Saturday, August 2, 2008

PostHeaderIcon Expanded Offshore Drilling -- Reality Check

Yes, I agree that we should responsibly look at how to open up more OCS acreage for exploration and potential development.... however...

As someone who actually works in the energy industry -- Big Oil, as some call it -- I have to say that a dose of reality is in order.

Reality #1: More OCS needs to be open to exploration. This has to be part of the U.S. energy portfolio -- too much of our economy depends on the products that come from oil and gas.

Reality #2: This is a long-term process. It takes a lot of time just to set up the leases, process the bids and just get the legal matters in place before you can even send in the first exploration drill ship. It will reasonably be more than 10 years before the first production can be expected from any finds.

Reality #3: You can't just "drill now", as John McSame keeps harping on. It may be a great slogan, but here's the question: with what? Oil field services are scrambling at this point to meet the demand for the current queue of opportunities just in the Gulf of Mexico -- so much so that exploration & development costs have risen by nearly 20% over the last two years. Why? There simply isn't enough equipment, materials or skilled labor to be able to expand our capacity to "drill more now". We are at or nearly at the physical limit of what the oil industry can actually do -- and remain relatively safe and environmentally benign.

Reality #4: Economics matter. Uncertainty matters more. Imagine if you had a business prospect that was economic (7-12% return on capital) but on the assumption that any cost increases for labor, materials, etc. would only rise at the regular inflationary rate (3-5% per year)... now factor in a jump of 10-20% per year and weak dollar, and those prospects have to be constantly re-evaluated. Now layer in political instability (Middle East / Asia), increased competition with national oil companies (NOCs), NIMBY, and a host of other factors -- it's a risky business to be in, even when you know that the oil and gas are actually there.

Reality #5: Fungibility. Oil (and natural gas to a lesser degree) is highly fungible on a world market. It's not just a matter of production off the U.S. coast going directly to the U.S. market. Our market is inextricably linked to the world market -- and while we're playing by quasi-free-market rules, most of the other players are not. On the supply side, the cartels and NOCs control the vast majority of a fairly inelastic supply. On the demand side, China and most other developing countries heavily subsidize consumption which skews demand outside of what it would be under normal pricing.

As has been said, we can't drill ourselves out of this. But we can't simply take that option off the table as we transition to a balanced energy portfolio. Barack Obama has signaled he is open to a more nuanced approach towards energy policy. That is a welcome development.

The final reality goes back to: time. Now is the time to start thinking 10-20 years out, so that domestically we have enough prospects in the queue to be able to maintain it's portion of a balanced energy portfolio. This is a heavy industry that we can't simply allow to be shipped overseas.


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