Gulf spill will force industry consolidation
Expect a wave of M&A in the US Gulf of Mexico next year, as independents find that new costs and liabilities make deep-water exploration in the region too risky, writes Simon Crompton
THE COST to BP of the Gulf of Mexico (GOM) oil spill will be high, but few people think it will bankrupt the company. Cost estimates range from $8bn to $40bn, largely depending on the results of various legal actions. That is not critical for a company that generated $239bn in revenue last year. But for Anadarko Petroleum, a 25% partner in the blown-out Macondo well, a quarter of those costs looks much more troubling. The company's 2009 revenues amounted to $9bn.
Anadarko is the most exposed of the independent producers in the Gulf. It is a partner in 23 producing fields and the area's largest independent deep-water operator. The next biggest is ATP Oil and Gas, with six. Of all the oil companies, only Shell – with 25 – is involved in more producing projects than Anadarko.
However, all the independents will come under financial pressure next year, as they struggle to put development projects back on track and to cope with increased costs from regulation. They may also decide that operating in deep water is just too much of a risk.
The majors are ready and willing to take over. "There will be a lot of opportunities for us to pick up assets in the Gulf of Mexico next year," the chief executive (CEO) of one international oil company tells Petroleum Economist. "Independents won't be able to afford it and we will be able to pick off the best ones."
The best comparison for the costs of clean-up in the GOM remains Exxon Valdez, says Citigroup, despite the differences in temperature and crude (warmer waters and lighter oil should make the operation easier). That spill cost $6.3bn to clean up in 2010 money. Adding the cost of killing the well and subsea containment would increase it to $7bn.
Disbursements for economic loss and damages are harder to estimate, as shown by the surprise imposition of $120m to compensate the rig workers laid off because of a six-month drilling moratorium (see p4). Although BP agreed on June 16 to pay $20bn into a compensation fund over the next three and a half years, President Barack Obama made it clear that the figure was not capped. But that total of $27bn should be tax deductible and 35% should be paid by BP's partners (assuming no negligence is proved on BP's part). That would reduce the total to around $11bn.
Yet UBS, an investment bank, puts the figure at over $40bn. The difference is the potential for punitive damages awarded as a result of the US government's criminal investigation and other private lawsuits being brought against BP. In addition, the political reaction has proved hard to predict throughout and that remains the case: the company would undergo a fundamental transformation if the spill were to end up – as a result of political pressure, for example, or if BP decided its image had been irreparably damaged in the US – forcing it to scale back its operations in the country, which accounts for 33% of upstream profits.
BP said on 16 June that it would cancel its $10.5bn 2010 dividend and sell assets worth a further $10bn, easily covering all but the last of these costs. But a company such as Anadarko has fewer options: even spread over several years, a bill of $3bn would cripple the firm – it says it had insurance on Macondo of about $177.5m. And that is the bill for a minority stakeholder; Anadarko has plenty of deep-water operations in the Gulf where it is operator and where it would be liable for a much larger bill in the case of a similar incident. Its average working interest is 66% across the 575 blocks in which it is involved.
"For independent players producing in the Gulf, this disaster has to tell them that they are betting the company every time they drill a well," says an energy mergers and acquisitions consultant.
The increased risk was made clear on 11 June when the US House of Representatives' Environment and Natural Resources Committee passed a bill removing the $75m cap on liability for damage from oil spills that was put in place after Exxon Valdez. A similar bill is in a Senate budget committee.
Jim Hackett, Anadarko's CEO, told investors in May that the oil spill would not change his company's strategy in the Gulf. In early June, he changed tack slightly, saying the company was "evaluating opportunities to reallocate some of the 2010 capital from the Gulf to other areas of our global portfolio" – the firm has operations in Brazil, southeast Asia and across Africa. At the time of writing BP's share price had lost 48% of its value since the oil spill; Anadarko's had lost 54% (see Figure 1).
