Is An Offshore Drilling Boom In The Cards?

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US President Donald Trump’s inclination towards the country’s energy sector has not been a secret. After implementing the Tax Cuts And Jobs Act last month, which was believed to be unreasonably favorable to the conventional energy sector, Trump’s administration is now in talks for opening up almost 90% of the US coastline for offshore drilling in the coming years. While the decision still has many hurdles to overcome before it gets implemented, we believe that this could result in a huge upside for the oil and gas industry in a high price environment.

However, the current slump in commodity prices and weak cash flow positions may not allow many exploration and production companies to come forward to bid for these offshore leases due to the capital intensive nature of these projects. Further, offshore drilling generally involves a high risk of oil spills and other accidents that can hamper the environment and lead to loss of life and property. Thus, we believe that the Trump government has a number of hurdles to overcome before it can convert this proposal into a reality.

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Low Demand For Offshore Drilling In Current Price Scenario

The oil and gas industry has been suffering from its worst-ever downturn over the last three years. The commodity slowdown has not only pushed a number of smaller oil and gas companies towards bankruptcy, but it has also drastically hampered the profitability and eroded the cash flows of established players such as Exxon Mobil. That said, commodity prices showed some signs of recovery in 2017, with the Organization of Petroleum Exporting Countries (OPEC) and some Non-OPEC members implementing oil production cuts of 1.8 million barrels of oil per day (bpd) until the end of 2018, boosting oil prices for the year. For the full year 2017, WTI crude oil price averaged at $51 per barrel, almost $8 per barrel higher compared to 2016. At present, oil prices are trading at around $62 per barrel, which is sufficient for most of the oil and gas companies to break-even on their onshore production.

However, despite the anticipated rebound in oil prices, E&P companies through the US are restricting their capital spending budgets for 2018 and beyond, in order to better manage their cash flows and be prepared in case the market does not recover as expected. With these regulated capital budgets, these energy companies are trying to maximize their output from their existing wells and are focusing on high-margin onshore oil plays. This implies these companies have limited appetite to explore and invest in capital intensive offshore projects.

Further, even if these companies manage to raise funds to invest in these offshore projects, the cost of production of these projects is significantly higher than that of onshore projects. This implies that the companies will not be able to generate enough return on their capital, making it difficult for them to continue working on these projects. Thus, if Trump’s proposal to initiate offshore drilling along the US coastline is approved, there might not be enough producers to bid for these projects, thereby defeating the purpose of this exercise.

Increasing Output In An Oversupplied Market Can Be Dangerous

As mentioned earlier, the OPEC members have been holding back their oil output over the last one year with an aim to boost the oil prices. While the commodity prices have improved notably as a result of this strategy, the continued rise in North American oil supply has somewhat offset the impact of OPEC’s production cuts. The recovery in oil prices instigated the US shale producers to reinstate their operations to leverage higher prices, leading to a surge in the oil supply. At the end of 2017, the US oil production stood at 9.78 million bpd, almost 13% higher compared to where they were at the time when the OPEC announced the production cuts in November 2016.

Now, the new proposal aims to open up offshore drilling in the Arctic, Atlantic, and Pacific Oceans. These waters are expected to hold reserves of roughly 90 billion barrels of oil and 319 trillion cubic feet of natural gas, which is almost 80% higher than that currently available. Thus, if this proposal becomes a reality, it would mean that the US oil output will increase further in the long term, which will keep the markets oversupplied. As a result, the commodity prices will continue to weaken, reducing the profitability of energy companies, and delaying the government’s objective to make the US an energy superpower.

Environmental Hazards

There is a reason why the offshore drilling markets are not as popular and developed as the onshore drilling markets in the US. In the past, several unexpected and unfortunate accidents, such as oil spills and leaks, have occurred in these offshore waters, which not only disrupted the flora and fauna in the nearby areas but also eroded the fortunes of the companies involved for several years. Since then, several environmentalists and leaders have been trying to protect these areas by restricting drilling. Consequently, we believe that these environmentalists are likely to retaliate the latest proposal with all their might. In the worst case, if the Trump government manages to pass through the environmental review, the large integrated companies that undertake offshore drilling projects may not be too keen on investing in these projects for now. This is because not only are these projects high-risk and capital intensive, they could bring in negative publicity to these companies which could be detrimental for them in the current weak price environment.

Stay tuned for our next analysis where we will discuss how the proposed offshore drilling plan, if implemented, will impact Transocean, the largest offshore service provider.

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