Joseph L. Shaefer's  Instablog

Fair warning: My "relative" optimism places me squarely in the minority on this subject.  I believe the reporting and commentary has been either one-sided or incindiary thus far. 

One thing the crowd that loves to hate the oil, gas and coal that provide them the electricity to fire up their computers and printers so they can write their hate letters about fossil fuels, fuel the autos that take them to the post office, and provide the jet fuel to send their letters to me, need to know: I own a home in the Florida Keys and have been a diver who has seen marine environmental destruction and rebirth over 40 years of diving. 

Fort Lauderdale used to pump its untreated sewage out to the second and third reefs off the coast, decimating the (out of sight to most, out of mind) precious corals that, along with the mangroves displaced by condos, had protected the beaches from hurricane devastation for thousands of years.  Like most old divers, I fought for the marine environment long before it was cool to be a limousine or Hummer environmentalist.

But I try to be rational about this issue and recognize that, until we can switch to alternative and renewable energy sources like solar and wind, all of us, in the developing world in particular, are unlikely to voluntarily stop seeking a better life.  To achieve that better life, we need food, shelter, and some other basics.  All depend upon prodigious amounts of energy to achieve – transportation, lighting, heating, world commerce, etc.

Someday we’ll have solar,  which will only kill tens of thousands of desert tortoises and other reptilian and mammalian life while consuming ever-larger quantities of ever-decreasing fresh water.  Someday we’ll have wind power, which will only kill hundreds of thousands of birds while requiring incredibly expensive maintenance and an entirely new (and expensive) infrastructure to be able to store and transmit energy from the barrens to the population centers. 

I’m not complaining or being facetious – merely pointing out that There Is No Such Thing as a Free Lunch, and those promising a full alternative-energy meal at no expense are deceiving themselves.  (Not that it matters – someone will still claim I am secretly being paid by Big Oil…when in fact I’ll be hip deep in salt water spreading hay, human hair or whatever it takes to protect my precious sea birds, fishes, shellfish, and corals.)

In the Real World we are still going to be seeking and using fossil fuels for the foreseeable future.  And we are still going to be seeking them on the inner and outer continental shelves of the UK, Norway, South America, West Africa, the Gulf of Mexico, the Persian Gulf and other places.  If we get really good at figuring out how to get closer to 99.9999% fail-safe in harsh environments – deep and/or nearly-freezing waters -- we may add Alaska and the Arctic to that list.

The failure of the Deepwater Horizon has multiple parents, I’m sure.  There’s plenty of blame to go around, between BP, Transocean (RIG), Cameron (CAM), Halliburton (HAL), overzealous governmental entities looking for royalty income, ever-hungry people around the world looking for more, more, more, etc.  But there’ll be time enough for finger-pointing later.  Right now I only have two concerns: (1) how do we stop the current catastrophe from becoming any worse, and (2) how do we increase our fail-safe in these environments to 99.9999% for future exploration and production?

Offshore oil and gas operations are among the toughest, most intense, and possibly most fruitful energy projects still remaining on the planet.  And lest anyone think we can shut down “all 10” offshore operations or some such, according to Offshore Engineering Magazine there are 7000 production platforms, 180,000 kilometers (112,000 miles) of pipelines, and 40,000 producing offfshore wells already in service to the world's economy.

Deepwater Horizon now carries the moniker of the biggest environmental disaster in memory.  In fact, it may be.  Or it may not be.  Certainly in terms of oil spilled, it’s right up there.  In 1989, the Exxon Valdez spilled 250,000 barrels of oil into Prince William Sound.  Ten years earlier, the Ixtoc exploratory well in the Gulf of Mexico dumped some 480,000 barrels over the 9 months it took the Mexican government to get it capped.  An average of 10,000-30,000 barrels per day were discharged into the Gulf until it was finally capped.  Prevailing currents carried the oil to the Texas coastline, where 162 miles of beaches were affected.  (Footnote: To which Mexico said, ‘Too bad, so sad,’ when the US requested they assist with our cleanup costs -- w2hile they insist BP pay them for any damage to their coast.)

There have been hundreds of other spills, as well as all the natural seeps that have been leaking for thousands of years (though only a half-dozen or so larger than Exxon Valdez.)  Comparing Ixtoc and Valdez to Deepwater Horizon, BP estimates that the spill has thus far leaked about 100,000 barrels.  The most extreme estimates range as high as 400,000.  Into the fray, according to NOAA (the National Oceanic & Atmospheric Administration) we now have over 10,000 personnel responding to protect wildlife and the beaches, 290 surface vessels on site, and 1 million feet of containment boom deployed.

