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Rethinking Offshore Drilling

“Royal Dutch Shell shares have also dropped – around 11% – since the BP oil spill began.”

Published May 28, 2010 7:20 AM

As the BP (BP: 45.38, +2.97, +7.00%) spill in the Gulf of Mexico continues, the Obama administration is reviewing its position on offshore drilling, which could add further selling pressure on BP and Royal Dutch Shell (RDS-A, RDS-B), among other oil companies. On Thursday, the President announced the suspension of most offshore drilling operations in the Gulf and postponed or canceled drilling in Virginia and in the Arctic. Meanwhile, the head of the regulatory agency Minerals Management Service resigned, suggesting a shakeup of management and an improvement in safety and regulations to come.

The changes are designed to decrease the possibility of another spill of this magnitude, but they also present obstacles to the offshore drilling sector. The outlook for BP’s stock, which has spiraled downward since the blowout began on April 20, grows only more pessimistic. Shares are down 22% since then and the company’s market capitalization has dropped by $35 billion. Preliminary estimates of clean up and containment costs have risen to $3 billion and projections for earnings per share for 2010 have dropped by 6%, wrote Lucy Haskins, an analyst at Barclays Capital in London, in a report. There also could be overhang on “the uncertainties still surrounding the management of the spill and the reputational and possible opportunity costs to the company in the longer term.” BP’s offshore drilling operations, for example, could suffer. Earlier this year the company announced that it was paying Devon Energy (DVN: 63.38, +3.09, +5.12%) $7 billion for assets that included U.S. deepwater in the Gulf of Mexico. Now, the company may not see much of a return on that expense until it introduces new safety standards and the Obama administration permits offshore drilling to resume.

Royal Dutch Shell shares have also dropped – around 11% – since the BP oil spill began. That may in part be due to the uncertainty surrounding its offshore drilling operations; the company was set to start oil drilling off the coast of Alaska this summer, but President Obama’s announcement will likely bring those plans to a halt. In the long run, that overhang could be offset by expansions elsewhere in the energy sector; today, Shell announced that it’s buying U.S.-based natural gas explorer East Resources underscoring the possibility of increasing natural gas demand to come.

Another potential expansion could be in oil sands – a growing sector particularly in Canada. Yesterday, Enbridge (ENB: 44.73, +1.29, +2.96%), a pipeline company, asked regulators for approval of a pipeline that would transport oil from Canada’s oil sands to its western coast to export to Asia’s markets. “Because of the oil spill in the Gulf, we expect that we will see further expansion of alternative methods of oil exploration, and the oil sands should have a bright future,” wrote Tom McIntyre, CEO of McIntyre, Freedman & Flynn Investment Advisors, in a report, citing Suncor (SU: 30.84, +2.07, +7.19%) as a company that could also benefit.

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