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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Chevron’s Mishap Highlights Risk of Deepwater Drilling

The Big Foot oil development deep in the Gulf of Mexico (GoM) was supposed to be a tangible sign that the area had moved back to normal after the Deepwater Horizon disaster a few years ago.

It was also supposed to be a signal of intent from Chevron and the start of an important long-term opportunity to expand the firm’s production base. Chevron pushed ahead to start development of the Big Foot area in 2010 and the formation is estimated to have 200 million recoverable barrels of oil and a 35 year life. So earlier this year, Chevron moved to finally begin tapping those resources.

Then almost as soon as the project started, everything fell apart for Chevron with Big Foot. It’s not clear exactly what happened with Chevron’s Big Foot project, but the mooring cables for the production platform sank in the GoM in June. The subsea installation tendons on the project sustained damage and Chevron has moved the platform to a sheltered area to assess the problem. The result is that production in the area won’t start this year as planned. Related: Congress To Lift Oil Export Ban Next Month?

For a company as big as Chevron, one production issue at one site is not an existential threat by any means. But the delay is an embarrassing set-back and with the development of such a huge reserve indefinitely on hold, it’s clearly emblematic of what is going on across the board in the oil sector right now. As one analyst wrote after the fiasco: “The mishap … is clearly a negative from production, cash flow and operational excellence standpoints.”

With oil prices having collapsed, many formations that were once economically viable now no longer make sense. Deepwater production falls very much into this category. Not all deep water is created equal of course, but deep water is very expensive and requires massive upfront cash investments. Chevron made an ambitious bet on its $5 billion Big Foot platform, and that bet is not panning out so far. Related: The Saudi Oil Price War Is Backfiring

Now obviously Chevron is not going to let a $5 billion investment sit forever and it has already invested many of the sunk costs needed to make Big Foot viable. So sooner or later, the company will start producing from the project. For that matter, the production lifespan on Big Foot is so long that the price of oil today is almost immaterial compared with the expected price of oil over the next 30 years. I’m not alone in that assessment, but again the true significance of the Big Foot set-back is not related to Chevron.

Instead investors need to see the Big Foot debacle as a symbol of the challenge that deep water drillers will face over the next couple of years. Chevron has a massive exploratory budget and the best technology money can buy. Yet even for that firm, deep water drilling proved challenging. In the context of $50 per barrel oil, it’s unlikely that many new deep water projects will get started. Related:Tech Giants Opt For Renewables On Cost, Not Just Good PR

This will mean a dramatic decrease in activity for the entire deep water drilling sector. Investors should keep an eye on announcements from the majors, but until projects like Big Foot start getting a lot more enthusiastic response from executives, the deep water industry and all firms associated with it will remain under pressure.

By Michael McDonald of Oilprice.com

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