It’s been a month and a half since BP’s (NYSE: BP) Macondo exploration well in the Mississippi Canyon of the Gulf of Mexico blew out, killing 11 people and sinking the deepwater Horizon drilling rig. At this point investors are familiar with the unsettling images of oil and natural gas gushing uncontrollably from the deepwater well.

BP’s attempts to activate the damaged subsea blowout preventer and kill the well by pumping drilling mud into the well-pipe have failed. However, the company’s latest effort–a containment dome fitting over the damaged blowout preventer–appears to have met with some measure of success. It’s possible that as BP optimizes this solution, the company might be able to collect 80 to 90 percent of the oil and gas leaking from the well.

Of course, the ultimate solution will be the completion of two relief wells that will allow BP to plug the leaking well permanently.  These wells aren’t due to be completed until August, and relief wells are no simple technological feat; it may take some time for BP to place the relief wells correctly so that they intersect the damaged Macondo well.

The Macondo spill is the largest in US history, though it’s neither the largest in history nor the largest spill in the Gulf of Mexico. That dubious distinction goes to the 3 million barrels that spilled from the IXTOC-1 well in the Bay of Campeche back in 1979. That well flowed out of control for nearly 300 days before it was finally brought under control by two relief wells. But regardless of the Macondo spill’s size, the disaster will impose a considerable environmental and economic cost.

BP has already paid out more than $1 billion as a direct result of the spill, and the final bill will be many multiples of that. However, the spill’s ramifications for the offshore drilling industry and energy prices are more important for long-term investors. The good news: master limited partnerships (MLP) face only a modest impact, and many will benefit as drilling shifts from offshore to onshore.

The Drilling Moratorium

From a purely economic perspective, the moratorium on deepwater drilling in the Gulf of Mexico will have the most profound impact on the energy industry. Immediately after the Macondo blowout, the Obama Administration announced a month-long halt to new drilling permits in the Gulf of Mexico and ordered that all rigs currently operating in the region be inspected.

On May 27 the administration extended the moratorium on new offshore well permits by a further six months, canceling two planned lease sales. But many analysts were surprised when the administration announced that wells currently being drilled in water deeper than 500 feet will be halted as soon as it is safe for producers to stop operations. This mandate covers 33 wells currently being drilled and, by extension, 33 deepwater rigs drilling those wells.

The moratorium is strict. The standard definition of deepwater is any well located in water more than 1,000 feet deep; by using a 500-foot standard, the moratorium actually extends to wells traditionally considered shallow-water wells. In other words, the moratorium’s ultimate impact on production will be greater than previously thought.

And although the administration has confirmed that shallow-water wells won’t be affected by the six-month moratorium, new permits will be on hold until new safety regulations and inspection procedures are in place–a process that could take some time.

Insurance premiums for shallow-water drillers likely will spike because of the spill, and the region could become uninsurable if the government substantially increases the cap on liabilities. Producers generally regard the shallow-water Gulf of Mexico as a relatively high-cost region; the economics for natural gas production were already marginal in the current pricing environment.

It appears the government will continue to allow workover operations at existing wells–that is, repairing wells they’ve already drilled. And most important, the ban has no immediate impact on previously drilled deepwater wells that produce oil and natural gas.

The moratorium does not mean that all production from the Gulf of Mexico–nearly one third of total US output–will cease immediately.

The ban’s ultimate impact on the energy industry’s profits and production depends on the length of the moratorium and what regulations are put in place once it’s lifted.

The 33 deepwater rigs now idled in the Gulf are primarily booked under long-term contracts to operators like BP or ExxonMobil (NYSE: XOM). But most drilling contracts contain force majeure clauses that are triggered if drilling is interrupted for a certain period.

At that point the day-rates decline slightly for a period, after which the producer can cancel the contract. Many analysts expect the six-month moratorium to extend well into 2011, perhaps lasting a year or more. In that case, the contracts for most of the deepwater rigs operating in the Gulf would be canceled, and many units would seek work in other regions.

Plenty of deepwater projects are underway in deepwater Brazil, offshore West Africa and other areas. But the sudden influx of these new rigs will depress day-rates across the entire industry.

