A Revitalized Gulf

Surf’s up! And that has operators waxing up their oil-services surfboards to catch post-Macondo swells in the Gulf of Mexico over the next half decade.

Operators are spying two waves on the horizon. The first is propelled by recent transactions on the shelf, where operators are consolidating inexpensive, legacy properties, moving in with workovers or infill drilling, increasing production—or at least keeping production stable—and generating free cash flow. This free cash is funding ambitious projects globally or, increasingly, in the onshore U.S.

The second, larger wave involves the deep water, which is rising in importance in the intermediate future as operators get multi-year projects back on track.

Notes Barclays Capital oil services analyst James West, “The ‘permitorium’ that plagued the U.S. Gulf of Mexico following the moratorium in the region has ceased and permitting is back to pre-Macondo levels. February marked the most active permitting month in the Gulf since the end of the moratorium with 58 total permits issued, including 22 permits for new wells.”

Meanwhile rig utilization is tightening—Gulf fleet utilization is up 15% since February 2011 to 63.7% in March, according to ODS-Petrodata, the third time in the past four months utilization topped 60%. The Gulf will soon see a squeeze, since drilling equipment sailed out of the region to meet voracious international demand post-Macondo. The number of Gulf fleet units fell from 124 in March 2011 to 113 a year later, while rigs at work rose from 70 to 74 during the same period.

But the big story offshore—and one that will impact the Gulf—is that global fleet utilization is maxing out across most offshore rig classes, and the number of newbuilds is not keeping pace with expected demand over the next half decade.

Consequently, the Gulf”s resurgence reflects a global trend. Both Wall Street and the industry have turned their focus offshore, particularly to the deep and ultra-deepwater space, as the industry suits up for a golden era of deepwater effort in frontier settings around the globe, including the Gulf of Mexico.

“A gradually improving regulatory climate, $100-per-barrel oil prices, political pressure on the current administration to relieve consumer pain at the pump, and impressive prospectivity of the deepwater Gulf have all contributed to the ongoing post-Macondo revitalization of one of the world’s most important deepwater basins,” notes Jeff Spittel, oil services analyst with Global Hunter Securities Inc., in a recent report.

It was a photo finish in 2011 in the U.S. Gulf as the top two or three producers in each commodity generated nearly identical volumes.

Equipment scramble

The number of active Gulf projects climbed above 75 in February, more than double the mid-30s tallied when the Macondo well was finally brought under control in August 2010. And that has sparked a scramble to obtain quality equipment.

Marathon Oil chief executive officer Clarence Cazalot spotlighted the trend during the recent Howard Weil Energy Conference held in New Orleans. Marathon has 20 Gulf prospects split almost evenly between Miocene and Paleogene targets in the deep water, with a potential billion barrels in risked resources.

“The issue for us is securing additional rig commitments, most likely in 2013, to continue on with drilling out our portfolio,” Cazalot told investors at Howard Weil. Marathon will spend $500 million per year in the immediate future on “impact” exploration with a particular focus on the Gulf of Mexico. The company is currently participating in deepwater appraisal wells with Statoil as well as in Noble Energy’s Gunflint prospect.

And yes, Dude, that trend means it will cost more for operators to surf the Gulf. Global rig rates for ultra-deepwater (UDW) equipment first cracked the $500,000-per-day level in September 2011 and are floating closer to the $700,000-per-day threshold. Tightness in the UDW market has moved down market, where it is reflected in higher rates for deepwater and midwater units in first-quarter 2012 fixtures.

One first-quarter 2012 example involves Noble Corp.’s Jim Day. Shell signed the sixth-generation, 12,000-foot semisubmersible to a new three-year contract in the Gulf of Mexico for $530,000 per day beginning in 2013. The contrast between this current rate and prior rates illustrates the rapidly changing market. In March, Shell also began drilling the Mars B prospect, following the arrival of Noble Corp.’s newbuild Bully I drillship, which began a five-year contract at $469,000 per day. The state-of-the-art drillship was commissioned before the global market tightened. Today, a similar vessel could add another quarter-million dollars per day to the tender in the Gulf.

While headline news has been mostly about deepwater activity, operator interest remains broad across rig classes, according to Diamond Offshore chief executive Larry Dickerson.

“One of the things in the U.S. Gulf is a lot of interest now in midwater P&A (plugging and abandonment) post-Macondo, because of the push from the oil companies to take projects that have ceased production and go in and set plugs and make sure those things are handled,” Dickerson said at Howard Weil. “We think a lot of midwater units may come off contract in Mexico or Brazil, and the Gulf is a fallback area that has a great amount of growth.”

A premium setting

The Gulf has a lot going for it as the industry leaves Macondo in its wake. There is the installed world-class infrastructure of people, expertise and support facilities scattered from Corpus Christi to Mississippi, with beneficial concentrations in Houston and New Orleans. There is the prize itself. The Gulf features multiple trap types, migration pathways and a geological smorgasbord. Finally, the Gulf is attractive because operators have access to high-margin opportunities in a favorable fiscal setting with a product that can be delivered into one of the world’s premium petroleum-consuming markets—the onshore U.S.

These days, deepwater prospects are spread across three major zones, including the Lower Tertiary, highlighted at Walker Ridge; the rapidly developing Miocene in Green Canyon and points south, home to the Heidelberg, K2, Tahiti, Vito, and Caesar/Tonga discoveries; and the emerging subsalt Pliocene play, with its headline Lucius discovery and nascent prospects at Spartacus, Marcus and Phobos.

