Wednesday, June 2, 2010

The Outlook for Oil Companies in the Gulf. Great article!

By Ben Baden

Share ThisIn the wake of the explosion aboard BP’s Deepwater Horizon rig in the Gulf of Mexico, President Obama has promised to pursue tougher regulations for the oil industry. Last week, he announced a far-reaching moratorium on offshore drilling that will affect operations from the Gulf all the way to the Arctic Ocean. BP’s future is certainly unclear: The company’s stock has plummeted from about $60 to just below $37 since the explosion that created the leak on April 20. BP has lost $75 billion in market value since the spill, according to the Associated Press. For insight into what this government intervention means for the oil industry, U.S. News spoke with Tim Parker, an analyst a T. Rowe Price who will become the manger of T. Rowe Price’s New Era fund at the end of June. (The fund’s current manager, Charles M. Ober, is retiring later this year after managing the fund since 1997.)

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How important is offshore drilling in the Gulf of Mexico for oil companies like BP?

The Gulf of Mexico—particularly deepwater—can be one of the most lucrative places you do business, period, because the tax structure in the U.S. is such that you pay a fixed royalty ... so it can be disproportionately profitable when there are high oil prices. To BP, for example, the value of a barrel of oil produced in the Gulf is worth about three times the value of a barrel produced in Russia where you have a very thin margin. So this is pretty juicy stuff. That is the reason they were so anxious to do more of it, and, unfortunately, they cut some corners. That is one thing to keep in mind. It’s very lucrative. There will likely be increased costs due to increased regulation, but nothing that would make it so costly that you wouldn’t do it. It may make small players not want to do it. If I don’t have big enough pockets, I probably can’t do it, but if I’m a big guy with big enough pockets I still make really good money here. ... We pay high personal income taxes and we pay high corporate taxes in this country, but we do not pay high royalty taxes in the grand scheme of things.

Plus, these are good-sized discoveries. They’re not the biggest in the world, but they are often over 100 million barrels and often can be tied back into other developments making them much cheaper to develop, so all in they’re very profitable. The other thing to remember is, if you’re a Western producer, you generally don’t get the ability to produce heavily within the Middle East. Maybe you get a chance to play in Iraq now for a thin $1 or $2 a barrel margin and you’re just doing that to get your foot in the door, but out of your few places to grow, one of them is deepwater. That is the Gulf of Mexico, Brazil, or West Africa.

How do you assess the damage done to BP?

You don’t know just how far the rabbit hole goes in terms of the damage of the cost of the spill itself and litigation to whatever added regulatory cost you might have to the cost of cultural change. I think if BP ever wants to work in a lot of countries again, they need to demonstrate that they’re putting safety first. ... I by no means think that BP has disappeared. ... It ought to be a better stock in two, three, or four years from now, but that’s a long time to wait.

How will oil services companies fare?

You’re seeing service companies just getting shellacked on the back of downgrades by Morgan Stanley and others who are rightly saying that earnings will be off because they won’t be doing work in the Gulf of Mexico. ... You’ve got stocks like that, that are being disproportionately hit and don’t have the same liability issues as BP. If anything, the service companies should see more earnings and revenue over time from the regulation because you will do things like run more cement lining and have bigger blowout prevents, so ultimately they should be beneficiaries.

As an analyst, how do you go about valuing these companies?

Is it today that you feel like doubling down [on BP]? I don’t know, but it’s probably somewhere in this meltdown. ... You can value more easily service companies because you can just impute a value to what were their gains in the Gulf of Mexico and figure that’s not going to happen for the next couple of quarters and factor that into your valuation and say it ought to be down X. ... When you look through that earnings impact, it’s pretty modest. ... It’s easier to step in the fray there where you can see that the earnings issue is your issue, not an unquantifiable bucket of legal liabilities and cultural change that you have at BP. In BP, you’re trying to value the ultimate value of those costs. In other companies, you’re trying to find the loss of value from the loss of activity, and that is a little easier to figure out.

What is the future of offshore drilling in the Gulf of Mexico?

I think you will have a clear view of where it is in six months. It may not be “game on” in six months, but you will have the new rules of engagement. ... It feels more like things get pushed to the right than stopped, because this is still a valuable and lucrative area. It doesn’t make a lot of sense to throw the baby out with the bathwater. In many ways, this moratorium feels a bit knee-jerk—meaning most of the wells are fine. For example, Chevron wells already have more safeties in place, but they have to stop, too. ... Now, what they’re terming over 500 feet, you have to stop what you’re doing and no new permits are allowed. So, if you’re in the middle of drilling and it’s unsafe to stop, then you need to get to a point where it’s safe and then stop. If you were asking for a permit, because you wanted to drill in a few months, you can’t have it. It will be quiet in water over 500 feet except for the wells drilling around [the BP spill] to relieve it. ... Shallow water—sub-500 feet—shouldn’t be affected.

This is a disaster of titanic proportions. I’m not trying to minimize that, but I think we can point a lot more to one bad actor or a series of actors related to this particular well as opposed to the industry. And then, “If you wanted us all to be safer, shouldn’t we be out there practicing?” And then finally, “If you want to be reelected, don’t you want unemployment to go down?” Because unemployment will not be a happy friend in the Gulf Coast. I guarantee it. The energy economy is huge around the Gulf Coast. It’s a lot bigger than the shrimpers. ... Finally, I know I don’t particularly love importing all of this oil, and we’re taking one chunk of our domestic production off-line more or less. ... Minerals royalties are the second biggest source of income behind income tax for this government, so it’s not really in the government’s interest to keep this off-line forever. It’s quite lucrative. The political pressure they’re feeling is immense, so of course they need to act, but it strikes me as more political than rational. ... I pray this never happens again, but ultimately, I do think we’ll drill in the Gulf again with more safety and regulations.

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