Twelve months after the Deepwater Horizon incident, the ramifications for the industry are difficult to quantify. The effects are tangled and far reaching, and grappling with them is like trying to fend off the giant squid in Jules Verne’s 20,000 Leagues Under the Sea—there are tentacles everywhere.

Data points also range widely. As of early March, just one deepwater permit, for a sidetrack, had been issued for the Gulf of Mexico. Taking advantage of slower times, shallow-water operators have been making acquisitions to build up their positions. But Seahawk Drilling LLC, a shallow-water player, has filed for bank­ruptcy, and some deepwater rigs have left the waters. Two reports on the incident have been issued, one of which reads like a Crichton novel. And the price of WTI crude has topped $100 a barrel.

New rules have been issued, and there has been plenty of conjecture about their effects. A nascent containment business has turned into a fulcrum for the resumption of deepwater drilling. The official inquest has not been finalized.

There are dozens of ways to slice the numbers, but every metric highlights the importance of the Gulf to the U.S. supply picture. According to IHS, the U.S. deepwater Gulf would have ranked No. 8 in the world in discovered barrels of oil equivalent from 2000 to 2009, were it a nation. The inclusion of shallow-water discoveries pushes its rank to No. 3 globally. One fact is irrefutable: the importance of Gulf of Mexico oil to the U.S. economy is massive, and its comeback is imperative.

Finally, progress

Noble Energy Inc., Houston, received the first deepwater drilling permit issued since the Macondo incident, on February 28, 2011. Although it is technically a sidetrack of a well the company was drilling at the time the deepwater-drilling moratorium was instituted, Bureau of Ocean Energy Management Regulation and Enforcement (BOEMRE) director Michael Bromwich said it was treated like a new well because of the need for a containment plan under the new regulations.

After considering the specifics, BOEMRE was able to permit the well, located on Mississippi Canyon Block 519, based on a containment plan that includes Helix Energy Solutions Group Inc.’s capping stack, augmented by Noble's own equipment. The capping stack is meant to stop the flow of oil should a well-control event occur.

?Ron Neal, president of Houston Energy LP, says Noble Energy Inc. has been leading the industry with its involvement in the Helix Energy Solutions capping stack system.

Ron Neal, president of Houston Energy LP, says Noble has been leading the industry with its involvement in the Helix Energy Solutions system. Houston Energy is a nonoperating stakeholder in the well, and BP also has a stake.

“Noble has been one of the principal drivers in helping create the Helix system. That well has been used as the model to build around,” he says.

Bromwich indicated the permit was ripe for a decision, given that an acceptable, approved containment system had been matched to it. The Helix solution had just passed some federal inspections. “It was ready to be acted on and approved,” he said in a briefing the day of the announcement

The well, approximately 70 miles southeast of Venice, Louisiana, is in 6,500 feet of water and was approved with a worst-case discharge calculation of 69,700 barrels of oil a day. The Helix stack is currently accepted for work in up to 5,600 feet of water, so complementary equipment was needed. This additional equipment was not specified, but Bromwich said it was factored into the decision.

“Operators may have additional resources that they can bring to bear that will enhance the packages that Helix and MWC (Marine Well Containment Co.) may be able to offer,” Bromwich said. “Noble has supplemented what they are obtaining from Helix with their own equipment and resources, which is what made us comfortable in approving the application.”

?The number of jackup new-well spuds and floater new-well spuds in the Gulf of Mexico has fallen dramatically.

Every subsequent permit will be processed similarly, with a custom containment and intervention plan submitted in tandem with the well data.

“Based on the depth of the well and, as importantly, the characteristics of the well, we determined the capping stack Helix has was sufficient to cap the well without any flowback,” said Bromwich. He stressed that this permit was not a general approval of the Helix solution, nor would his agency issue a standard approval of the Marine Well Containment design when it was ready. Each permit is assessed on a well-by-well basis.

Bromwich said the bureau was advised that Noble would begin drilling in April after final inspection of equipment, such as the blowout preventer (BOP).

Shallow water

The Friday after the Macondo incident, a newly formed industry group of shelf-focused companies was in Washington, D.C., pleading its case for lifting the moratorium on shallow-water operations. Originally a collection of nine drillers and an offshore service-vessel company, the Shallow Water Energy Security Coalition was led by John Rynd, the chief executive officer of preeminent shallow-water jackup driller Hercules Offshore Inc. At press time, Hercules had agreed to buy Seahawk’s assets.

“On May 8, they announced a total moratorium, and shallow-water drillers were immediately impacted,” Rynd says. Permitting ceased.

