Grupo de Economia da Energia

The accident in the Gulf of Mexico and its consequences for the World Oil Industry

In oil on 05/07/2010 at 00:28

By Helder Queiroz

Over the last decade, the global oil industry (GOI) was strongly affected by the changes observed: i) asset configuration due to transactions of mergers and acquisitions; ii) market conditions, with changes in supply and demand structures; and iii) regulatory frameworks of the main producing countries.

Over the past five years, in particular, there was a major change in economic conditions of GOI: high international prices that reached the level of US$ 145 per barrel, after a long period of relatively low prices (below US$ 28 in 1986-1998).

Despite the hard drop recorded in July 2008 causing a new price level around US$ 60-80 per barrel and the reduction in global demand in 2009 due to the downturn in world economic activity, factors of uncertainty are present regarding the future expansion of production capacity.

The BP’s Deep Water Horizon offshore accident in the Gulf of Mexico adds a strong new element of uncertainty for the global oil industry. The severity of this accident allows drawing a parallel with the nuclear accident at Chernobyl in the former Soviet Union in 1986. For the nuclear industry, this accident caused two types of regulatory and economic effects.

First, several countries have decommissioned their nuclear programs during the subsequent years. Paradoxically (or ironically), the recent resumption of construction of nuclear plants has been supported by environmental motivations. In the northern hemisphere power generation remains predominantly based on coal, and nuclear plants can be an alternative for countries dominating nuclear technology to reduce CO2 emissions.

Second, the consequences of the accident crossed the borders of the former Soviet Union and affected the nuclear generation industry worldwide. This is explained by the substantial increase in costs of nuclear generation, due to the need for new practices in risk and safety management.

Can these two impacts be registered in the GOI? The answer is no for the first and yes for the second.

Regarding the first one, it is hard to imagine a drastic reduction in offshore oil activity. As you know, reserves of oil have relevance that transcends economic issues, and they are also understood as a matter of geopolitics. However, there is a relevant obstacle for finding new oil exploration areas: diminishing the frequency of discovering large fields. This subjects the search process – and the planning for the expenses involved in such process – for new reserves, upon denoting reduced likelihood for getting fields able to change significantly the risk-benefit activities of Exploration & Production (E&P) worldwide. The onshore opportunities have been mapped already and are less promising. Therefore, the new frontiers of oil exploration move to deeper and deeper waters, and the Brazilian Pre-salt constitutes a model for finding hard-to-access and expensive reserves.

Moreover, disruption of nuclear programs from the second half of 1980s was made possible by the maturity of the gas turbine technology, which has benefited from a shorter period of construction. This last factor, in fact, made gas turbines a perfect ally of the reform programs related to electricity sector for expanding the private share in the sector, given that the profile of investments in this type of plant made the project more attractive to the private sector.

For the GOI, the alternatives that would allow fast replacement of oil are far from being mature and, in fact, competitive. Moreover, they depend upon much deeper review of national energy policies than those that are occurring in different countries, in order to meet the goals of reducing emissions. There is no consensus on the adequacy of regulatory and economic tools that should be used or level of effort and commitment by countries with different degrees of oil dependence.

Although the Obama administration is trying to offer now explanations to the American public opinion, the attempt to stop provisorily oil exploration will produce very little impact and penalization to BP. This is because a permanent prohibition to offshore oil exploration activity would be contrary to the goal of reducing USA energy dependence in relation to crude oil imports from the Persian Gulf Arab countries. Furthermore, this is a privileged arena for the oil industry lobby in the USA and, therefore, is hardly surprising the legal battle established on this subject, just after the judgment of the New Orleans magistrate in favor of 32 oil companies that have managed to stop, on 22 June, the moratorium sought by the White House. We have to mention that the Gulf of Mexico accounts for one third of USA oil production and the main area of new discoveries.

While we may believe a statement by U.S. President arguing that “as 9/11 has profoundly changed our view of our vulnerabilities and foreign policy, I believe this disaster is going to change our view for many years about the environment and energy,” the transformation of that view, at concrete level, meets serious obstacles in the short and medium term due to the reasons mentioned above.

Concerning the second one, the Deep Water Horizon accident can cause economic impacts comparable to Chernobyl’s, particularly in relation to the global reach of its consequences. Clearly, the British company BP’s reputation is at risk, for the explosion discredited its technological expertise in deep waters. However, the accident intensified the debate in the GOI on offshore drilling in terms of safety and environmental impact. There is no coincidence that about 200 oil companies met in early June in the USA to assess the consequences of this accident.

The demands of government officials and regulators bodies will become undoubtedly stricter, as occurred after the accident in Chernobyl. The need to adjust the oil industry to the new safety and risk management regulations will result in higher costs due to the need to review the technical criteria used by oil companies in this type of activity. Expenditure on insurance contracts for platforms should also become more expensive.

If implemented indeed, these rules may delay the startup of new production platforms in the context of very limited excess capacity. In these new conditions of the GOI, we have to wait and see what the pace of adjustment of the oil companies to new regulations and type of impact they will raise in the cost production structure of oil companies.  But it seems evident that even if BP will be penalized severely, the consequences of the Deep Water Horizon accident will be absorbed by all oil companies.

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