production of new crude oil to the whims of company bottom lines is no longer an option.

This could have been avoided, and BP will be paying the price for some time to come.

Unfortunately, 11 platform workers paid a far heavier price, as will the hundreds of thousands of people whose livelihood will be destroyed in the aftermath of the disaster in the Gulf of Mexico.

Back in Pittsburgh, I spent most of this Memorial Day weekend evaluating what Washington will be doing in the aftermath of the spill.

Some of what is coming will require intense ongoing negotiations. That the increasingly heavy hand of government is coming, however, seems an absolute certainty. And the results will have a direct bearing on how you will invest in oil production over the next several years.

The production sector needs to brace for heavier government regulations. What happens there will change the prioritizing of companies and projects for investors at large…

Four (Highly) Probable Regulatory Changes on the Way

The current energy bill in D.C. is dead, thanks to the Deepwater Horizon explosion and the millions of gallons of crude oil creeping toward the U.S. coastline even now. When the platform went down, a basic assumption of the legislation also sunk. New volume from offshore drilling was essential to balance alternative energy projects, environmental and green initiatives… and the first steps away from over-reliance on oil.

That policy offset is no longer possible.

There will be no new drilling offshore for the foreseeable future, and that means the energy bill must go back to square one.

When a new version emerges, there will be a far heavier dose of government oversight. The move in that direction will intensify as more documentation surfaces on the ill-advised approach of BP to ramp up commercial drilling in the face of clear indications that risk factors were going through the roof.

Personal frustration has set in for another reason, too…

Having evaluated strategic risk assessment plans, I have background in the risk side of such projects. I know that, in situations such as this one, there is a rig operator (Transocean) and a project operator (BP). The project operator pays the bills, thereby having final say in all production decisions. The guys who know how to stabilize the rig can certainly provide input, but the project operator can overrule them.

Just as BP did on this occasion.

The only solution now is to wait upon the drilling of relief wells, which will be in place no earlier than mid-August. Nobody has any idea how much damage will result in the interim. Well before then, the anger inside the Beltway will translate into government regulatory changes.

As I have noted here before, I would prefer the private sector to determine investment priorities. However, the general community also has interests that oblige government involvement. Much of what investors do bounces between these two poles. That tension is always present.

Yet, the extremes need to be avoided.

On one end, we have nationalized oil companies and the death of private investment. On the other, we have attention only to profit margins… and the death of entire habitats. BP has singlehandedly made such navigation more difficult.

I believe we will shortly see the following four regulatory changes:

  1. Any drilling allowed in offshore waters or sensitive areas – and perhaps more generally, too – will require the drilling of relief wells along with the primary production location. Many parts of the world already require this. It is difficult to accept that places like Vietnam have more comprehensive drilling regulations than the U.S.
  2. Agency review of the wellhead environment, especially logging and stabilization data, will take place before any permission for commercial production is given. In what currently passes for oversight, operators are allowed to approximate many of the figures, filling in the actual results only once the flow rate has reached project levels. No more.
  3. Licenses will not be granted until the operator can provide detailed geological indications of the expected reservoir volume. Ask BP how much oil may be gushing out, and they will admit they do not know, because they have no overall reservoir estimates. Current regulations allow companies to finalize such figures only after sinking additional examination wells subsequent to commercial production taking place. In this way, companies provide conservative estimates of reserves for finance purposes and then exceed them once production comes in… thereby enhancing return on investment.
  4. Final say on major elements of production start-up will transfer from the companies to government representatives. This will include a formal agency approval of the risk assessment plan, compliance with that plan, and a series of specific government authorizations for each major step in the start-up process.

The new environment will require that companies focus on developing safer fields. That could also mean fields of lower output, closer to existing production or located in basins that have a documented extraction record. Certainly, drilling offshore of the U.S. will move to the back burner, even while it expands elsewhere.

Once the terrain is clearer, I will discuss the companies whose projects and direction will actually benefit from the new approach coming out of Washington. Stay tuned.


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