The Second Shoe Has Fallen - More to Come

I don't pretend to be an expert on offshore drilling, but I have done some work with energy companies, I have contacts in the industry, and I've lived in energy-producing regions and worked at banks that made loans - substantial loans - to drilling companies. So I think I have a reasonable understanding of some fundamental issues related to the energy industry, and the business world in general, that seem to have escaped Team Obama.

1. Companies are in business to make money. If they can't make it in one place they'll go elsewhere.

2. Offshore drilling rigs aren't fixed structures. They are mobile - essentially floating platforms - meaning that they can be moved from one location to another.

The net result of 1 and 2, combined with an ill thought out and illogical moratorium on offshore drilling, is that rig owners will move them from unprofitable locations to profitable ones when conditions warrant.

The first shoe fell on July 9:

Diamond Offshore announced Friday that its Ocean Endeavor drilling rig will leave the Gulf of Mexico and move to Egyptian waters immediately — making it the first to abandon the United States in the wake of the BP oil spill and a ban on deep-water drilling.

Larry Dickerson, CEO of Houston-based Diamond, signaled that other of his company's rigs could be relocated, too.

"As a result of the uncertainties surrounding the offshore drilling moratorium, we are actively seeking international opportunities to keep our rigs fully employed," Dickerson said. "We greatly regret the loss of U.S. jobs that will result from this rig relocation."

It was unclear how many U.S. jobs could leave with the Ocean Endeavor, but typically more than 100 workers are on the rig at any given time, doing everything from drilling to cooking meals. Onshore, a network of businesses supplies the rigs with groceries, equipment, uniforms and drilling materials.

"It's not unusual for an energy service company to have 1,000 vendors that they buy from or purchase services from," noted Rep. Kevin Brady, R-The Woodlands. As a result, Brady said, the economic damage from the moratorium stretches far and wide.

Dan Pickering, a financial analyst with Tudor, Pickering Holt & Co. Securities, said the legal uncertainties surrounding the ban - and the administration's plan to issue a new, revised moratorium - ensure that no companies will resume deep-water drilling in U.S. waters anytime soon.

"Are you really going to spend $5 million … getting ready to drill a well that someone would then probably block you from drilling?" Pickering said.


Pickering added that prospects are high that a dozen rigs ultimately could leave the Gulf of Mexico because of the ban.

Brady said the rig owners are searching for revenue - even if it means relocating to get it.

"There are two types of rigs in the deep-water Gulf today: those that are leaving the country and those that want to, because with this moratorium hanging over their heads, they simply can't go back to work," Brady said. "I'm afraid this is the first of many rigs and many American jobs to leave the Gulf."

Once the rigs relocate, it could be a minimum of five to 10 years before they return, predicted Rep. Pete Olson, R-Sugar Land.

"We cannot afford to lose these jobs or the energy they provide," Olson said. "President Obama should allow this moratorium to remain lifted and let Americans get back to work."

The second shoe fell shortly thereafter.

Diamond Offshore Drilling has pulled another rig out of the Gulf of Mexico due to restrictions on deepwater drilling in U.S. waters due to the BP oil spill.

The Houston company said this week that it has ordered the Ocean Confidence rig to the Republic of Congo. The rig departed the Gulf over the weekend and is expected to arrive off the African coast in 60 days.

Diamond Offshore said it moved the rig after rewriting a drilling contract with a subsidiary of Murphy Exploration and Production Co. Its current contract with Murphy was changed to a one-year commitment in the Gulf that will begin when Murphy is confident it can get permits to drill.

In exchange, the companies signed a new agreement to drill off the coast of the Republic of Congo.

The Congo project is expected to generate about $234 million in total revenue.

It is widely expected that many offshore operators will move equipment out of the Gulf until the backlash from BP's out-of-control well subsides.

