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What BP’s New Oil Strike Means

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A vast discovery in the Gulf of Mexico is the latest sign of success in a high-risk, high-reward strategy

By Stanley Reed

It may be one of the biggest oil finds of the year, if not the decade. In recent weeks, executives at BP’s exploration centers in Houston and London have been closely tracking the progress of a very deep well that BP contractors were drilling into the seabed of the western Gulf of Mexico. In late August the exploratory well, known as Tiber, was completed. Now word is trickling out that BP (BP) has scored one of the largest discoveries yet in the gulf. BP’s chief of exploration, Michael Daly, terms the Tiber find “a very significant discovery” and says it is even “better” than the Kaskida field, another huge BP property in the Gulf of Mexico, with an estimated 4 billion to 6 billion barrels of oil in place.

BP has struggled recently, the result of highly publicized battles with its Russian partners and a series of accidents in the U.S. at its Texas refinery and on Alaska’s North Slope. Now it is getting a huge shot in the arm from its gulf finds, which are just coming onstream with highly profitable oil. Tiber provides further confirmation of BP’s vanguard status among companies probing the ancient geological zones far below the seabed of the gulf in water a mile deep.

The London company’s two-decade commitment to the gulf has helped resurrect a region that was being dismissed as “the Dead Sea” in the 1990s, after companies hit a series of dry holes. “With respect to the Gulf of Mexico, BP has done very, very well,” says Richard Gordon, president of Gordon Energy Solutions, an Overland Park (Kan.) oil and gas consultancy.

Tiber and Kaskida will take years to develop, and BP runs the risk of cost overruns, another crash in the price of oil, and unforeseen, expensive challenges in extracting all that crude. But BP’s star gulf property, a massive oil and gas field about 140 miles southeast of New Orleans called Thunder Horse, is already raking in cash for the company (ExxonMobil owns 25% of Thunder Horse). Visitors to the BP production platform for Thunder Horse must first board a helicopter at an airstrip at Houma in the Louisiana bayou. Dodging thunderstorms, the chopper flies over a seascape that reveals the history of the gulf oil industry, as the platforms evolve from shack-like structures in shallow water to massive, deepwater drill ships farther out to sea. Finally, a monstrous gray platform floating on four red legs comes into view. The size of a sports stadium, the Thunder Horse platform is tethered to the ocean bottom by huge chains in 6,000 feet of water and is one of the biggest in the world.

For Andy Inglis (pronounced Ingalls), BP’s exploration and production chief and Daly’s boss, Thunder Horse is the jewel in BP’s crown, worth all the snafus and delays the company had to overcome before it could succeed at the cutting edge of ultra-deepsea drilling. The company and its suppliers had to devise dozens of new components and materials for the platform, such as valves and coatings to withstand the searing temperatures and intense pressures on wells that must go through four miles of seabed. In 2005 a hurricane left the platform listing to one side, and in 2007 a mass of equipment connecting up the wellheads on the sea floor had to be brought back to the surface to fix faulty welds.

“Prepared to Work on the Frontier”

Thunder Horse is ramping up to its 300,000-barrels-per-day target—making it the No. 2 producer in the U.S. after Alaska’s Prudhoe Bay. Thunder Horse’s oil is among the most profitable in BP’s portfolio. Fadel Gheit, an analyst at Oppenheimer (OPY) in New York, figures that at a price of $60 per barrel, BP will earn pretax profits in the mid-$20s per barrel from Thunder Horse, perhaps four times what it earns in high-tax Russia.

Two other huge deepwater Gulf of Mexico fields, BP’s Atlantis and Mad Dog, have also come onstream in recent years. BP is now the lead producer in the gulf, and projects such as Thunder Horse have added about 1.2 million barrels per day to total U.S. output, arresting a long decline in American production and decreasing dependence on imported energy. The deepwater gulf is “one of the few bright spots in global oil production,” says Bob MacKnight, an analyst at consultants PFC Energy in Washington. BP now reckons an additional 22 billion to 40 billion barrels of reserves are to be found there.

Finds like Thunder Horse, Tiber, and Kaskida fit BP’s high-risk, high-return strategy to a T. “We don’t do simple things,” Inglis says. “We are prepared to work at the frontier and manage the risks.” BP wants to do big projects of a billion barrels or more because that’s the only way to replace the huge volumes that it produces, and large scale translates into high returns. Unlike ExxonMobil (XOM) and Royal Dutch Shell (RDSa), which have substantial refining and marketing operations, BP is largely an exploration and production company. BP wants to be a first mover and get the choice deals ahead of everyone else. And BP stands out as a high roller among the majors. Witness TNK-BP, the company’s turbulent though lucrative joint venture with a group of Russian oligarchs who forced the ouster of the venture’s expatriate CEO last year. Then there’s BP’s lonely decision a few weeks ago to become the first big oil company to return to Iraq while ExxonMobil and Royal Dutch Shell balked at the Iraqis’ tough terms.

