What's Next for U.S. Offshore Oil Drilling?

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Includes: BHI, BOLT, BP, DRQ, XLE
by: David Fessler

Can you hear that scurrying sound?

It’s the sound of expensive shoes scampering across the floor of BP’s legal department, as hordes of lawyers try to minimize the financial damage to the firm from the Gulf of Mexico oil spill.

Lawsuits against BP and the other companies responsible are arriving by the dozen. And environmentalists are predicting carnage for marine life in the Gulf.

Many onlookers, blitzed with TV images of wildlife choking and dying in thick sludge and Southerners fearful of losing their livelihoods, would probably subscribe to the “take ‘big oil’ to the cleaners” viewpoint.

And as shares of the companies involved get hammered on the market, few have much sympathy for them.

Let’s take a look at the facts as we know them… the ramifications for the parties concerned… and draw some less emotional conclusions about where we go from here with regard to the future of offshore oil drilling.

Deepwater… And Deep Trouble

Fifty miles off the coast of Louisiana stood the Deepwater Horizon oil rig.

Having discovered oil, a well was drilled some 5,000 feet below sea level in an attempt to extract the gloopy commodity that the world treats as its security blanket.

The well casing was being readied for temporary abandonment – a common operation with offshore wells and consistent with normal oilfield practices.

As part of that process, Halliburton Company (NYSE: HAL) was contracted to provide several specialized services on the rig. One of them was “cementing in” the final production casing of the well.

Halliburton invented the process of oilfield well-case cementing and performs thousands of successful jobs every year.

Halliburton says it did the Deepwater Horizon procedure in accordance with the well’s design. On April 19, tests to ensure the strength of the well casing were successfully completed. The rig explosion occurred roughly 20 hours later.

There is still no plausible explanation for the explosion that set off a chain of events that led to the sinking of the rig, and the tragic loss of 11 lives. But at the time of the explosion, Halliburton had not yet placed the temporary cement plug – the final step in the well abandonment process.

At this point, the focus of the investigation is centered on Halliburton’s cementing process, although it’s too early to draw any conclusions.

And the three ensuing leaks from the pipelines have led to the giant oil slick.

The Blame Game Centers on the Blowout “Preventer”

BP issued a statement saying the explosion was due to “equipment failure.”

Actually, make that a gigantic understatement. I mean, who couldn’t have figured that out for themselves?

Still, until thorough investigation is completed, it’s the only answer we have.

And the culprit: the blowout preventer (BOP).

Investment U - What

Blowout Preventer

This is a large valve that seals off a wellhead. Needless to say, it’s one of the most important pieces of equipment.

They come in different varieties and have been used since the 1940s on virtually all wellheads, both on and offshore.

The BOP used on the Deepwater Horizon rig was made by Cameron International Corporation (NYSE: CAM).

BOPs are usually stacked together and most have acoustic actuators – a device that allows underwater crews to activate BOPs in the event of an emergency. Trouble is, the BOP stack on the BP well didn’t have an acoustic actuator. According to The Wall Street Journal, both Brazil and Norway require an actuator on all undersea wellheads.

Click to enlarge

However, it’s not yet known whether any safety procedures were violated.

The BP-Exxon Valdez Comparison

The current spill has obviously drawn comparisons with the Exxon Valdez oil tanker spill in Alaska back in March 1989.

Assuming a constant rate of leakage, around 3.6 million gallons of oil will have leaked from the well by the time you read this. That pales in comparison to the Exxon Valdez, which leaked 11 million gallons.

The other big difference here is the distance from shore. Oil from the Exxon Valdez spill was catastrophic – it hit 1,300 miles of coastline, affected 28 wildlife species and reportedly killed more than 253,200 animals.

Most of the heavy concentrations of oil from the current spill are still out in the Gulf. And although some oil has made landfall, containment and oil boom crews have had more time to prevent most of it hitting shore.

Nearly 1,000,000 feet of containment boom has already been deployed and the thickest parts of the slick are being corralled and burned before they reach the shore. Small skimmer ships can handle most of the oil that reaches the containment booms near shore.

I could be wrong, but my guess is that the numbers of wildlife that will ultimately be affected will be far less than the Exxon Valdez spill back in 1989.

And then there’s the dome…

The Containment Dome Cometh

BP successfully plugged the smallest of the three leaks in the pipeline on Wednesday.

But to stuff the biggest leak, BP has recruited Wild Well Control, an oil services company specializing in oil disasters.

It’s constructed a giant 98-ton, 40-foot tall steel dome, which is being lowered over the largest leak. A pipe is being connected to it and will bring the oil to the surface, where it will be loaded into transport ships.

If everything goes as planned, it will plug up 85% to 90% of the leak. By that point, we might be dealing with a total of about five million gallons of oil in the Gulf. And in addition to the measures I mentioned a moment ago, the waves will break up some of the oil and it will sink to the bottom of the Gulf.

Given my engineering background, I tend to view something like this a problem to solve and I’m betting on success here.

The question then becomes: What’s next for the future of U.S. offshore oil drilling?

The Future of Offshore Oil Drilling

In order to reverse the renewed negativity towards U.S. offshore oil drilling, we need to know two pieces of information:

  1. What caused the initial oil rig explosion that led to the loss of life and spill?
  2. Why didn’t the blowout preventer operate as designed?

Now let’s cut past the 24/7 media frenzy and political chest-thumping for a second. Just because a problem happened, it doesn’t mean offshore drilling is going to stop. In fact, it will continue unabated around the world.

When asked about the future of offshore drilling, Democratic Louisiana Senator Mary Landrieu told CNBC’s “Squawk Box” on Wednesday morning: “It’s time for the yellow light, not the red light.”

Oil Spill Bargains

Now let’s don our investor hats.

But beforehand, let me head off any potential comments, bashing me for being a cold, callous capitalist, looking to profit from a disaster in which lives were lost and the environment and livelihoods are affected. I’m as concerned about this event as anyone and I truly hope the damage is minimized.

But in watching and reading the media coverage, I just don’t think this situation will be anywhere near as bad as some are saying. And once it’s over and the hype dies down, we’ll return to the age-old issue of America’s homegrown energy resources.

So once this event is history, where will the investment opportunities lie?

Quite simply, as the world continues to quench its seemingly endless thirst for oil, a host of oil and oil service companies will continue to benefit. There’s an ETF that represents them – the Energy Select Sector SPDR (NYSE: XLE). Its portfolio contains oil giants like:

  • Exxon Mobil (NYSE: XOM),
  • Chevron Corp (NYSE: CVX),
  • ConocoPhillips (NYSE: COP),
  • Schlumberger (NYSE: SLB),
  • Anadarko Petroleum (NYSE: APC)
  • And Devon Energy (NYSE: DVN).

Any if you’re looking for individual investments, other oil firms with strong positions include:

  • Baker Hughes (NYSE: BHI),
  • Drill-Quip, Inc (NYSE: DRQ),
  • Bolt Technology Corp (Nasdaq: BOLT).

Disclosure: None.