Note that, in addition to conditions 1 and 2 mentioned above, a major contributing factor is that businesses do not like uncertainty. Sometimes referred to as FUD (Fear, Uncertainty, and Doubt), this generally spurs a firm to take whatever actions it can to reduce it. In this case, that involves fleeing from a FUD-rich environment (Fear that the obama administration will hamstring the energy industry, Uncertainty about the offshore drilling moratorium, and Doubt that, under obama, the business and regulatory climate will improve) to one with greater certainty. It's pretty sad when Egypt and the Congo - the Congo, for God's sake - are perceived to have a more stable business environment than the U.S.

The disturbing thing about obama's reaction (lack of action regarding the cleanup; debilitating action regarding drilling) is that it reflects a total lack of understanding regarding offshore drilling. A few facts from a recent WSJ article:

The most recent spill of this magnitude was the Exxon Valdez tanker accident in 1989. The largest before that was the Santa Barbara offshore oil well leak in 1969.

The infrequency of big spills is extraordinary considering the size of the offshore oil industry that provides Americans with affordable energy. According to the Interior Department's most recent data, in 2002 the Outer Continental Shelf had 4,000 oil and gas facilities, 80,000 workers in offshore and support activities, and 33,000 miles of pipeline. Between 1985 and 2001, these offshore facilities produced seven billion barrels of oil. The spill rate was a minuscule 0.001%.

Got that? Once every 20 years or so there's a major oil spill. Percentage-wise, it's 1/1000 of 1%. What other industry has a similar track record?

According to the National Academy of Sciences—which in 2002 completed the third version of its "Oil in the Sea" report—only 1% of oil discharges in North Americas are related to petroleum extraction. Some 62% of oil in U.S. waters is due to natural seepage from the ocean floor, putting 47 million gallons of crude oil into North American water every year. The Gulf leak is estimated to have leaked between two million and three million gallons in two weeks.

What? Oil spills are a natural occurrence? Next we'll be told that the earth's temperature goes through natural cycles of cooling and warming.

Such an accident is still unacceptable, which is why the drilling industry has invested heavily to prevent them. The BP well had a blowout preventer, which contains several mechanisms designed to seal pipes in the event of a problem. These protections have worked in the past, and the reason for the failure this time is unknown. This was no routine safety failure but a surprising first.

One reason the industry has a good track record is precisely because of the financial consequences of accidents. The Exxon Valdez dumped 260,000 barrels of oil, and Exxon spent $3.14 billion on cleanup. Do the math, and Exxon spent nearly 600 times more on cleanup and litigation than what the oil was worth at that time.

This is Key Point #1 that obama and his ilk just don't get. Drilling firms HATE spills. They have a vested interest in doing whatever they can to prevent them, because it's bad for business.

As for a drilling moratorium, it is no guarantee against oil spills. It may even lead to more of them. Political fantasies about ending our oil addiction notwithstanding, the U.S. economy will need oil and other fossil fuels for decades to come. If we don't drill for it at home, the oil will have to arrive by tanker and barges. Tankers are responsible for more spills than offshore wells, and those spills tend to be bigger and closer to shore—which usually means more environmental harm.

And here is Key Point #2. The Law of Unintended Consequences comes into play. Shutting down offshore rigs just transfers the risks elsewhere - in this case closer to home.

The larger reality is that energy production is never going to be accident free. No difficult human endeavor is, whether space travel or using giant cranes to build skyscrapers. The rest of the world is working to exploit its offshore oil and gas reserves despite the risk of spills. We need to be mindful of such risks, and to include prevention and clean up in the cost of doing business, but a modern economy can't run without oil.

To summarize, obama's response to the situation is to take actions that eliminate jobs here, create jobs in other countries, enrich those countries at the expense of the U.S., and increase the likelihood of more spills.

I used to think his missteps were ignorance. Now I doubt that anyone can be that stupid. There has to be an element of malice in there somewhere. Perhaps he's figured out that La., Miss., Ala., and Fla. are going to be red states in the next few elections, and is punishing them. He may also be trying to reinvigorate his leftist base, which is growing increasingly disillusioned with him. In any event, it's painfully obvious he does not have the best interests of the United States at heart.

God help us all...