Deepwater Disaster Doesn't Change Need for Deepwater Drilling

Gary Gibson: Byron, can you start off by telling Whiskey readers a little about why we’re searching for deep sea oil in the first place? I mean, we know about peak oil already. But… is it really THAT bad that we’re having to search for oil buried beneath 12,000 feet of water? And after the water, another 10,000 feet of dense rock? That’s a lot of risk to take. Seems to be proof for the end of cheap oil theory, right?

Byron King: Exactly. The days of drilling a hole beneath the soil in Texas, inserting a pipe and watching oil gush out are gone. We’re never going back to those days.

It gets into what we’re dealing with here in the search for deep sea oil… The energy industry has to go deeper and deeper to make things work. Risking more and more capital – and unfortunately, lives – along the way.

Look at what we’ve seen in the last 20 years or so, since 1990, when the oil industry really started to go deep. There was something like an “arms race” to develop better and better deepwater technology, to go for the next levels down.  We’ve seen this race to deeper and deeper water. And it’s all because the so called “cheap oil” is gone.

It used to be that drilling at 1,000 feet water depth was the edge of technology!  You know, back then in the early 1990s it was 1,500 feet, then it was 2,500 feet, then it was 5,000 feet…7,500, 10,000. Now they’re drilling at 12,000 feet of water.

It’s doable.  But it’s mind-blowing as well.  I mean, 12,000 feet of water is where the Titanic sits.  That’s how deep that water is. Let me stress: 12,000 feet is really deep water.  So in 20 years, we’re gone from 1,000 to 12,000 feet: huge, huge technological leap. And the only thing that lets you do that is technology.

In the same sense you have a much, much better computer today than you did in 1990, you have much better offshore drilling equipment today than you did in 1990.  You have bigger, better rigs.  You have more powerful rigs. You have far better positioning, far better station keeping.  You got much stronger steel.  You’ve got better pipe. The way they do these risers is just astonishing.  Risers are not just pieces of steel pipe.  These risers are an entire, complex mechanical and hydraulic system that connects the drill ship on the surface with the workings on the sea floor 2 miles down.  These things are incredible specimens of engineering.

Keeping with the risers, they’re wrapped in this stuff called syntactic foam.  This foam is super high-tech stuff.  It keeps the risers buoyant.   So you have riser sections that, in the air, weigh many, many tons.  But in the water, it’s essentially buoyant.  You can push the risers around with a little remote operating vehicle with a couple of little propellers on the back of it.  So this stuff is really astonishing.

Gary: OK, so all this new technology is needed. The risks seem great. They obviously wouldn’t be doing this if the reward of finding new oil wasn’t great. But with the recent disaster in the gulf, the question on everyone’s mind is… what happens when that technology fails? So can you shine a little more light on the disaster itself. Starting maybe with all the players involved? I know you’ve recommended a lot of these deep-sea oil companies in your paid Outstanding Investments newsletter…

Byron: I’ll tell you more about what I’m telling Outstanding Investments readers in a second. But first, lets talk about the players…

Transocean owned the rig, and they were under contract with BP.  In the world of offshore drilling, the leaseholder or the operator — in this case, BP — really is driving the bus. It’s like chartering an airplane to go from here to there, but you have to file the flight plan and you have to work the airline to decide what is it that you want on the airplane. From the looks of it, Transocean was doing what the BP people wanted them to do.  BP basically lost control of the well.

From what I’ve seen and heard from the witnesses, BP was trying to make up for lost time, with a well that was behind schedule and over budget.  During the drilling, the BP guidance was to put extra weight on the bit.  OK, so they drilled faster.  But then they wound up cracking and fracturing the rock on the way down,  This made it more difficult to complete the well and cement it.

Ultimately, when the investigators recover all the data, the blowout preventer, examples of the down-hole pipe and cement…  when they get it all torn apart and figure out what happened, there’s going to be just a huge amount of human error in there.

So right now, when they say “Oh, you know, this piece of equipment failed or this piece of technology didn’t work or whatever”, that’s just not the whole story.

Sure maybe some piece of equipment failed or the technology didn’t work, but that’s because there was some sort of human control or human intervention or human oversight that let things progress from one bad situation to another bad situation.  And from bad to worse to the absolute worst. That’s what we’re seeing.

Again, though, it’s because offshore development is the future of oil. The oil industry wouldn’t be taking these risks if cheap oil was still with us. We’re just starting to scratch the surface of this deep-sea stuff. The cheap stuff’s gone. Gotta go offshore…

Gary: Right. So there’s BP and Transocean. Who else is involved…? Or, said a different way, what other technologies are needed?

Byron: Well, then there are the blowout preventers. And in the particular case of the gulf disaster, it was a Cameron product…

And you know, Cameron builds good blow out preventers.  They invented the blow out preventer.  There would be no blow out preventers if it weren’t for a guy named Mr. Cameron.  And so they know what they’re doing.