And it’s not just the rigs. Deepwater projects are extremely service-intensive. Companies such as Schlumberger (NYSE: SLB) and Baker Hughes (NYSE: BHI) have sizable workforces stationed in the Gulf–workers experienced in handling all sorts of functions related to drilling technically complex wells. The services firms will likely relocate staff members to other deepwater regions.

This sudden influx of service labor and new rigs may enable Brazil’s national oil company Petrobras (NYSE: PBR) and similar firms to accelerate their drilling plans.

Once all of these assets and talent leave the Gulf, it will take months to reverse the situation; when the government lifts the moratorium, drilling activity would take some time to reach former levels. And new regulations that require major changes to equipment and procedures could delay the restart even further.

Deepwater wells in the Gulf have a high decline rate–as time passes, the underground pressures diminish rapidly and production tails off. Decline rates reportedly can be as high as 20 to 40 percent annually in the first year after a deepwater well peaks; it won’t take long for a moratorium to have a real impact on production.

Crude oil prices have suffered in recent weeks because of nagging concerns that the EU credit crunch will morph into a 2008-style global credit crunch. But such an outcome is unlikely, and our favorite MLPs continue to raise equity and debt capital at attractive rates.

Ultimately, the Macondo disaster is bullish for oil prices; it means weaker non-OPEC production growth.

Even as output falls in the Gulf of Mexico, US demand for oil appears to be recovering a good deal faster than most had expected.

Source: Energy Information Administration

As part of its weekly petroleum inventory reports, the US Energy Information Administration (EIA) releases data comparing consumption over the most recent four-week period to the same period a year earlier. This is a volatile measure but provides a good indication of changes in US oil demand over time.

US oil demand is currently growing at a rate of more than 8 percent year over year–the fastest pace of growth since 2006, long before the credit crisis of late 2008.

Of course, this 8 percent year-over-year growth rate compares current consumption with the relatively depressed demand environment of one year ago. However, this is still a notable improvement, and the trend appears to have accelerated since the end of last year.

Rising oil demand and Gulf supply concerns are bullish for crude. Meanwhile, the moratorium is clearly bearish for some drilling contractors with heavy exposure to the Gulf that will now be forced to scramble to signs new contracts abroad.

The MLP Effect

Most of the stocks in our coverage universe won’t suffer a major impact even if the moratorium carries on for a significant period of time.

The recommendation with the most direct exposure is Conservative Portfolio holding Enterprise Products Partners LP (NYSE: EPD). Enterprise owns about 2,500 miles of offshore oil and natural gas pipelines and gathering systems, as well as six offshore hub platforms that process oil and gas volumes produced in the Gulf of Mexico.

This is a fee-based business. Enterprise is paid a minimum fee whether or not the pipelines and hubs are used. The partnership also receives a fee based on the volume of oil and gas passing through its facilities. These fees are all defined under long-term contracts and aren’t based on prevailing commodity prices.

Some of these pipelines and hubs are designed to handle volume produced from deepwater regions of the Gulf of Mexico. For example, the 80 percent-owned Independence Hub located in Mississippi Canyon Block 920 is designed to process gas gathered from deepwater fields in the region. The damaged Macondo well is located in Mississippi Canyon block 252–the same general area of the Gulf.

But we don’t expect Enterprise’s operations to take a hit.

Although Enterprise’s offshore operations are sizeable in absolute terms, the division is only a minor contributor to the MLP’s cash flows. Enterprise breaks down its business into five segments: NGL (Natural Gas Liquid) Pipelines and Services, Onshore Gas Pipelines, Onshore Crude Oil Pipelines, Offshore Pipelines and Refined Products. Of those five segments, Offshore Pipelines and Services is by far the smallest, accounting for just 1.33 percent of revenues in 2009. 

Enterprise has always made a point of diversifying its business to avoid inordinate exposure to a single segment or to commodity prices. That costs the MLP some upside in strong environments but insulates its core business from shocks such as the current disaster.