“Our wells typically take 30 days to drill, and permitting was historically ‘just-in-time.’ We would be under tow to the next location and the customer would receive their permit somewhere between when we got off the last well and when we got on his well,” he says. This process minimized downtime and cost between jobs. Under the moratorium, however, rigs would finish jobs only to enter permit purgatory.

“Full-stop meant rigs would roll off and have nowhere to go,” he says.

rig with nowhere to go is in a bad way. Even the most inexpensive rigs incur tens of thousands of dollars of cost per day to remain at the ready, even if they are not actively drilling.

The coalition argued the difference in risk profile between wells drilled in shallow water, defined as 500 feet or less, and deepwater. With more than 46,000 wells drilled since the Truman administration, the Outer Continental Shelf has a well-established record and plenty of data and historical information. Operationally, drilling pressures and temperatures are low, and containment is easier and less technology-intensive than for deepwater blowouts. Well-control equipment can be mounted at rig level instead of deep underwater. Everything is more accessible.

From a discharge standpoint, much of shallow-water drilling targets natural gas, and these wells generally leak only gas bubbles in the event of well-control problems. The 10-company association was apparently somewhat successful in its efforts, as the moratorium on shallow-water operations was lifted on May 28.

Regulation

“In early June, they issued NTL (Notice to Lessees) 05,” says Rynd. “This required new inspection of BOPs, and customers had to have certifications on casing and cement design. CEOs had to certify compliance.” Rynd says the industry met these challenges quickly and hoped business would return to normal levels.

“The industry got through that in two weeks.” But permitting continues to be a problem. The time to submit and go through approval is still unacceptably long, in the view of service companies.

“A drill rig is like a factory. We manufacture a hole in the ground. The higher the utilization is, the higher the revenue. Just-in-time permitting really helped with utilization. The other thing is, now, even when you get a permit, you may be idle 10 days. That is 10 days of cost. ”

Then the situation got a lot more complicated, according to Rynd. On June 18, NTL 06 was released. The government required additional information on blowout scenarios, including calculations for “worst-case discharge” of hydrocarbons into the environment, and the manner in which the company applying for a permit would deal with that scenario. These complicated requirements added a subjective component to the approval process, and approval became less certain.

Time is money

“The market is still challenged, and the obvious reason is the regulatory environment. Customers don’t have manpower to get permits through the system now,” says Rynd. “If you look at where the price of oil is relative to natural gas, we were on a pretty robust recovery on the shelf until April 20. This issue around NTL 06 and worst-case discharge has really thwarted recovery on the shelf. There would be more rigs running on oil-related or liquids-type wells that aren’t getting permitted in due course.”

Intuitively, demand for rigs should be up. Prices averaging more than $90 per barrel suggest more producers would be drilling oil and liquids plays. But data show this isn’t the case. The latest rig count from ODS-Petrodata shows the Gulf of Mexico rig utilization rate at 52.4%, a full quarter below the mean utilization of the rig fleet worldwide.

From 2007 to 2009, shelf permits were granted at a rate of just above 30 per month, notes Rynd. In 2010, before the Macondo incident, the average was 24 permits a month. According to the BOEMRE website, at press time just 37 new shallow wells had been permitted since June 8, 2010. And Rynd notes that as of mid-February, just 12 had been issued in 2011.

“Chevron USA is big enough to throw the technical people at this,” says Rynd. Smaller E&P players, however, who comprise the bulk of shallow-water operators, may not be.

And, it isn’t just the operators who may be understaffed and ill prepared to develop the several-hundred-page exploration plans and worst-case discharge reports that are now required.

BOEMRE director Bromwich has repeatedly said he needs additional funding from the Obama administration to hire more staff.

Adaptation

For E&P companies with the ability to develop such plans, the impact of new oversight may be manageable—acceptance of longer planning horizons as the new normal. In fact, Chevron just received permits for two shallow-water sidetracks offshore Louisiana in Vermillion Block 245.

?“We will be drilling exploration wells (in the shallow Gulf) in 2011,” says Gary Hanna, chief executive of Energy Partners Ltd.

Some even view the situation opportunistically. Gary Hanna, CEO of E&P firm Energy Partners Ltd., says now could be a good time to get into the shallow Gulf, if you plan ahead, as he has.

“We will be drilling exploration wells in 2011. To that end, we are way out ahead of the permitting process,” he says.

Hanna’s New Orleans-based company just acquired a sizable shallow-water asset package from Anglo Suisse Offshore Partners LLC for $200.7 million, with both current production and exploration targets. He characterizes the A&D market as active. EPL anticipates no problems getting permits for its recompletion operations, and Hanna says there is a good amount of data available from previous exploration wells on the shelf to use in permit applications. That kind of comparable information from nearby projects is something BOEMRE looks for to back up worst-case discharge calculations, and it can help turnaround times and remove some uncertainty from approval.

