Trend toward deepwater drilling likely to continue
Comment of the Day

June 22 2010

Commentary by David Fuller

Trend toward deepwater drilling likely to continue

This is an informative article by Steven Mufson for the Washington Post. Here is the opening
Willie Sutton robbed banks because that's where the money is. And oil companies venture into deep waters for exploration because that's where the oil is.

That's why -- even though President Obama has imposed a six-month moratorium on deep-water exploration drilling in the Gulf of Mexico -- the oil and gas industry is going to be back. And it's why in other countries, the deep-water search hasn't stopped.

Within five years, global deep-water production is expected to rise by two-thirds, to 10 million barrels a day, according to Cambridge Energy Research Associates. That's equivalent to the amount of crude oil that the world's largest exporter, Saudi Arabia, produces. And in the United States, improved technology for extracting oil from deep water accounted for about 70 percent of the increase in the U.S. Geological Survey's estimates of recoverable U.S. oil reserves in recent years.

Those big stakes explain why the oil industry is worried about Obama's moratorium, which has idled 33 deep-water drilling rigs in the gulf. Interior Secretary Ken Salazar has described the moratorium as hitting "the pause button," but oil service firms -- and Gulf Coast politicians -- want the government to hit the play button again.

Houston-based Diamond Offshore, which owns the world's second-largest fleet of floating drilling rigs, and Hornbeck Offshore Services of New Orleans have asked federal judges to issue temporary restraining orders that would lift Obama's moratorium without waiting for Interior to come up with new regulations. Diamond said the moratorium amounted to an illegal "taking" from the company. Louisiana Gov. Bobby Jindal (R) filed a brief supporting Hornbeck, complaining that the state government "was completely ignored" in the imposition of the moratorium.

However, environmental groups and much of Obama's Democratic base are wary of lifting the moratorium. Michael Brune, executive director of the Sierra Club, said talking about lifting the moratorium while the well is still leaking is like "talking about how to get more kindling" while your "house is engulfed in flames."

David Fuller's view Politically, I can understand why President Obama might wish to maintain his six-month moratorium on offshore drilling until it expires, the BP well has been successfully capped, the oil residue has been largely cleaned up and some new safety regulations for the oil industry are in place. The ban on deep-water drilling would conveniently last until after the November elections. However, it was overturned this afternoon by a New Orleans Federal Judge, although the White House is likely to challenge this ruling.

Meanwhile, uncertainties following BP's accident, including tighter regulation and higher insurance costs, are likely to remain headwinds for the offshore oil industry until all the facts are known. Other influences will be the price of crude oil and the overall strength or weakness of stock markets. My guess is that both crude oil and leading stock markets will be higher near yearend than they are today, although we can expect some volatility.

Choppy stock market action and lingering uncertainties regarding deep-water drilling should provide some opportunities to accumulate these energy stocks at reasonable levels. For conservative investors, my guess is that Royal Dutch Shell (RDSB LN) (weekly & daily), (RDS/A US) (weekly & daily), will benefit at BP's expense over the long term, at least in terms of investor interest while the latter's dividend remains cancelled.

I have included charts for both the London and US listings so that you can see RDS's performance in both GBP and USD (less back history on weekly chart in $). The price performance has been uninspiring but RDS currently pays a dividend of approximately 6%. I would rather hold RDS than a bond and maintain that a longer-term consequence of BP's accident in the Gulf of Mexico will be a somewhat higher floor price for crude oil than would have otherwise occurred.

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