By: Richard Mason
July/August 2010

The backlash of the Macondo well blowout in the Gulf of Mexico appears to have washed all the way to the Rockies, as evidenced by the daily news shows in Colorado Springs carrying a steady feed of oil industry executives, including CEO Tony Haywood, testifying before angry Congressional panels. So it was little surprise that the Macondo well blowout — and its potential repercussions — was Topic Number One in conversations among oil and gas operators attending the Independent Petroleum Association of America (IPAA) summer meeting there.

The policy trade group for oil and gas operators was clearly concerned. While most news coverage in the industry focused on the impacts of a six-month moratorium in deepwater drilling, later suspended by a federal district court judge in New Orleans, the organization’s governmental relations staff noted that the fallout from the blowout had shifted the political climate in oil and gas off its axis.

Or, as IPAA Chairman Bruce Vincent told members of the trade group, “The environmental fervor that exists today and is emboldened (by the blowout) is at a level that we’ve never seen before.”

Bottom line: the industry has few friends at the moment on Capitol Hill, or among the media.
To the contrary, the Macondo event has renewed vigor for a host of regulatory and environmental issues that the industry previously had thwarted, including federal regulation of hydraulic fracturing fluids, assaults on long-time industry tax practices, and possibly cap-and-trade.

Rex Tillerson, ExxonMobil; John Watson, Chevron; James Mulva, Conoco Phillips; Marvin Odum, Shell Oil Company; Lamar McKay, BP America Inc. testify.

After the Macondo well is capped and the beaches cleaned, the oil and gas industry is going to spend a period of time, measured in years, dealing with the political and regulatory aftermath.

Make no mistake, the industry will be garnering additional scrutiny. That scrutiny will not be confined to the deepwater segment in oil and gas. It is going to impact events onshore as well. In fact, well blowouts onshore in Pennsylvania and West Virginia resulted in drilling moratoriums for specific oil and gas operators in the wake of the Macondo incident. While the regulatory approach in Pennsylvania was not unexpected, the fact that regulators in West Virginia chose the same tactic in their investigatory process illustrates just how quickly the political climate is changing.

It means service industry contractors are going to be working for customers who face greater regulatory hurdles. As a result, customers are going to become even more involved in safety, environmental issues and best practices around the well site. Furthermore, these regulatory changes are going to cost operators more to do business, adding a measure of uncertainty to project economics.

Think of it as a return to the regulatory climate of the 1990s. In retrospect, the industry may look back on the first decade of the 21st century as a golden age characterized by attractive commodity prices, greater demand for field services and rising access to resources.

In contrast, the Macondo well blowout may become a long-term agent for change in the industry much the way the Exxon Valdez fashioned public perception of the oil and gas industry for nearly a generation.

As one IPAA staffer confided in Colorado Springs: “This sets the industry back 20 years.”

Unfortunately it comes at a time when the industry had made significant progress on issues such as resource access, favorable tax treatment and the ability to beat back the steady stream of unfavorable legislation that crops up on Capitol Hill. When it comes to policy at the national level, success for oil and gas industry trade groups is often measured not by what is accomplished in legislation; rather, success is defined by what has been defeated.

What does it mean for well site contractors? For pro-active managements, this new era presents a potential business opportunity. Renewed attention to detail and greater emphasis on safe operations and environmental performance for customers will become a competitive advantage in an era of greater regulatory scrutiny, whether the service provider is a publicly-held national company or an independent regional company with a handful of service rigs. While no one can change the impact of the Gulf deepwater blowout, all service providers can manage their individual business in a changing regulatory climate.

A second outcome — and this remains the subject of debate — is that the pace of oil and gas exploration and development is going to slow, which will ultimately impact production and commodity prices. Granted, an oily residue clouds everyone’s crystal ball at the moment, but one line of thinking suggests that a sustained deepwater drilling moratorium will impact the supply side of oil and gas and won’t be confined solely to the deepwater market. There is now observable evidence, according to the IPAA, that federal agencies such as the Department of the Interior are purposely slowing the pace at which permits are approved for public lands onshore.

