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BP Oil Spill Aftermath: Interview With Elliott Gue, Editor of The Energy Strategist

By Jim Fink on September 15, 2010

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The BP (NYSE: BP) oil spill may have been capped on July 15th, but the long-lasting effects of the 205 million gallons of crude oil released into the Gulf of Mexico over a three-month span have yet to play out. The only certainty is that deepwater oil drillers in the U.S. face increased regulation. The Obama Administration and the U.S. Congress are sure to take action to guard against such a disaster from ever happening again.

On September 8th, BP released the results of its own internal investigation into what caused the oil spill. Not surprisingly, it points fingers at others, including Transocean (NYSE: RIG) and Halliburton (NYSE: HAL). A more objective analysis presented by the CBS newsmagazine 60 Minutes puts the blame directly on BP.

Besides blame, other key questions remain:

  • What does the aftermath of the BP oil spill mean for energy investments?
  • Are there winners and losers?
  • How can energy investors position themselves to make money?

All BP-related questions and many more will be answered on September 22nd when Elliott Gue, energy expert and editor of The Energy Strategist investment service, hosts a live webinar. In this live Sept. 22nd webinar, he will also explain why he foresees the price of oil skyrocketing back to $150 per gallon and which oil stocks are most likely to skyrocket in response.

Interview

In hopes of getting a sneak peek into what he will discuss during his live webinar, I caught up with Elliott earlier this week and he was gracious enough to sit down with me and provide some insights into the likely aftermath of the BP oil spill. It was a fascinating interview and I was particularly impressed with Elliott’s extensive knowledge and genuine passion for the energy markets. And he is a really nice guy to boot! 

The transcript of our chat is below. I hope you enjoy it as much as I did. 

Jim Fink: Elliott, welcome to Investing Daily. I’m excited to hear your current thoughts about the energy markets.

Elliott Gue: Jim, thank you for the opportunity to discuss my upcoming live webinar with the readers of Investing Daily. It’s a pleasure to be here today and give my impressions of the BP oil spill.

Jim: What is the environmental impact of the BP oil spill? Is it over? What historical precedents can we look at to help us know what to expect?

Elliott: It’s not possible to know all of the impacts of the BP oil spill on the environment and scientists will undoubtedly be studying the spill and its long-term effects for years to come. However, the media tends to blow events like this way out of proportion with reality and the coverage in May and June was prone to hyperbole and sensationalism. Of course, BP and the Gulf spill also quickly became political footballs, further escalating the rhetoric.

The spill will be a lot less damaging than many initially feared and the Gulf of Mexico is a lot more resilient than most give it credit for. In 1979, the Ixtoc-1 well in Mexico’s shallow-water Bay of Campeche blew out and it took Petroleos Mexicanos (PEMEX) 10 months to plug the well and bring the gusher under control. Ultimately, the Ixtoc spill was estimated to be more than 3.3 million barrels, not much less than the approximately 4.9 million barrels released from Macondo.  Predictably, there was a significant immediate impact on local bird populations and commercial fisheries had to be closed for a time after the spill. But most scientists were surprised how quickly marine life recovered.

The fact is that in the warm waters of the Gulf of Mexico oil degrades at a far faster pace than in colder climates such as Alaska – the basic rule of thumb is that for every 10 degrees Celsius oil degrades at about twice the speed. In addition, hundreds of natural oil seeps in the Gulf of Mexico have been leaking oil long before man ever started drilling for crude. It’s impossible to know how much oil enters the Gulf naturally in this way but most estimate its 1 to 1.5 million barrels per year. As a result, there are naturally occurring microbes in the Gulf that essentially eat the oil and speed the breakdown of oil. Scientists recently announced the discovery of an entirely new species of microbe that acts at colder temperatures and in deeper waters than previously thought possible.

I do believe the worst is over in terms of environmental damage to the Gulf.

Jim: How will the BP oil spill affect oil and natural gas supplies and prices short term and long term?      

Elliott: The Administration’s drilling moratorium in the Gulf of Mexico doesn’t impact production from existing, producing deep or shallow water fields in the Gulf. Therefore, there is little or no immediate impact on crude oil or natural gas production in the short run.

It’s the intermediate to long-term growth prospects that worry me. The deepwater is one of the only sources of U.S. oil production that has actually grown in recent years and some of the new finds in the Gulf were among the largest and most promising in the world. According to the Energy Information Administration’s (EIA) own estimates, U.S. offshore oil production was expected to account for half of total growth in U.S. output between 2010 and 2020.