For smaller independents such as ATP, which has three fields in development in the Gulf's deep waters in addition to its six producers, the costs of a spill could be even harder to cover. Its revenues in 2009 were $81m, less than a hundredth of Anadarko's.
A rise in operating costs may also force independents out of deep water. There has already been an increase in rules for the verification of blowout preventers, certification of well-casing and compliance procedures, and for company CEOs to approve equipment and safety procedures. This applies to all GOM waters, regardless of depth, but greater deep-water regulation is expected once a new board within the US interior department and Obama's National Commission report later in the year.
Most of the majors already operate to higher standards as a result of tougher regulations in other parts of the world. Shell, for example, has a single set of rules for safety at the wellhead that is applied everywhere it operates. They are driven by Norway, where the regulations are most constrictive, but applied everywhere, the company says. Independents with operations only in the US may find the adjustment harder.
Insurance costs will also rise. Anadarko has already said it has accepted its premiums will increase and has planned accordingly. Ratings agency Moody's Investors Service predicts property coverage for deep-water rigs will be up to 50% higher next year. Deutsche Bank forecasts a 10% rise in the cost of deep-water operations as a result of greater regulation and insurance coverage combined.
But the biggest cost for independents will be the months that extra checks could add to the time it takes to bring a field from discovery to development. "Smaller exploration and production companies are very cash flow-focused and these kind of delays may have a material effect on project economics," says Andy Brogan, partner at Ernst & Young, adding that the value of a project can decrease by 10% for every year production is put back.
Even before the crisis, long lead times were one reason cited by US independent Devon Energy for selling its deep-water assets to BP in November 2009. Plains Exploration & Production, a smaller independent, is also looking to sell or spin-off some Gulf assets, according to RBC Capital Markets. Plains has a 33% stake in the Lucius and 100% ownership of the Friesian deep-water discoveries.
Not sure where to turn
It will be particularly hard for independent companies to plan their operations over the coming months given the uncertainty of what regulation could bring. Possibilities include higher taxes to fund regulation, longer permitting times, stricter standards and more frequent inspection. It could take years for the full costs to become clear.
"Uncertainty is the name of the game," says Thom Payne, an analyst at Douglas Westwood, a consultancy. "For the smaller operators, it makes balancing the books very hard."
Independents will be less able to absorb extra costs than the majors, not just because they are less cash rich, but because their businesses are less diversified. Anadarko relied on the deep-water Gulf for 25% of its first-quarter 2010 production; and the region accounts for 67% of ATP's proved reserves. BP has the biggest Gulf presence of the majors, with around 11% of its output – 420,000 barrels of oil equivalent a day – coming from the area. Chevron is next with 8-9%, followed by ExxonMobil with 4% and ConocoPhillips with 2-3%, according to investment bank Barclays.
So which companies are most likely to benefit from assets sales? Shell has made developed countries a priority and listed the Gulf as one of its main targets over the next four years, the other two being Australia and US unconventional gas. Chevron has also said the GOM will play a central part in its production growth.
There could also be consolidation further down the chain. Apache, the second-biggest US independent after Anadarko, has said it will proceed with the $2.7bn cash and stock purchase of Mariner Energy, which was arranged in April, five days before the Macondo spill – 55% of Mariner's reserves are in the Gulf, with 20% in deep water.
But some analysts believe the independents will manage the increased costs associated with operating in the region. "Similar predictions were made after Hurricane Katrina and other disasters over the past 25 years," says Bob Gillon of IHS Herold, a consultancy. "Costs of bonding and insurance seemed to go up prohibitively, but the independents found a way to cope."
Nonetheless, Gillon does accept that the Macondo disaster is a unique event; most at risk will be companies with a high degree of exposure to deep-water GOM operations. One example he gives is Cobalt International, which focuses purely on deep water in the Gulf, Angola and Gabon – it has interests in 227 blocks in Gulf deep waters that have yet to be brought into production, representing 37% of its reserves. Cobalt is one of only two companies to declare force majeure on a drilling rig since the spill. The other is Anadarko.