Deep Water Drilling and Expensive Oil

Byron: This blow out in the Gulf of Mexico absolutely should not have happened. Yes, it could have been prevented. But we are already on the other side of Peak Oil. Oil is going to keep getting more expensive and eventually it could get too expensive for life to be anything like what we’ve become accustomed to. The only way to keep that from happening is to go get more oil. A lot more oil. And there is a lot more oil out there, but it’s under a lot of water.

In the three years or so that I’ve been editing Outstanding Investments I’ve tailored the energy side of the portfolio heavily toward deep water oil exploration. And people say well gee, you have an awful lot of exposure for one segment of the industry. Well, that’s because that’s where the oil is.

Gary: Exactly.

Byron: You go where the oil is and the big oil is in deep water. I mean, there’s oil on shore in some parts of the world, but these are parts of the world where most investible plays can’t go. I mean, Saudis, they have lots of oil. Venezuela, they got lots of oil. Mexico, they got more oil than people give them credit for although they’re doing a horrible job of exploiting it. It’s the resource nationalism of the world.

On shore and in many parts of the world — Russia as well as all through the Middle East — the big private oil companies are just publicly owned and other oil companies are just not able to get their foot in the door. Or if they do, it’s under very, very, very limited, very circumscribed procedures. BP bought into the recovery of the rocky oil industry, but they’re getting paid a fee per barrel that they produce.

It’s a pittance really in terms of what’s coming out of the ground and the contribution that they would make towards bringing it out of the ground. So anyhow, where is the big oil in the world? How does a big oil company “move its needle”? How does it move its reserve needle? You go offshore, and you go into deep water, because that’s the last frontier. It’s the unexploited oil deposits. It’s big deposits. You can get these super wells out there where you can make 20,000…30,000…50,000 barrels a day out of one well. Because of these huge volumes and high pressures. Which the flip side of that is that if you blow out your well, which is what we’re seeing you can make a big mess in a fast hurry. That’s what we’re seeing in the Gulf of Mexico right now.

Gary: That can happen on shore as well. But under water, under all that water, that’s the other side of it. That when things go wrong…

Byron: That is the other side of it and I honestly am highly critical of the oil industry and the regulatory side of the house, too, for a distinct lack of imagination over the last 20 years. Everybody was imagining going further out and going deeper and deeper water, deeper and deeper wells. But there has been precious little R&D done in deep water well control, and deep water blow outs. We are watching — say in the last month — 20 years worth of research and development happen inside of a month.

They are literally just taking ideas, throwing them against the wall to see if they stick. You know, whether it’s that big box. Whether it’s the top hat, the top kill, the junk shot, the bridging shot. You know, all these different things that they’re talking about. We’re watching 20 years worth of R&D happening inside of a month and nobody really thought about it. Nobody put any big money into it.

Instead the money went into technology to conduct the operation and in a sense, the idea was that we’re going to put money into building really good equipment, and our technology is so good, and our procedures are so good that nothing bad will ever happen. Well something really bad happened. Now what? I mean that argument doesn’t hold water anymore, which is why at least in the U.S. — and it might be something that spreads elsewhere in the world — the offshore deep-water drilling regime anymore is going to become a much more exclusive club.

Only larger companies with deeper pockets who can afford the regulatory requirements need apply in the offshore deep water drilling space. To the extent that the U.S. government and other governments in the world really permit that kind of deep water drilling. There’s a, there’s a very loud and growing louder, very vocal segment within the political crown out there that just wants to say “see, we told you so.” This deep-water stuff, you should never do it.

To which I say there’s really an element of energy hypocrisy here because the same people who are saying we shouldn’t drill offshore are also the same ones who say we shouldn’t drill on shore. I mean, for the lack of drilling on 640 acres of land in the Arctic National Wildlife Refuge, for example – when I say 640 acres, I mean an acre here and an acre there. I don’t mean like all in one big spot either.

For the lack of drilling in the Arctic National Wildlife Refuge, which you do in the wintertime built on ice pads using ice roads when it’s 40 below 0, and all animal and plant life is in a hybernetic state. And we do understand how to drill in an on shore arctic environment. That is quite doable. And we have existing infrastructure 20, 30, 50 miles away in Prudhoe Bay and a working pipeline, the Alaskan pipeline.

For this lack of drilling in the Arctic National Wildlife Refuge that is all the more incentive for the energy industry to go into the far offshore and drill wells so far away that if something bad happens, it’s almost impossible to conceive of how you could control the problem. You know, in a very perverse sort of way, it’s almost good that the well blew out offshore Louisiana. Not that it’s a good thing because that’s not a good thing.

Gary: Of course.