Of all the other accidental spills in history, there is one to which I had a front row seat and which may bear the greatest similarity to this one in terms of similar temperatures in summertime, in terms of its occurrence in warm, non-turbulent waters that – except in the event of a major hurricane – slow the movement of the oil, and in terms of the miles of shallow sandy beaches that might be affected (unlike the cold, turbulent and rocky shorelines in, say, Prince William Sound.)  That is the ecological disaster fomented by Saddam Hussein in a fit of childish pique at the conclusion of the first Persian Gulf War in 1991.

Here is what it looked like from the ground, where I was:

And here is what one unusually isolated burn looked like from a great distance on a low pass from the air:

A Congressional Report published in 1992 estimated that, in addition to the oil spewed onto the ground in Kuwait, 4 to 6 million more barrels of oil were released into the Persian Gulf. That’s roughly ten times the size of Ixtoc, and clearly the biggest man-caused spill ever!  Most of this oil eventually moved south and along the northern coastal areas of Saudi Arabia.  Yet, because of the warm climate, about half the oil evaporated in the sunshine and much of it was recovered on the surface using techniques similar to, but not as sophisticated as, the techniques being used to clean up Deepwater Horizon.  (By the way, the best estimates are that roughly 250,000 barrels per year pollute the Persian Gulf as a side effect of all the drilling, transporting and, in some cases, unsafe practices that take place there.)

None of this mitigates the horror of the possible devastation that could take place as we approach hurricane season with the Macondo field well still uncapped.  (Though there is another school of thought that says a hurricane would disperse the oil microscopically into lesser and lesser dangerous concentrations.)  But neither does it mitigate the likelihood that exploration will continue.

Those who are only interested in grand-standing will bloviate about raising the liability limits on oil companies, or punishing the innocent, or preventing all exploration.  Cooler minds will work overtime to figure out ways to make the possibility of such an event recurring less likely and will strive to increase the fail-safe procedures for all exploration, onshore or offshore.  The grand-standing will be loud and obnoxious.  After all, politicians from the lowest to the highest, enjoy the bully pulpit of elected office. 

But it’s the engineers working in cramped cubicles and testing on the open seas I’m more interested in hearing from.  And since the reality is that the world will not slake its appetite for energy, it is these engineers who will learn from this tragedy and move us forward.
 

If you expect that some of the firms today which are most maligned will recover, and that Deepwater Horizon will not spell doom for offshore exploration, you might take a look at BP, which now sells at a trailing PE of 7 and a fraction and yields 6.3%.  Earnings could take a hit that make that PE meaningless in the short term but in the long term BP has the wherewithal and cash flow to eclipse one or two bad quarters.  The same applies to Transocean.  RIG has now declined to within a whisker of its low for the year.  Or, If you don’t mind the extra exposure you could you could do as I have done and purchase and/or sell LEAPs. 

We sold the RIG 55 puts of Jan 2011, receiving enough in premium income to fund 70% of the purchase price of the RIG Jan 80 2012 calls.  Our worst-case scenario is that the stock is put to us at 55 and continues going south beyond Jan 2012.  In that case, we lose 100% of what we paid for the calls and own RIG by Jan 2011 at 49.50.  Better case, we’re put the stock and it closes at 88 or more by Jan 2012, giving us a whopping profit on the shares put to us and a break-even to miniscule profit on the shares we hold a call on.   Best case, it keeps rising well above 88 as its earnings improve.  A lot can happen over the next 20 months…

Finally, you can avoid any firm directly affected by Deepwater Horizon but still buy the energy company stocks that have fallen in sympathy with BP, RIG, et al.  I consider Exxon (XOM) below $65 a gift.  France’s Total (TOT) is near it’s low for the year.  Norway’s Statoil (STO) has a higher PE and a lower yield but I love their conservative management, their safety record in harsh environments, and their cutting-edge technologies.  I believe any of the above will be higher in a year – and, as always, I encourage you to do your own research and see if you agree...

Author's Disclosure: We and / or clients for whom these investments are appropriate, are long BP, RIG, XOM and STO ( and still have a very large cash cushion, which we’d love to deploy – at lower prices.)

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