“Our idea is to be well out ahead of those (permits) four, five or six months to assure that we are not slowed down,” says Hanna. He thinks that BOEMRE is adding staff and trying to address its capacity problem. Whether this could be a permanent change for the shallow water remains to be seen.

“I think what it has forced the industry to do is to plan out ahead a bit better,” he says. “Where we previously could get these permits in short order, we understand they are taking longer. We needed to plan our drilling season out.”

How far out one plans is somewhat a function of BOEMRE paperwork throughput. Hanna thinks that shallow-water E&P companies have not really changed their plans. In fact, he is positive on the Gulf and thinks it is a good play for companies like his that have knowledge and experience in the area.

“I haven’t seen a change in strategy. I think we are seeing some companies that had maybe slowed down their drilling come back into the market. That may be kind of a wait-and-see attitude that may have had something to do with the permitting issues. I think that has been reflected in a number of people’s budgets,” Hanna says. Part of the attractiveness of the Gulf for him, in fact, is the hesitation of those less familiar with operations there.

“It’s out of favor. Macondo didn’t help that, but for a number of reasons the GOM has been out of favor. I think it is a good time to play the Gulf. It’s a great place to pick up assets for a reasonable cost.”

The siege commences

While the shallow-water industry faced some difficulties even before the Macondo blowout, the sustained stagnation in permitting on the Outer Continental Shelf has certainly increased pressure on drillers and offshore service companies.

Rynd says the shallow water was in somewhat of a resurgence prior to Macondo, and permitting and spudding data generally bear that out. Now, the uncertainty around permitting for his customers and the operational lag time is squeezing the entire sector.

“We were fortunate, because from 2006 on, we had tried to grow internationally,” Rynd says of Hercules. “But between 2008 and 2009, we laid off 45% of our global workforce.” His competition, especially companies that relied entirely on the Gulf for revenue, has not been so lucky.

Seahawk Drilling LLC announced bank­ruptcy in early January 2011. Rynd thinks the moratorium contributed to Seahawk’s demise. A shallow-water driller operating solely in the Gulf, the market fell out from under the company just when business appeared to be picking up. Analysts have pointed to the legacy debt Seahawk was carrying, but Rynd says dwindling revenue also was a factor.

“They were all GOM. They had nowhere to hide, and no other cash flow to get them through.” Drillers have to walk the line between operating costs and catching contracts, Rynd says. If a driller wants to keep a rig ready to go, it must do maintenance and pay the crew. Not doing so lowers costs but also takes the rig off the active market.

“It costs $25,000 a day to run or stack ready. Everyone has to balance that cost with the possibility of a returning market, and signs were starting to be there,” says Rynd of the Gulf just prior to the blowout. For the Gulf of Mexico to operate best, he says, it needs a healthy shallow-water industry to support operators, and to provide the jobs and hydrocarbons the U.S. needs.

?Shallow-water permits issued for January and the first half of February 2011 were about two-thirds fewer than those issued in the same period in 2010.

Despite today’s somewhat nebulous conditions, Rynd is positive about the Gulf’s future, his outlook spurred by recent M&A activity. Companies like EPL, Apache Corp. and Energy XXI have recently announced sizeable acquisitions of shallow Gulf properties with the intent to develop them.

“When we see key customers continue to reinvest in the Gulf, it gives us confidence. If we saw those guys leave, that would make us nervous.”

Now Rynd is primarily concerned with timing. For the shallow-water driller, high volume, efficiency and predictability are key. Rynd is waiting for permitting to pick up. Though he believes it will increase, he is not sure when.

“Is it this year or next year that we get to a normal pace of business?” he asks.

The deepwater problem

Deepwater drilling came to a complete halt with the first moratorium and has not resumed. For Ron Neal, it was a turning point. Houston Energy is one of the independents that had deepwater operations in the Gulf at the time of the incident. A smaller, private company, it has had to adjust to new realities.

Independents are the largest leaseholders in the GOM, with interest in 52% of deepwater leases, and 40% of deepwater wells drilled. Their participation in the deepwater is important, but the new circumstances make their continued participation a challenge.

“It requires a tremendous amount of resources to fill out the paperwork,” says Neal. A partner of his has submitted 1,200 pages for a permit because of new engineering and worst-case-discharge scenarios.

“They want detailed engineering and geologic input,” he says. Like Sarbanes-Oxley, completion of the permit application has required a focus from management.

“Prior to the NTLs, permitting was handled by lower-level engineering techs and geology techs. Now, it is being handled by senior-level staff. Management-level staff members in those fields are filling out all the details that are required. It is significantly more comprehensive.