At press time, Hornbeck Offshore succeeded in obtaining a New Orleans federal court injunction tossing out the deepwater moratorium, though a number of industry observers expect the administration to prevail on appeal. Regardless, the change in regulatory climate as a result of Macondo sets in motion a series of events that may tighten natural gas markets through reduced access to resources, a slowdown in the pace of development, higher regulatory hurdles and greater costs for operators in the form of higher fees.

As for oil, the deepwater accounts for roughly one-third of U.S. oil production. There are more than 3,500 platforms producing oil and gas in the Gulf of Mexico and the drilling moratorium would only impact 33 drilling projects near-term. However an extended ban adds another element of uncertainty to a global crude oil market that continues to see rising demand in non-OECD nations such as China. Additionally, deepwater production was responsible in 2008 for reversing a long-term trend of steadily declining U.S. oil production. The deepwater sector also generates 11 percent of U.S. natural gas.

Shorter term, here are some of the issues experiencing choppy waters as a result of the Gulf well blowout.
• Raising the liability cap for oil and gas producers beyond the $75 million specified in the Oil Spill Liability Trust Fund and Oil Pollution Act of 1990. This has broad popular support but would be disruptive to the global insurance market on a practical basis. There aren’t enough assets available to the insurance industry to underwrite policies that protect against multi-billion events. If those caps are raised, only a handful of self-insured major oil companies would have the financial wherewithal for deepwater exploration. When coupled with the fact that several significant deepwater discoveries in recent years stem from the efforts of large independents (e.g. Anadarko’s Lucius well) raising liability caps, while a popular solution to “punish” Big Oil, has unintended ramifications.
• Renewed calls for increased taxation on energy. Vermont Senator Bernie Sanders proffered an amendment to eliminate long-standing industry practices such as Intangible Drilling Costs and the percentage depletion allowance. The amendment was defeated in June, but nothing is ever permanently defeated on Capitol Hill. The current administration recently renewed its backing for eliminating the intangible drilling costs (IDC) tax deduction for operators and momentum appears to be building for some modification in tax codes.

After the income tax, the second largest revenue generator for the federal government includes leases and royalties from oil and gas production on public lands or offshore, according to the IPAA. The IPAA estimates that elimination of the IDC, percentage depletion, the marginal well tax credit and the enhanced oil recovery credit would reduce investment in new U.S. production up to 40 percent and, over three to four years, result in a 20 percent decline in oil production and a 12 percent decline in natural gas production. While it’s unlikely all of these taxes will be eliminated — some may.

In addition to attempts to end current tax incentives, the industry is facing higher user and inspection fees and a greater likelihood that royalty rates will rise for oil and gas production on federal lands or offshore.
• Access to resources. Industry efforts to expand access to federal lands has turned into a battle to maintain existing access. For example, the Department of the Interior has cancelled 77 existing leases in Utah and another 61 in Montana.
• New regulations. The most illustrative example focuses on the battleground surrounding hydraulic fracturing as unconventional oil and gas development expands across the U.S. onshore sector. Previously, regulation was left to individual states, but efforts are underway to have the Environmental Protection Agency regulate hydraulic fracturing at the federal level. The industry had successfully deflected the effort by substituting a call for the EPA to study the issue with hearings scheduled across the U.S. in June. However, the Macondo incident provides renewed momentum to opponents of hydraulic fracturing. In Pennsylvania, one senator called for a year-long moratorium on new gas drilling permits pending study. The effort is likely to be unsuccessful, but it illustrates how the political climate is changing. Opposition to hydraulic fracturing focuses on having service companies disclose the chemicals used in hydraulic fracturing. That effort could lead to requirements that operators install equipment that monitors what goes in a well, and what comes out. Stay tuned.