How New Offshore Regulations Will Power the Oil Equipment Market
Washington is likely soon to be lifting the moratorium on deepwater drilling in the Gulf of Mexico. The six-month ban, implemented in the wake of the Deepwater Horizon explosion and oil spill, is set to expire on November 30th.
But for the ban to end, two things must happen. First, realistic estimates have to emerge on how much crude is actually needed from deepwater sources. And second, the federal government will have to determine new drilling regulations and put them into effect.
When this all falls into place, there will be an interesting play within a specific segment of the oil field services market.
And it will be time to make some serious money.
Factor No. 1: The Supply Question
The first is the easy one. Forget the pundits telling you this is an election year and lifting the moratorium will impact vote totals. Forget the talking heads advising the need to move money back into the besieged Gulf region’s economy. Don’t get me wrong – both of these are certainly true, especially the latter concern.
However, this is a straight supply/demand read, and it is trending decidedly in one direction. Up.
We are receiving additional indications that demand is moving back into the market. That, coupled with delays in bringing new major fields on-line, and the factors I mentioned last Friday ("What Crude Oil Prices Are Telling Us"),has pressured oil futures prices into a perfect contango effect (where bid prices increase the further one moves out on the curve).
Now, the culprit behind all of this is the question about supply moving forward.
Everybody in the industry recognizes that most of the major fields yet to be discovered are offshore, and the majority of them are in deepwater. U.S. policymakers had expected that, between now and 2015, 3% to 4% of new supply coming into the American market needs to be deepwater, just to keep domestic production from declining faster than it is going to anyway. Globally, the contribution from deepwater will need to be at least 10% of all international production by the time we get to 2015, just to keep pace with expected demand.
Forget about everything else. This is a matter of an essential sourcing and balancing of production. Reports issued from the International Energy Agency, the World Bank, the U.S. , and even the German and American militaries express rising concern over adequate oil supply to met accelerating demand (see "‘Peak Oil’ Is Back on the Radar," September 10th).
This is actually the confluence of two separate streams of demand. One is the return of demand to the market, as the recession subsides. This demand was always there but had been withdrawn following a significant retraction in manufacturing and industrial use, accentuated by a severe construction in bank credit.
The other is entirely new demand emerging from developing countries throughout the world. Yes, this speaks of China, India, and a resurgent East Asia. But it also reflects entirely new regions of major demand that used to be completely off the map – like West Africa, for example.
In addition, dominant producers, such as Saudi Arabia, Kuwait, and Russia, are rapidly diversifying into placing greater reliance on exporting refined product and petrochemicals. Increasing demand within the producing countries themselves means less volume available to meet demand elsewhere.
In short, deepwater deposits are going to be an absolute necessity moving forward. They are the last frontier of significant finds.
Yet it is the second factor that will be the most significant development short-term. It will also provide you with an early profit move…
Factor No. 2: New Regulations
Gone is the scandal-ridden MMS (Mineral Management Service). A no-nonsense regulatory agency, headed by a no-nonsense director, is here to replace it.
The new agency is the BOEMRE (Bureau of Ocean Energy Management, Regulation, and Enforcement), and the director is former Justice Department Inspector General Michael Bromwich. Bromwich does not take prisoners, and neither will his new bureau.
Already, the Department of the Interior has begun to lay out stricter drilling regulations, and BOEMRE will be far more intrusive in the offshore production process than MMS ever was. Both of these groups’ moves will translate into regulations and enforcement that put a premium on operational safety, a reworking of procedures, and more frequent overhauls of platform, rig, casing, and preventive equipment.
This last element will be a very interesting engine for profit.
It makes no difference what project is considered. Platforms will need to be improved, equipment replaced and overhauled, redundant systems set up. Interior has also already signaled that platforms no longer in use – and there are hundreds of them littering the Gulf – will need to be dismantled and hauled away.
Companies that specialize in the equipping of platforms tend to be the ones contacted when a platform needs to be taken down, as well. In short, both of the initial primary drives emerging from the first wave of the new regulations will add significantly to their bottom lines.
The big boys will certainly benefit: Schlumberger Ltd. (NYSE:SLB), Halliburton Co. (NYSE:HAL), Baker Hughes Inc. (NYSE:BHI), and Weatherford International Ltd. (NYSE:WFT). Almost by default, the central position they already hold in the wide range of services required by the offshore industry will move more business to them in this new regulatory environment.
Yet there may be an even greater upside potential for companies that have a track record of focusing on the equipment side of offshore drilling. Such equipment is just as necessary for putting facilities out into deepwater as it is for dismantling them once they are no longer in use. Both operations will be coming under the watchful eyes of Director Bromwich and the BOEMRE and will demand more frequent replacement and reworking.
This sector will be expanding as the regulations become known. But for now, I would suggest that you put two of these companies on you radar – TETRA Technologies Inc. (NYSE:TTI) and Global Industries Ltd. (Nasdaq:GLBL). Rig and platform operators had been relying on their equipment know-how even before the oil spill.
And in the near future, BOEMRE and the new regulatory environment are likely to prompt that reliance even more.