Second, the moratorium does not mean that these revenues will disappear. The ban doesn’t impact wells that are already producing oil or natural gas; the moratorium won’t have an immediate effect on deepwater volumes that Enterprise already receives through its offshore hubs. And shallow-water production from the Gulf will continue to feed Enterprise’s pipelines and processing hubs.

Over the long term, the impact on Enterprise’s deepwater business will depend on the length of the moratorium. Production from the deepwater fields hooked up to Enterprise’s hubs and pipelines will diminish over time, following normal decline rates. But such a drop is a ways off; many of the fields Enterprise serves are still relatively young deepwater projects. 

Of course, the growth prospects for its offshore business will take a hit.

Enterprise planned to expand some of its hubs and systems to collect production from new deepwater projects due to come onstream over the next few years. This moratorium likely means that some of the projected increases in deepwater Gulf production over the next 2 to 3 years will simply fail to materialize.

Bottom line: Enterprise’s offshore business won’t sustain a crippling hit from Macondo disaster, but the drilling moratorium will negatively impact growth. The effects will increase in severity the longer the ban is in place. However, even in a worst-case scenario, Enterprise will be able to absorb the hit from its tiny offshore segment and this headwind shouldn’t affect its ability to pay distributions. Enterprise Products Partners remains one of the lowest-risk and most diversified MLPs in our coverage universe and rates a buy under 36.

There are other ramifications worth watching. Although Enterprise is the only MLP with extensive offshore platform assets, several MLPs–including Enterprise–have gas processing capacity or pipelines located near the Gulf Coast.

Over time deepwater production volumes will begin to level off and decline due to the lack of new drilling–that will mean lower throughput volumes for the industry. Because deepwater natural gas tends to be wet gas–high in natural gas liquids (NGLs) content–it requires extensive processing; falling deepwater volumes is an incremental negative for Gulf Coast processors.

But this onshore activity and processing volumes should offset this negative. Enterprise owns significant onshore processing assets that would be negatively impacted by a protracted moratorium. However, production growth from unconventional natural gas fields located onshore is filling the gap.

A great example of this is the Eagle Ford Shale located in south Texas. The Eagle Ford is a relatively new unconventional natural gas field. Although producers have been buying up properties in the region for some time, most kept mum on its prospects until they’d assembled sufficient acreage. Early results from the area are impressive, and it appears the northern part of the play is capable of producing large quantities of crude oil and NGLs alongside natural gas.

Transporting and processing gas from the Eagle Ford will require extensive pipeline and processing capacity. Enterprise is the early leader in the Eagle Ford–the company already has significant pipeline and processing capacity in the region. Some of this existing capacity was designed to handle production from the Gulf and conventional onshore production, but these assets are being converted to accept volumes from the Eagle Ford. The company has announced its intention to build a 140-mile long pipeline to handle the additional production.

Onshore drilling activity and unconventional plays should benefit from the Macondo disaster.  The threat of lower natural gas production from the Gulf coupled with predictions for a much more active-than-usual hurricane season have helped to push natural gas prices higher since the Macondo spill. That’s encouraging more drilling activity.

Over the long term, if the US is unable to generate oil and gas production growth offshore, the only real alternative is to accelerate development of oil and NGLs production onshore. This is already in the works; several major international oil companies have announce plans to form joint ventures with US producers in key shale plays or make outright acquisitions.

The latest to join the fray is Royal Dutch Shell (NYSE: RDS.A). In May, the Anglo-Dutch giant announced it had agreed to a $4.7 billion acquisition of a private firm with significant acreage in the Marcellus field of Appalachia. And ExxonMobil’s planned purchase of US shale gas specialist XTO Energy (NYSE: XTO) is on track to close over the next few weeks.

Shares of Range Resources Corp (NYSE: RRC), Petrohawk Energy Corp (NYSE: HK) and other  names that are heavily involved in unconventional gas drilling have surged, suggesting the market expects these companies to benefit in the wake of the Macondo disaster.

The need to build out infrastructure to support onshore US unconventional gas, NGLs and oil production will be a major growth driver for MLPs. The Macondo disaster will accelerate onshore growth, outweighing any impacts from lower Gulf production volumes.