The Right Risks

BP’s approach to finding new oil and gas involves big but calibrated gambles. Exploration wells in the deepwater Gulf of Mexico, for example, take months to drill and cost up to $200 million to bring onstream. With an overall exploration budget of $600 million to $1 billion per year, BP goes to great lengths to make sure it is taking the right risks. Four times a year, exploration boss Daly gathers his 15 or so chief lieutenants from around the world, usually in Houston or London, to decide where to spend money next. The goal is to back the best ideas—not just spread exploration budgets evenly among the various teams. The team that proposes a drilling prospect sets out in a few pages what it expects to find, including the amount of oil and gas and the cost of drilling. According to one participant, discussions can get quite tense, “because people are battling for projects they care about.” BP’s success rate on the 15 to 25 exploration wells it drills per year: about 60%.

For the past eight years, BP has led its peers among the majors in what’s known as organic reserve replacement—additions to its reserve base that don’t include any oil picked up through mergers. “Among the majors, BP stands out,” says Irene Himona, the analyst at Exane BNP Paribas who wrote the study that ranks BP at the top. “It has created, through exploration, very large assets, which go on producing for the next 20 to 30 years,” she adds.

Things weren’t always so upbeat. BP got its feet wet in the deepwater of the gulf more than 20 years ago. But, along with other companies, it hit a dead end in the early 1990s, drilling a series of costly dry holes trying to replicate Shell Oil’s deepwater success there. David Rainey, a dry-mannered Northern Irishman who now heads BP’s gulf exploration team, recalls how other companies gave up, thinking the area was played out and too expensive, while the former Soviet Union, which was just opening up, looked more attractive than it turned out to be.

Cindy A. Yeilding, a bubbly Southern Methodist University graduate who bids for BP at U.S. government auctions of gulf oil acreage, recalls fearing that BP’s gulf group, too, would get the chop. But BP’s brain trust looked at the pattern of discoveries in the deepwater and saw they were large and not trailing off in size, which is usually the case in a maturing area of production. The call: While the region was tricky, it still had a world-class future. And since it was under the control of the U.S., rather than a developing-world dictator, the oil was more accessible.

Thinking Small

BP management told its explorers to go back to the drawing boards and come up with a new plan of attack. They had been drilling spots that looked good on seismic surveys, the maps generated by bouncing sound waves off the rocks below the earth’s surface, but that approach had failed. Armed with new technology that allowed them to drill much deeper, the explorers went back to basic petroleum geology: Their aim was to figure out where in the gulf large amounts of oil, which is formed from the remnants of microorganisms that died millions of years ago, might have migrated up through the earth’s crust and then hit a seal of rock and salt. “You have to learn to think like an oil molecule,” Rainey says.

One BP explorer, Neil Piggott, even went 2,000 feet down in a submarine to get a firsthand look at oil and gas seeping out of the sea bottom. There in the inky darkness he saw masses of bacteria feeding on the oil and 30-foot-long tube worms that in turn were eating the bacteria. The seeps were further evidence that there was more oil farther out in the gulf.

The explorers soon identified Thunder Horse field as a potential “elephant”—industry slang for a colossal find—but some at BP were skeptical. Would the rocks bearing the oil be so deep and subject to such high temperatures that they would not be porous enough to let oil flow through? BP decided to drill an exploratory well. In April 1999, the well hit oil. Says Yeilding: “This opened up the potential of the whole Gulf of Mexico deepwater.”

To keep hitting home runs in the gulf, BP needs to find more challenging plays. Its explorers have been locking up positions in even more difficult areas west of Thunder Horse. In August, BP led the bidding at the biannual lease auctions held by the Minerals Management Service of the Interior Dept. in New Orleans. BP bid about $50 million of the $145 million total for about 40 tracts in the western gulf.

BP’s explorers have also been leaders in coming to terms with the ancient salt layers, thousands of feet thick, that cover much of the oil and gas accumulations in the gulf and other deepwater regions. Oil companies had shied away from the salt because it distorts seismic waves, obscuring what’s underneath. But BP’s explorers figured out how to look under the salt with new techniques, such as towing ribbons of seismic sensors behind boats over suspected fields to obtain sharper images of what lay below. “We stopped being afraid of the salt,” says Yeilding, who has spent time in France and Canada studying rock formations like those at the gulf’s bottom.

No Chest-Thumping

Deepwater is now a favorite haunt of BP: It is a major presence in the waters off Angola and is probing the Beaufort Sea in the Canadian Arctic. The company likes to apply what it has learned in the gulf and Alaska to other zones. One play it is beginning to scope out is the Gulf of Sirte off Libya, where prospective oil and gas deposits lie in the sands put down by ancient river systems.

BP is once again playing the maverick in Libya. Outbid in open bid rounds, the company spent two years lobbying Muammar Qaddafi to grant BP a concession involving huge swaths of offshore and onshore acreage exceeding the size of Belgium. Daly says the next meeting of his explorers will give the green light to the first Libyan wells.

BP explorers know that no matter how many Thunder Horse and Tiber winners they hit, they had better not become smug. Two years ago they drilled a prospect in the gulf that had them so excited they called it Big Kahuna. As it turns out, they had the geology wrong and found nothing. “We try to stay humble,” Rainey says. “When we don’t, we get kicked in the behind.”

Reed is London bureau chief for BusinessWeek.

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