Royal Dutch Shell Plc  .com Rotating Header Image


Wall Street Journal Graphic

Going Deep

Big oil companies see the Gulf of Mexico as expensive — and one of the last places available to them

August 27, 2007

As geopolitical turmoil makes Big Oil’s portfolio more risky, the Gulf of Mexico is fast becoming the energy world’s savings bonds. While it’s unlikely to match expanding production in West Africa or the Middle East, the area is immune to sudden shocks that come from working under unpredictable governments that control most reserves world-wide.

Companies are snapping up drilling rights in the Gulf on a scale not seen since the late ’90s, when heavy bidding was fueled by the first hard evidence of deep water’s oil-drilling potential and a lower tax rate.

The hope of discovering the next half-billion-barrel oil field is still a big lure. But for the international oil companies that rule the Gulf, the new oil rush has as much to do with the lack of options elsewhere as the size of undiscovered reserves.

The deep-water Gulf is one of the last places where independent oil companies can get first crack at untapped oil — relatively free of competition from national oil companies backed by increasingly aggressive host governments. And that sort of security is enough to trump skyrocketing development costs, bureaucratic hurdles and mounting evidence that the Gulf’s oil will prove far more difficult to extract than expected.

“There is a persistent belief that Big Oil can increase supplies anytime,” ConocoPhillips Chief Executive Jim Mulva said in a July speech before the U.S. Chamber of Commerce. “But most of the world’s oil is controlled by exporting nations. [So] there is a great deal of international competition for opportunities to develop” what’s left.

Room to Grow

Houston-based Conoco, which owns a large amount of territory in the Gulf but performs very little exploration or production work, plans to increase its holdings in the area over the next couple of years — when swaths of territory in the Gulf that sold in the record leasing of the late ’90s come up for sale again. Companies have 10 years to drill in a parcel before the rights go back up for sale. But with demand for rigs outstripping supply, not all promising prospects have been explored.

“It is likely that many high-quality leases will expire without being tested,” says a May report by the U.S. Minerals Management Service, the agency that regulates production in federal waters and sells oil-exploration rights to companies. The agency plans to hold two new auctions later this year, providing an opportunity for more companies to jump in.

If oil companies’ production forecasts pan out, the Gulf’s production should increase by 1.2 million barrels by 2015, according to government estimates. That’s the first domestic increase in production in 20 years. But it’s smaller than a projected 1.8-million-barrel increase over the same period in Angola or 1.7 million barrels in Nigeria, two other regions where offshore production is expanding.

Long, Expensive Path

But to meet those forecasts, oil companies are going to have to travel down a long, expensive path.

The last decade of exploration was made possible by breakthroughs in seismic imaging in the late ’90s, a technique used to create an underground map that can highlight likely oil and gas reserves. Seismic technology had been around for decades, but a thick layer of salt beneath the Gulf floor had made accurate imaging impossible.
Improving seismic techniques and billions spent on drilling have yielded dozens of discoveries, but the salt still gets in the way. Companies often don’t know exactly what they’ll find under the salt until after they’ve built a multibillion-dollar platform and start producing.

Others have faced issues with equipment. For instance, Chevron Corp., the largest acreage holder in the deep-water Gulf, recently delayed first production at its Tahiti field, 190 miles south of New Orleans, from mid-2008 after discovering problems with shackles used to keep the floating platform in place. The oil company hasn’t given a new start date for Tahiti.

Even without equipment failures, some companies have had a bumpy ride. Anadarko Petroleum Corp. had big plans for its K2 field when it started production in 2005, but it struggled to reach half of its 80,000-barrel-a-day target amid problems maintaining well pressure. Then in February, the Houston-based company doubled its estimate of the size of K2’s reservoir, to between two billion and four billion barrels. But there’s a catch: While the field is proving larger than expected, extracting that oil will require a complicated and expensive series of chemical injections, which can make it easier to flush petroleum out of a difficult reservoir.

The deep-water Gulf has given the energy industry few, if any, unqualified hits this decade, in contrast to other new exploration areas where early expectations are often exceeded, says Mike Rodgers, a partner with consulting firm PFC Energy in Washington, D.C.

But with oil at around $70 a barrel, even an underperforming field can still be counted as a success if it was commissioned when prices were expected to top out at $40. BP PLC and Chevron both quote prices between $30 and $40 a barrel as enough to justify developing their most expensive projects in the Gulf.

And deep-water producers haven’t changed their outlook even as the cost of finding and developing an oil field in the Gulf quadrupled between 2000 and 2005, according to a study by the U.S. Minerals Management Service.

Most companies say the region’s stability and the low royalties demanded by the U.S. government far outweigh any production problems. “There are relatively few places in the world we can still hunt for those size prizes,” says Paul Siegele, Chevron’s vice president for Gulf of Mexico deep-water exploration and production. “It’s accessible to Western companies and has relatively good fiscal terms compared to some other places in the world.”

The U.S. takes 42% of revenue generated in the deep-water Gulf of Mexico, compared with Angola’s 60% and Nigeria’s 87% of offshore production, according to a May report by the U.S. Government Accountability Office.

Political Stability

The Gulf also is considered free of political risk. A general strike in Nigeria in May, for instance, threatened producers’ ability to load oil onto tankers for export.

“Just like a stock portfolio, oil companies have to keep a mixed blend,” says Bob Fryklund, vice president of industry relations at energy consultancy IHS Inc. in Houston. “Some guys prefer a bond-type approach. The U.S. government is pretty stable, [so] overall [the Gulf] has been a fairly risk-free place from that standpoint.”

But the U.S. isn’t immune from some of the forces making it difficult for oil companies to operate abroad. The U.S. raised royalties on new deep-water leases to 16.7% in January from 12.5%, the first increase in at least 15 years.

Congress also has been pushing to abolish “royalty relief,” a waiver of taxes on some Gulf production granted when oil prices were low. The waiver has applied to leases sold in 1998 and 1999 even as prices have topped $70 a barrel. The House included a new fee on future production on the 1998-99 leases in its energy bill. But the Senate, which must approve the charge, rejected a similar tax measure this year.

South Bound

One thing the U.S. government isn’t budging on is opening up more of the eastern Gulf of Mexico to exploration. In July, a bill to allow seismic testing of closed-off areas of the eastern Gulf was shot down in the Senate.

“We need more access,” says John Hofmeister, president of Royal Dutch Shell PLC’s U.S. operations. “We’re only allowed access to 15% of the outer continental shelf. We don’t know [what’s out there] until the chance to explore.”

Unable to go east, companies are pushing farther south. In the coming lease sales from the Minerals Management Service, acreage 250 miles southwest of New Orleans will be at the center of a fierce bidding war, predicts Matthew Jurecky, a Houston-based analyst at Scottish energy consulting firm Wood Mackenzie.

Mr. Jurecky said in a report last month that deep-water bids will top $1 billion in two sales this year. “With…low political risk, and vast infrastructure,” he wrote, “the rising prices in [the Gulf of Mexico] are substantiated.”

–Mr. Baskin is a staff reporter for Dow Jones Newswires in Houston. He can be reached at [email protected]. Jessica Resnick-Ault in Houston and Ian Talley in Washington, D.C., contributed to this article. and its sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.


Leave a Comment

%d bloggers like this: