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Gregory Brew

Gregory Brew

Dr. Gregory Brew is a researcher and analyst based in Washington D.C. He is a fellow at the Metropolitan Society for International Affairs, and his…

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Is Gulf Of Mexico Oil Output About To Peak?

Amid strong indicators that U.S. shale production will reach new heights by the end of 2017, efforts to promote further exploration and production in the Gulf of Mexico, long a center of U.S. energy output, have run into some headwinds.

Some even doubt that Gulf production, much of it from expensive off-shore rigs, can compete in the “lower for longer” price climate that will likely endure through the end of 2017.

With a much longer lag-time for off-shore projects, production in the Gulf of Mexico (GOM) is less sensitive to short-term changes in price. But with the consensus around lower prices growing, it’s possible likely that investment in offshore may taper off, as investment seeks out more reliable returns from shale fields.

On Wednesday the first bids on new oil and gas leases in the Gulf of Mexico were offered. The Secretary of the Interior, Ryan Zinke, revealed plans to offer new leases on a track of some 75.9 million acres in July. The Trump Administration, which is staunchly pro-energy and is planning to free up federal land to oil and gas exploration, estimates the area contains 550 million barrels and 1.25 trillion cubic feet of natural gas.

The round of bids offered today come with a 12.5 percent royalty rate on leases at less than 200 meters, 18.75 percent for those at depths greater than 200 meters. These are favorable rates designed to entice new bids. The Department of the Interior has nine more lease sales scheduled between 2018 and 2022, with all but one focused on the Gulf of Mexico. Related: Russian Energy Minister: No Additional Output Cuts Are Needed

But the response to the auction has been timid. As of Wednesday morning, only about one percent of the total area had attracted investor interest, and pre-bidding seemed sluggish.

The Gulf of Mexico typically accounts for about twenty percent of total U.S. production, while offshore activity currently contributes about 1.6 million bpd. Following a steady decline in output between 2010 and 2014, offshore production surged in 2015 and 2016, as new projects were completed and off-shore rigs came on line, according to EIA data.

In April the EIA reported GOM production, which was already at seasonally high levels, was set to increase by the end of the year, with seven additional projects coming on line by the end of the year. In January the EIA predicted GOM output would help lift total US production by 400,000 bpd by year’s end. Gulf output will rise by 300,000 bpd above its 2016 level. The EIA has more recently estimated GOM production in 2018 to average 1.91 million bpd, a record level.

The current rig count of 17 is unchanged year-on-year from 2016. One new rig operated by Hess Corporation for the Stampede development began moving into position in early August and will begin producing in early 2018. Stampede is estimated to hold 350 million barrels of oil equivalent, and Hess’ operation alone could add 80,000 bpd to total GOM output.

Yet while this causes a spike in production for 2017, the forecast looks more grim. The off-shore active rig count has bene falling since 2014, while the number of development and exploratory wells have also been in decline.

Low prices and high uncertainty is pushing investors towards short-term opportunities, chiefly in U.S. shale which has earned big gains this year. GOM, with its long lag-times and significant capital expenditures, is a safe bet if prices can be assured in two-to-three years’ time.

If the EIA data is any indication, next year could be a banner one for Gulf producers, and companies like Hess and Chevron are looking to capitalize on new developments. There has also been an expansion of Mexican off-shore investment, as its energy industry liberalizes. Related: Goldman: $50 Oil More Profitable Than $100 Oil

Interest in off-shore activity in other parts of the United States has declined, however, particularly in the southeast: interest in new off-shore drilling in North Carolina has ebbed recently, in part due to concerns about climate change and lingering memories of the Deepwater Horizon oil spill.

With strong support from the Trump Administration, off-shore drilling in the Gulf of Mexico may continue to perform, despite low prices and stiff competition. But the current environment and “lower for longer” thinking may stymie additional off-shore development in the future.

By Gregory Brew for Oilprice.com

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