Neal believes increased time and effort for permitting is the new status quo. What is more difficult to come to grips with is uncertainty about the fledgling rules. When it comes to calculating worst-case discharge, BOEMRE engineers have to accept a company’s calculations based on the maximum calculation of many variables, like permeability, porosity, water saturation, drainage, pressure and annulus size. Neal’s operating partner had problems with the worst-case discharge requirements when it submitted its application.

“They were told their calculations were wrong. And BOEMRE did give them the calculation, but would not give them the input data.” Neal says BOEMRE did not reveal how it got its inputs. This generated friction between the two groups, drawing out the process.

All in the timing

Each individual well can require weeks to go through a process that was largely codified in NTL 06, according to Neal. BOEMRE director Bromwich says that, unlike exploration plans, which have a discrete time frame for approval, there is no such clock for permits. Deepwater drilling does not appear to be as time-sensitive to permitting as shallow water, but the reduction of total permits per year could have negative consequences for U.S. production and rig utilization.

Investment-banking firm FBR Capital Markets, in a report issued on the heels of Noble’s recent permit, advised investors not to be too bullish on the news. After a historical analysis, FBR concluded that deepwater permitting must approach previous levels to put the industry back to work.

?The number of jackup rigs working in the Gulf of Mexico held steady from January 2010 through January 2011, but the number of floating rigs working fell precipitously.

“Full deepwater deployment historically requires about 70 new deepwater APDs (applications for permit to drill) per year,” the FBR analysts said. “After eliminating obvious outliers, data show that it took an average of 183 days from approval of the initial APD to the completion of approximately 300 deepwater wells completed from 2005 through 2009. Of these wells, 86% were completed in less than one year.”

The industry cannot rely on drilling previously permitted wells to stay working.

“The vast majority of deepwater wells are completed in less than a year. Assuming that historical rates of permitting need to be met in order to fully deploy deepwater equipment in the Gulf, BOEMRE needs to issue approximately 70 new permits this year to wells in water depths over 1,000 feet,” notes the firm.

BOEMRE itself is unsure how many permits it could get through in a best-case scenario. Because each submission is largely one-off, and the bureau is understaffed, the situation looks grim in terms of reaching optimal utilization.

Fate of the independents

Each company that was in deepwater drilling has had to adapt. Some companies have not been able to do so quickly enough. How successful operators are at changing their behavior is largely a function of size, says Neal.

“If you are a small company and you are nothing but offshore, you’re toast. We were fortunate that we had a lot of business onshore. In fact, we moved all personnel that were working the shelf to onshore.” The company has used onshore production to mitigate the lack of deepwater production.

Smaller independents are a necessary cog in an efficient Gulf of Mexico offshore business, he says. But the moratorium may minimize their presence, and opportunities, in the Gulf.

“We are all part of the health of the system,” Neal says, “It is its own little environment that needs all the pieces to be viable for the entire animal to be viable. The majors need independents to help support the vendors like boat companies, logging companies and everything else.”

Each group has a niche that contributes to the overall economics and viability of Gulf operations. Without smaller independents, even the majors would have issues with services, prospect generation and other key functions in the E&P life cycle. Also endangered: the component of competition in a healthy Gulf of Mexico business landscape.

“All parties are necessary. If we are not there, fewer projects will go into production,” says Neal. What is material to a major is vastly different than what is material to an independent, which can be profitable with a smaller discovery. And, competition between majors and independents directly benefits the government.

“Without independents, there will be less competition for leases. We have beat majors before in leases. That’s money that goes directly to Treasury,” Neal points out.

The new reality

Conditions in the Gulf have been permanently altered, along with the landscape of players and opportunities. What impact this will have on economic details such as production rates, lease bids, and jobs remains to be seen.

Neal is pragmatic. “It’s just the world we live in today. My belief is you read the NTLs, and you comply.” Though there has now been a successful permit, no one is sure how many permits were not submitted, as companies waited for clarity. It is hoped that the recent issuance will remove some of the frustration about moving targets and a permitting process that seems to be a shot in the dark.

Neal doesn’t believe that BOEMRE engineers reviewing permits are under constraints, or are as punitive or arbitrary as some observers have implied.

“I’m sure they are all trying to do the best job possible, but there are different pressures. It’s very complex.” He would like more guidance on the subjective portions of the regulations.

“If you accept in today’s world you have to have a maximum-discharge case, and you have to plan for intervention and containment, and you want us to do that, that’s fine. But help us get there. Give us guidelines. Everyone wants to do a good job and no one wants this to happen again. I believe that totally.”