But the thing to keep in mind is that now you’re taking this onshore blowout technology, and adapting it to the oceanic environment, and more recently, to do it in a deep water environment.  So you’ve got these blow out preventers working under miles of water.

Now what happens with the blowout preventers is that when somebody builds a deep-water rig or a deep-water drilling vessel, they usually buy two blow out preventers, and they put them on the drilling ship or the vessel.  And they install one of them when they’re drilling the well.  The other is a backup.

When they’re finished drilling the well, the drilling people uninstall the blowout preventer and haul it back to the surface.  One way or the other, these blowout preventers are on the ship or they’re on the sea floor doing their thing.  And when they’re back on the ship, that’s when people do maintenance on then.

Now what apparently we’ve seen over the years is Transocean working with its client, which in this case is BP, and making certain modifications to the blowout preventer.  And that’s troublesome to me. Not that they made the modifications; it’s more the way that the modifications were made.  It’s the system under which people can modify these blow out preventers.

In this case, it got to the point where, when they went to try to shut off the blowout preventer in the first couple of days after the well blew, the BP people were trying to do things that were physically impossible to do.  That is, the drawings that they had for how the blowout preventer works weren’t the same as the real blowout preventer down on the seafloor.

Gary: Yeah, more of the finger pointing was about the newer drawings and where they were and why they weren’t available when they should have been. BP said a lot of time was wasted trying to operate blowout preventers on the ocean floor that didn’t match the drawings they had. But whatever accusations BP and Transocean want to hurl back and forth, Cameron is looking pretty good. They built good blowout preventers, like you said, and they’re not the ones who modified them or were trying to use them with plans that didn’t contain the modifications.

Byron: It would be like an airline company buying a jet from Boeing, and then doing its own modifications to the airplane and not having FAA approval or not working with Boeing to record the modifications.  And then the mechanics go to work on the aircraft, and it’s kind of like, “Wait a minute! What we’re finding here – this isn’t the Boeing spec and this isn’t what left the factory.”

Another analogy would be, you buy a car from Ford or General Motors, and then over the years, you swap out a different engine.  You swap out the transmission.  You put in different suspension.  You do most of your own maintenance.  You buy your own parts.  And you drive that car really hard.  And maybe you even drive it into the dirt.  And then years later, you have a traffic accident – you have a motor vehicle accident with that car. And now you’re going to go back and sue Ford or General Motors. Well, that’s kind of strange.

I guess that’s a way of moving to Cameron as an investment idea.  I mean, Cameron stock fell really hard in the couple of weeks after the Gulf of Mexico blow out.  But I think Cameron is going to come out of this looking pretty good.  They are not going to come out as blameworthy, because they didn’t build a bad or defective product.  The problem with the blowout preventer came long after this particular item left the Cameron factory.  So I think Cameron has been way over sold in that.

Gary: OK, we normally don’t talk specific stock stuff in Whiskey, but since you brought it up, readers may like to know a little more about the opportunities…

So lets talk more about that for a second. You’re saying Cameron’s a good “value” play in that way? And you’re not worried about Cameron at all?  You’re thinking they’re going to come out of this looking absolutely fine and that people will pile back into it because they made a good profit?

Byron: I think that Cameron is going to come out of this looking a lot better than many people think right now.  There will surely be a lot of emotional finger-pointing as the Gulf blowout progresses.  But I think that when people point the finger of blame at Cameron, they’re pointing the wrong finger at the wrong outfit.

Gary: Right.

Byron: Really, it’s so emotional that some people are pointing their middle finger at the companies involved.  We need to keep in under control, and follow the facts.

Gary: I mean, these guys, they invented the blow preventer.  You said without them there would not even be this technology in the first place.

Byron: There are really only a couple of companies in the world that make these blow out preventers.  One of them is Cameron, and another one is General Electric Oil and Gas, and those are the two I’d say largest suppliers.  It’s a very small industry.  And there just aren’t a lot of people, a lot of good companies out there building these items.  And they are super high technology items.

Anybody who thinks that a blowout preventer is just a big steel valve with a couple of pistons and some pipes and a few knobs and levers and bells and whistles and stuff…  Man, you don’t understand what goes into these babies.

The steel that goes into these blowout preventers gets traced back to the iron ore in the mill.  I mean, the, the quality is so, so high.  And the engineering and the testing that goes into these things… All because they’re intended not to fail.

But in this case, the blowout preventer appears to have not “failed,” but not “worked as intended” because it was damaged in some way.  There are claims that a rubber annular device was damaged several weeks before the blowout.  And if that’s true, that explains a lot to people who understand how these blowout preventers work.

But it doesn’t make Cameron a bad idea for the Outstanding Investments portfolio. Cameron is still a fantastic company to own. What’s happened here is a tragedy, of course, but as far as good investments like Cameron, it just makes them cheaper for a little while.

Byron King and Gary Gibson
Whiskey & Gunpowder

May 21, 2010

The Daily Reckoning