The original moratorium was scheduled to expire after six months (Nov. 30th) but I see a significant chance that it will be extended into 2011. Either way, much of the damage has already been done. Deepwater rigs that were intended to drill Gulf of Mexico fields have been released from their contracts and are now being moved abroad and put to work on multi-year deals. Many of these rigs won’t be available to come back to the Gulf. And even if the moratorium is lifted, the government is likely to impose a slew of new regulations on the industry that will raise the costs of exploration, development and production.

One particularly scary prospect is that regulations become so onerous that insurers will no longer cover drilling in the Gulf in either shallow or deep waters. This will limit activity to a handful of global giants and national oil companies (NOCs) like Brazil’s Petrobras (NYSE: PBR). The ultimate result of all this will be that expectations for oil production growth will need to be revised lower, the U.S. will become more dependent on imports and prices will be higher.

The good news is I see little or no change to deepwater drilling operations outside the U.S.; in fact, the influx of new rigs may allow some producers abroad to accelerate their drilling plans. I also see no impact on the natural gas markets as onshore gas production will be enough to offset any decline in production from offshore.

Jim: Which energy industry subsectors are hurt most and helped most from the spill? 

Elliott: The industry subsector most directly hurt by the moratorium is contract drilling. Most of the deepwater rigs operating in the Gulf of Mexico were contracted to producers under multi-year deals for attractive, fixed day-rates. These deals offered guaranteed cash flows and a sizeable return on investment.

Because of the Gulf moratorium, producers are able to break their contracts with these drillers, releasing the rigs. That leaves around 33 deepwater rigs formerly working in the Gulf looking for work in other countries; the sudden influx of rig supply has depressed the day-rates contract drillers can charge for their rigs.

In other cases, drillers and producers have negotiated special deals for handling rigs idled by the moratorium but, in almost all cases, these deals involve the contract driller taking a serious haircut on the rates they’re paid.

Contract drillers with heavy Gulf exposure are the hardest hit by the spill. In addition, watch out for rig contractors with older, less-powerful deepwater rigs; given the new supply competition, less capable units will have to take an even larger discount to win contracts. It may also be impossible to bring older rigs into compliance with new regulations that result from the spill. Drillers with little or no Gulf exposure and more modern rigs stand to benefit in this new environment for the same basic reasons.

Few subsectors will actually benefit from the moratorium. Some deepwater equipment manufacturers such as Cameron International (NYSE: CAM) will see some sales as new regulations force companies to buy new, more powerful blow-out preventers (BOP). I suspect that the failure of the BOP to shut off the Macondo well as it was designed to do will be a central part of the BP spill investigation.

Jim:  What about BP itself? Will the cleanup costs and criminal liability make it go bankrupt? Or is it a takeover target at its current depressed price?

Elliott: BP will not go bankrupt as a result of the Macondo spill. Back in May and June, bankruptcy speculation ran rampant because estimates as to the total cost of the spill varied widely and the rhetoric directed at the company was so extreme. The company will be cutting checks for this spill for a long time to come but it’s large enough to absorb the damage. Management believes that the more than $32 billion they’ve already reserved will be sufficient to cover the costs of the spill. In fact, the company is planning to re-examine its dividend suspension early next year, a sign of improving visibility.

You can see the receding risk of bankruptcy in BP’s bonds — some BP bonds that traded as low as 70 to 80 cents on the dollar back in late June are now trading back near par.

BP has some attractive assets but there are only a few companies large enough to take over BP, including ExxonMobil (NYSE: XOM) and Royal Dutch Shell (NYSE: RDS-A). Exxon may be reluctant to do another deal so quickly on the heels of its takeover of XTO Energy. Moreover, while risks are receding, any buyer would also be acquiring significant potential liabilities due to the spill. I just don’t see BP being acquired outright any time soon though it will likely make additional asset sales and these divestitures will generate upside for other firms.

Jim: Thank you for the valuable insights, Elliott!

Elliott: My pleasure.

Jim: For readers who want to learn more about the energy markets than Elliott could discuss in this interview, check out the live webinar Elliott’s hosting on September 22nd. Webinar attendees will also receive a free 90-day trial subscription to his energy stock advisory, The Energy Strategist.

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