Byron: But if this well had blown out, or if a well had blown out 8,000 miles away, let’s say 150 miles offshore of some African littoral, that is 2,000 miles away from the nearest serious infrastructure in Angola or South Africa or something like that. You know, I mean, how, how could you possibly begin to mobilize the resources to fight a deep-water blow out similar to what we’ve seen and what’s going on in the Gulf of Mexico. I mean, the Coast Guard and the U.S. government has, and BP of course something like 750 ships under its control right now.

They’ve got hundreds of aircraft flying all over the place, gathering data, spreading disbursements. They’ve got 250 miles of deployed booms in the water trying to keep that oil away from the shorelines and the marshlands. And really, they’ve done a remarkably good job of keeping the oil away from the shorelines and the marshlands. Yeah, there are tar balls here and there, but, you know, the oil hasn’t washed into the marshes yet. You know, they’ve kept the oil out at sea.

Out at sea that oil, you know, at least to the extent it gets to the surface, it bakes in the sun, and it’s a nice warm latitude of sunshine there. And the Gulf waters are warm, and there are oil-eating bacteria that are doing their thing. It’s not a good thing at all to have this happening. I’m just saying that in terms of mobilizing the military and the government and the civilian government and the industrial resources of the Gulf Coast to fight this oil slick. I guess you couldn’t pick a better place to have a deep-water well blow out and I can think of a lot worse places to have a deep-water well blow out.

Gary: There are going to be people who listen to this or read this and say that we were maybe a little callous or flip about it when we say this is the best case scenario for a disaster, that we’re able to control it. But isn’t that the reality of it. I mean, you’re drilling for oil. These things are going to happen. Do you feel that there is an element of inevitability in it?

Byron: Well, I hate to be so fatalistic about it as to say that you’re going to do something that’s ultra dangerous, which is drilling for oil far off in deep water, and say these things are going to happen. I really subscribe to that NASA mission control attitude that Gene Krantz had when he was running things down at NASA: perfection is the price of admission to mission control.

And I don’t think it’s too much to ask of the oil industry that they be perfect in terms of what they do and how they do it out there. I mean, if they can’t do it perfectly, I don’t think it’s too much to ask that they just tie the ship up to the pier and stay ashore and find something else to do with their capital. Because the problem is that a deep water blow out is so — the scope is so vast. These super wells are so prolific.

This blow out is spurting 5,000 barrels a day. That’s because the Cameron blow out preventer actually did work partially. I mean, that well could be blowing out – and I was just on a phone call yesterday listening in with Admiral Mary Landry of the Coast Guard. She said that the absolute worst-case scenario on this well is 55, 000 barrels a day. This well could be 11 times worse that it is, which tells you that the Cameron blow out preventer is doing something. You know, so I don’t want to go through life and I don’t want to write an investment newsletter that says oh, you know, this is just kind of the price we pay to work in these frontier areas.

Well, if that’s the price we’re going to pay to work in a frontier area that’s too high of a price because it’s not just the Gulf of Mexico. It’s the idea that lots of people are going to be drilling offshore. Brazil, the Mexicans want to drill in their deep water… offshore Africa, offshore India, in the frozen arctic ocean, off of Greenland, north of Norway. Things like that. The idea that we can somehow accept a blow out as the price or the cost of doing business…that’s just not acceptable to me.

And yes,, we have to have absolutely incredible technology, and it has to be really good and work real good. And it says something that Cameron and BP, or that Transocean and BP can modify the Cameron blow out preventer and not tell Cameron about it and not have some sort of an approval from the Mineral Management Service in the way that airlines have to keep their jets up to spec under the FAA. You know what I mean? I think there’s something wrong there.

Gary: Well, I certainly want to agree with you. I guess my concern is all those who will come out of the woodwork and decry what’s happened here…and then drive twenty miles to a supermarket and shop for goods brought in from across the country by a fleet of trucks. They just don’t appreciate how necessary offshore drilling is for their way of life to continue. It’s one thing to say BP or Transocean fouled things up royally, but it’s another to say that they shouldn’t be drilling in deep water at all.

Byron: Yeah. But hey, guess what: we’re on the backside of peak oil, or we’re on the backside of the Hubbard Curve.

Gary: Exactly!

Byron: Yeah, that Hubbard Curve thing. Sure, maybe in Saudi Arabia they can still lift oil out of the ground for $5.00 or $8.00 or $10.00 a barrel, but there’s just not that much cheap oil out there anymore. And so $70.00, $75.00 a barrel, $80.00 a barrel oil, there are a lot of people are still making a lot of money off that. And then there are plenty of hydrocarbon molecules out there in other unconventional spots. When we run out of $70.00 barrel oil, I assure you that there’s lots of $200.00 a barrel oil out there. And so companies are going to be making money in different places in different ways.

But right now and for quite awhile, the money is going to continue to be in deep water exploration. These oil companies have to get it right so disasters like the Gulf of Mexico don’t happen, but they also absolutely have to be out there in the deep water.

Byron King and Gary Gibson
Whiskey & Gunpowder

May 25, 2010

The Daily Reckoning