Recently announced plans in the Gulf include Eni Petroleum’s 18-well deepwater program over the next three years. Also in gear is ExxonMobil. The company’s senior vice president, Mark Albers, highlighted its Gulf intentions during a fourth-quarter 2011 earnings call.

“We hold a large, high-quality position of about 1.3 million acres,” Albers said. “The discoveries on our Hadrian blocks are among the most significant in the Gulf of Mexico in the last 10 years.”

ExxonMobil fully funded its Hadrian South subsea gas program in 2011 with an expected 2014 start-up. Appraisal drilling will commence this summer on Hadrian North, a 100,000-BOE-per-day project awaiting delivery of a newbuild semisubmersible floating production system (FPS). Back at Walker Ridge, front-end engineering and design are under way for a subsea tieback from the ExxonMobil-operated Julia structure to the Jack St. Malo production facility, expected to produce 190 million BOE over the life of the project.

A summary of scheduled deepwater projects suggests the Gulf of Mexico may add between 1-and 2 million barrels of oil equivalent per day to U.S. oil production by 2018.

ConocoPhillips, meanwhile, is looking to beef up its deepwater Gulf exposure. The company amassed a treasure chest of $2 billion to $3 billion to catch the anticipated wave of deepwater divestitures following the Macondo incident.

“But it just hasn’t materialized,” chief executive James Mulva explained during the company’s fourth-quarter 2011 earnings call. “So, therefore, we’ve done it by participation in lease sales.”

Make that Lease Sale 218, which signaled in December 2011 that the tide of operator interest had returned to the Gulf. ConocoPhillips dominated the sale, spreading $158 million across 75 blocks and easily topping ExxonMobil, the second-highest bidder at $63 million. ConocoPhillips surfaced as the winner on Keithley Canyon Block 95, the hottest parcel in the sale, which the major snatched away from six other suitors for $103 million. In all, operators proffered $713 million, making it the largest lease sale since the $742 million recorded in 1998.

Most of the near-term excitement is focused on Anadarko Petroleum Corp., the second-largest parcel holder in the Gulf deepwater sector with 3 million gross acres—and the most active Gulf driller over the past decade. At the Howard Weil conference, chief executive James Hackett acknowledged the company’s efforts to hang 10 in the deep water.

“When you look at the deepwater Gulf of Mexico, we’re back to pre-moratorium levels for our company, probably not for the industry quite yet, but we are planning six to eight appraisal wells this year, which is where we were before the moratorium was implemented.”

Anadarko intends to drill look-a-like structures around its Lucius discovery along with two additional Lucius delineation wells this summer.

“We are back and going strong in the Gulf of Mexico,” Hackett said.

Of course, the operator egg can get ahead of the infrastructure chicken. Getting that egg back to shore is often overlooked in the hype surrounding discoveries.

“The deepwater Gulf of Mexico is purely driven today by crude oil,” Williams Companies chief executive Alan Armstrong noted at the conference. The midstream giant is investing $1 billion in a floating production spar (FPS) called GulfStar. The FPS will provide production handling, pipeline transportation, and oil and gas gathering and processing services for Hess Corp. and Chevron in Tubular Bells Field, in the eastern Gulf of Mexico. The facility is expected to come on line in mid-2014.

“The reason the GulfStar FPS makes a lot of sense is we pre-engineer the facility, we don’t reinvent the wheel,” Armstrong said. “It’s a standard design and can be built here in the U.S. We can lift the production facilities onto the spar. These are designed to handle 75% of the plays that have been produced in the deepwater today.”

Williams has also embarked on a $600-million, 200-mile, large-diameter deepwater gas pipeline, the Keathley Canyon Connector, which will have gathering capacity of more than 400 million cubic feet equivalent per day. It will tie new discoveries at Chevron’s Moccasin, Anadarko’s Lucius and ExxonMobil’s Hadrian South back to the existing Discovery Pipeline and into the broader Gulf Coast transportation and processing complex when the connector comes on line in 2014.

OCS consolidation

With all the headlines on deepwater action, it’s easy to overlook events on the Outer Continental Shelf (OCS), which is undergoing consolidation.

Onshore independent SandRidge Energy Inc. made waves in February 2012 when, out of the blue, it purchased long-time Gulf of Mexico operator Dynamic Offshore Resources LLC for $1.275 billion in an evenly split stock and cash transaction. The deal brings to SandRidge 25,000 BOE per day in water depths of less than 300 feet, and proved reserves of 62.5 million BOE.

“The Gulf of Mexico has not been a place that I necessarily wanted to go and have a growth engine, and it’s not considered to be a growth engine, but we do believe that by spending $200 million a year, we can keep our production flat,” said chief executive Tom Ward in a fourth-quarter 2011 earnings call.

Importantly, the free cash flow thrown off by Dynamic’s Gulf properties will help SandRidge fund a massive drilling effort to develop the Mississippi Lime in Oklahoma and Kansas, doubling the company’s production, tripling operating income, and reducing debt. Sand - Ridge has extensive experience squeezing additional oil production from mature fields with high-quality reservoirs onshore. It plans 12 to 16 wells on the shelf in 2012.

Meanwhile more shelf properties are for sale, and the industry awaits further information on McMoRan Exploration’s ultradeep shelf gas prospects, which will influence demand for high-spec jackups.

Make no mistake: these days, everyone is shouting “Cowabunga!” when it comes to prospects in the Gulf.

For more on Gulf of Mexico activity and deals, see

OilandGasInvestor.com and A-Dcenter.com .