Risky Business

Fire boat response crews battle the blazing remnants of the off shore oil rig Deepwater Horizon Wednesday April 21, 2010.

Offshore drilling, particularly in deep water, makes the action available at Las Vegas casinos look almost tame.

The fire and sinking of the Deepwater Horizon earlier this week provides yet another example of just how complex and dangerous the energy business can be. Sure, poker players in Vegas can wager tens of thousands of dollars at a time. But consider this: the lost revenue to BP — just from the loss of the oil production from the well being drilled by the Deepwater Horizon — amounts to about $600,000 per day.

The preliminary assessment of the accident indicates that the rig, owned by Transocean, was hit by an uncontrolled blowout — an unexpected surge in pressure in the well bore — that sent oil and gas rushing to the surface and onto the rig floor. That led to a catastrophic explosion and fire.

The accident on the Deepwater Horizon reminds me of a brief conversation I had a few years ago with James Mulva, the CEO of ConocoPhillips. I asked Mulva to name the most difficult part of his job. His reply: assessing risk. He said that ConocoPhillips had so many different businesses in so many different parts of the world, that he had difficulty in figuring out all of the regulatory, political, currency, and other risks that the company was facing. That conversation led me to think about risks facing companies that are drilling offshore.

Geologic risk

Companies are betting huge sums of money that the geologic zone they are targeting will contain commercial quantities of oil and gas. But to assure commerciality, the geologic zone must have the right porosity and permeability. In 2006, Chevron, Devon Energy and Norway’s Statoil ASA announced a major discovery with a well called the Jack No. 2. The three companies found a huge field in the deepwater of the Gulf of Mexico, about 270 miles southwest of New Orleans. The Jack well, drilled in 7,000 feet of water, to a depth of more than 20,000 feet below the sea floor, found a major field in a geological area called the lower tertiary trend. That formation may hold up to 15 billion barrels of oil, an amount that could boost America’s reserves by 50 percent. The three companies took major geologic risk by targeting the lower tertiary, but they were proved right. The cost of being proved right? The Jack well cost more than $100 million.

Engineering risk

The Deepwater Horizon disaster had two of the world’s most experienced companies: Transocean and BP. And yet there was apparently a blowout. Why didn’t the blowout preventers on the rig kick in and seal the well? We don’t know the answer to that. Perhaps there was something wrong with the equipment that was being used on the well.

Companies working offshore are continually running up against engineering challenges. In January, New Orleans-based McMoRan Exploration announced that its ultra-deep Davy Jones well (drilled to 28,600 feet) had found 200 feet of pay zone. The well was drilled in 20 feet of water off the Louisiana coast. But to produce hydrocarbons from the new target zone, McMoRan is going to need special equipment that is capable of dealing with the high temperatures (more than 400 degrees Fahrenheit) and intense pressures (more than 20,000 pounds per square inch) that are found in the deep reservoir. That means developing new technologies.

Technology risk

In many ways, drilling in ultra-deep water is more akin to space exploration than it is to traditional oil and gas production. And with that cutting-edge exploration work, new technologies are always going to be essential. But will they work? All of the testing in the world cannot assure 100% success once the technology is put into the extreme environments that are common offshore. And as drilling moves progressively into ever-deeper water, the industry will inevitably have to rely more heavily on robots, submarines, and other high-tech machines, all of which is extraordinarily expensive.

Capital risk

The Deepwater Horizon was among Transocean’s newest rigs. The cost to fabricate the rig: About $600 million. Meanwhile, BP has another platform operating in the Gulf of Mexico, Thunder Horse, that cost about $1 billion. That’s a lot of capital. It also explains why the lease rates for rigs like the Deepwater Horizon are about $500,000 per day.

Weather risk

BP’s Thunder Horse platform may have cost $1 billion, but that doesn’t mean much when major hurricanes sweep through the Gulf. In 2005, the platform was evacuated ahead of Hurricane Dennis and when BP personnel returned the platform was listing dangerously and it was feared the vessel would capsize. BP eventually fixed the problems at Thunder Horse, at a cost of about $250 million. But Dennis was followed by Hurricanes Katrina and Rita which caused widespread damage to platforms and pipelines throughout the Gulf. By January 2006, five months after Katrina hit, about 27% of the Gulf’s oil production and 19% of its gas production was still shut in due to storm damage.

Human error risk

The causes of the Deepwater Horizon disaster aren’t yet known. And they may never be known. But in many industrial accidents, human error almost always figures into the equation.

Market risk

From the time a company obtains a lease to the time it begins actual production from an offshore rig, five years — or more — may elapse. During that time, the price of oil and natural gas fluctuates. Before committing to any project with that kind of time horizon, a company has to have a very strong belief in the future price of the commodities they will be selling.

The Deepwater Horizon disaster is lamentable. Eleven crew members are likely dead. Lawsuits have already been filed. More are likely to come. The disaster will undoubtedly drive the companies working offshore to redouble their safety protocols. And the disaster will give plenty of ammunition to environmentalists and others who are critical of offshore exploration and production.

But the trend toward ever-deeper, ever-more-complex offshore oil and gas exploration will not stop. About a third of all global oil production now comes from offshore wells. And given that big multinational companies like BP, Exxon Mobil, Chevron, and others are largely prevented from accessing the onshore reserves controlled by members of OPEC, the offshore is their only real growth opportunity. The reality is that big energy companies can’t afford to quit moving into ever-deeper water. Drilling offshore may be risky business, but for most of the big international oil companies, there are no other options.

This piece originally appeared in Energy Tribune

This piece originally appeared in Energy Tribune