Permit delays may threaten deepwater gulf future, new study says

Long-term Gulf of Mexico deepwater development could be seriously jeopardized if the US Department of the Interior increases the time spent reviewing and approving drilling permit applications, a Wood Mackenzie study commissioned by the American Petroleum Institute concluded.

Nick Snow
OGJ Washington Editor

WASHINGTON, DC, Jan. 25 -- Long-term Gulf of Mexico deepwater development could be seriously jeopardized if the US Department of the Interior increases the time spent reviewing and approving drilling permit applications, a Wood Mackenzie study commissioned by the American Petroleum Institute concluded. Nearly one third of domestic deepwater production could become uneconomic, resulting in less energy production, less investment, and less revenue to government, it warned.

“The potential harm is alarming,” said Kyle Isakower, API’s vice-president of economic and regulatory policy. “We are talking about a transformation of the future relevance of deepwater gulf development to US domestic energy production—and a major threat to gulf region jobs and to the nation’s energy security.” He said based on the development impacts outlined by WoodMac, API believes that as many as 125,000 jobs could be lost in 2015.

The study did not address the so-called “permitorium” under which no new deepwater permits in the gulf have been issued since the Apr. 20, 2010, Macondo well accident and subsequent oil spill, he told reporters in a Jan. 25 teleconference. It assumed that DOI and its Bureau of Ocean Energy Management, Regulation, and Enforcement would resume issuing permits but take more time doing so, Isakower said.

US Interior Sec. Ken Salazar and BOEMRE Director Michael R. Bromwich have indicated that this will be necessary so applicants’ declarations that they will meet new safety and environmental requirements can be properly reviewed.

“We understand we’re in a different environment, and that additional time is needed to do some proper vetting,” said Erik Milito, API’s upstream operations director, who also participated in the teleconference. “We don’t support rubber-stamping permits. But the longer you have these delays, the bigger their impacts on the economy. We want to see them limited to 1-2 months, not 1-2 years.”

What’s needed
Milito said DOI and BOEMRE need: to have a clear process in place for reviewing deepwater drilling plans, permits, and environmental assessments; to provide more clarity on what the new requirements mean and what companies are expected to provide; and to ensure the agency has the funding and work force necessary to get the job done promptly. “We support a strong regulatory framework and full staffing for the agency,” Milito said.

In its study, WoodMac estimated the potential production, investment, and government revenue impacts of permit delays that postpone a field’s startup by 1 year and delay drilling times by 10% and by 2 years with a 20% drilling time delay, compared with a base case with no delays for 25 identified, but undeveloped, deepwater gulf targets.

Expected development scenarios and full-field development economics were calculated using WoodMac’s global economic model to determine what impacts potential delays would have on financial returns in the gulf. Production, investment, and government revenue at risk due to permit delays were calculated using assumed financial hurdles of 15% nominal internal rate of return (IRR) and 8% nominal IRR for the deeper Lower Tertiary targets.

The study assumed no cost increases due to permit delays, but expected 1-2 years of total logistical delays for field development to be realistic. “Drilling wells and completing production facilities requires the alignment of a wide range of activities, such as delivery and installation of offshore underwater pipeline, equipment and other infrastructure,” it said. For example, even delays as short as a few weeks are compounded by each well and can create bottlenecks when planning for rig commitments, support services, and subsequent shipyard commitments, etc.”

It said the potential loss of commercial reserves from at-risk fields could be substantial. Ten fields, or 1.9 billion boe, of the 25 identified, undeveloped targets already were uneconomic under the base case. The number of uneconomic fields rose to 13 under the 1-year delay scenario and 17 with two-year delays.

Reserve reductions
Total recoverable reserves attributable to investment falling below the hurdle rates from the two delay cases were 2.7 billion boe for 1 year and 3.1 billion boe for 2 years out of a total estimate of 5.1 billion boe for all 25 fields in the analysis. There is an estimated total of 12.8 billion boe of gulf deepwater reserves, 7.7 billion boe of which is already online or under development in addition to WoodMac’s resource estimate for the 25 identified but undeveloped fields.

The study said the potential production volume of new fields already at risk in the base case reached a maximum 340,000 boe/d in 2019. The 1-year delay case put an additional 200,000 boe/d of production at risk, while the 2-year delays doubled the base case’s at-risk production to 680,000 boe/d—roughly equal to Alaska’s current total production, 12% of total US crude production, or about 34% of total gulf oil output, Isakower observed. The total production volume at risk in 2019 for the 1-year and 2-year scenarios represented 27% and 34% of the study’s base case throughput for the year.

“Government revenue would also be correspondingly lower as fewer developments meet required levels of return,” the study continued. It estimated that $8.2 billion of potential revenue under the base case from royalty and corporate taxes over the projects’ lives would be at risk. A 1-year delay in development would increase the potential government revenue loss by $5.5 billion to a total $13.7 billion loss. A 2-year delay timeframe would increase the amount by $8.9 billion to $17.1 billion.

The study conceded that some of the uneconomic fields would still be developed, but with lower returns than originally planned, mainly due to leasing and exploration costs which have been incurred already. “However, the analysis indicates that approximately two thirds of known probable discoveries in the deepwater gulf could fall below our economic thresholds on a full-cycle basis if significant permitting delays occur,” it continued.

“The results indicate the future of exploration in the gulf is very uncertain. Many high-risk and deep targets in the frontier and emerging plays may not be explored if only marginal returns are expected,” the study said. “Most of these types of targets were projected to provide much of the expected growth in the gulf. Significant increases in development costs, which were not part of this analysis, will further reduce the potential economic viability of the deepwater gulf.”

Losses already
Isakower said the US Energy Information Administration already has estimated that production will be lost simply because permits have not been awarded in the last 8-9 months. “If you look at its short-term outlook, EIA has downgraded its estimates even more since the 2011 preliminary annual energy outlook was published,” he said. The projection is similar to one by Wood Mac estimating revenue losses around $18 billion, he noted.

API has recommended that BOEMRE be allowed to use money which producers already pay in leases, bonus bids, and royalties to hire additional employees, Milito said. Rentals alone bring in about $200 million/year, making no new fees necessary so smaller operators can continue working in the deepwater gulf, he maintained. Leases start at $250,000 and go up into the millions of dollars, and rental rates have increased significantly and royalty rates have been raised twice in the last 10 years, he said.

“I think companies are trying to hold on and show some optimism. BOEMRE has engaged in a dialogue to try and resolve issues, but we don’t see a light at the end of the tunnel,” Milito said. “Companies are just holding on. Some have idle rigs and are keeping workers employed doing menial work, but they’re not doing what they want to do. The industry has been patient and can be for a short while longer, but that can only last for so long before it starts sending rigs to other parts of the world.”

Leasing is a long-term commitment, and the government should recognize that production can’t occur for 7-8 years, he continued. “We’ve seen at least two companies submit applications for suspensions, and they were denied. There’s a lot of frustration in the industry. We believe if you take a pause, the clock should stop,” Milito said. “BOEMRE has said it would review this on a lease-by-lease basis. Companies have fields which are part of their portfolio. We hope BOEMRE will reconsider and give more blanket extensions.”

Isakower said the prospect of significantly longer permitting delays is only part of troubling policy trends in the Obama administration. “We’ve seen calls for taxes which could lead to losses of jobs, revenue, and production. We’ve also seen a complete shutdown of deepwater permits in GOM that have led to a complete loss of revenue and jobs. Even when DOI gets back in the job of issuing permits, it has indicated it will move more slowly,” he said. “We think it’s important as the administration moves forward, it realizes the impacts of its decisions and policies.”

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