The Oil Industry: Parsing the Damage in the Gulf

May 12 2010

The Oil Industry: Parsing the Damage in the Gulf

Posted by Anthony Walker in Finance News

In the first days after the BP blowout in the Gulf of Mexico, the fallout seemed minimal. BP stood to suffer, but the spill, even leaking 1,000 barrels a day, seemed like it could be contained.

Three weeks later, the picture has shifted dramatically. Though existing drilling programs are proceeding, the Department of the Interior has issued a 30-day halt on new permits. Attempts to plug the Deepwater Horizon drilling rig — which is leaking 5,000 barrels a day now — have failed and economic and environmental damage continues to mount. Wednesday morning, the government announced a proposal to split the agency responsible for policing the oil industry and acting as its partner in drilling activities, which may or may not prevent future accidents.

So how has the picture for the oil industry in the Gulf shifted over the last weeks? The region today is producing between 1.06 million and 1.3 million barrels a day, accounting for roughly 20% to 25% of U.S. crude oil, says Kurt Hallead, an analyst with RBC Capital Markets. That’s down from a high of 1.7 million barrels it produced back in June 2002, when the Gulf provided about 30% of domestic production — but “still a big number,” he says.

But political tensions make it hard for the industry to project long-term outcomes, says Brian Milne energy editor at Telvent DTN, an information services company. “I know a couple legislators automatically said ‘not so fast on the offshore drilling,’” Milne adds. There’s a wide gap between the best- and worst-case scenarios being circulated.

The best-case scenario, says David Havens, an analyst with Sterne, Agee & Leach, is that rigs will be required to do retrofits and to add procedures that will improve drilling safety and operations. “The industry adapts,” he says. Worst case, “I think people will discuss a moratorium [on drilling], but the odds are fairly light,” he says.

Conjecture has led to swings in the stock price of a number of companies that operate in the Gulf. BP, for example, has fallen 18% in the wake of the spill. But investors are also taking a look at shallow water drillers, oil services companies, and cleanup companies. It’s a “total energy issue,” says RBC’s Hallead. “Whether it’s the oil companies or oil services companies, we need to be cognizant of what, if any, impact regulation could have,” he says. As long as that’s an unknown, “we can’t assess the cost or additional ramifications,” he says.

Here is a look at a cross section of three deep and shallow water drilling, contracting, services, and cleanup companies that operate in the Gulf:

Transocean

YTD Stock Move: -16.5%
Since the spill: -25%
Market Cap: $20B+

Transocean (RIG), the world’s largest offshore-drilling contractor and drilling-management-services company, is the owner of the Deepwater Horizon, the oil rig that exploded and sank in April. Prior to the disaster, Transocean had 13 rigs operating in the Gulf of Mexico, the most of any contractor. The company leases the Deepwater Horizon to BP.

Analysts say Transocean has some protection against companies like BP that it contracts with, limiting its liability in the case of an environmental disaster. “To the extent that there is gross negligence, they can be held accountable, but there’s a cap,” says Havens, calling Transocean’s liability in such contracts “extremely limited.” The company is large enough to absorb litigation expenses, says Havens.

RBC’s Hallead agrees that Transocean appears to have “very limited” liability based on due diligence, discussions with various stakeholders and experts and this week’s testimonies. The analyst says the liability is likely to be “substantially less” than the billions the company has lost in market share over the last two weeks. The drop in share price is “extreme relative to what their exposure will likely turn out to be,” he says. Litigation aside, any slowdown in U.S. offshore drilling could be costly. With Transocean and other parties now appearing before Congress to testify on the matter, the regulatory ramifications of the spill are yet unknown. “We need to be cognizant of the impact,” says Hallead. “We just don’t know what that could turn out to be.”

On Transocean’s most recent earnings call, CEO Steven Newman said that there were still a number of uncontracted new rigs scheduled to enter the market over the next several months. The company also indicated that it planned to spend $850 million constructing new rigs this year, and $450 million upgrading rigs according to contracts. As to the ongoing investigations, a Transocean spokesman says: “We are going to not get ahead of the facts of those investigations and speculate about anything.”

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