Offshore Drilling To Make A Resurgence In U.S.

U.S. President Obama just made some dramatic changes to the offshore oil and gas landscape. Let's take a look beneath some of the recent headlines to figure out just what Obama's actions will mean for the offshore oil landscape.

Storm Clouds in the Arctic

First, the bad news for the oil industry. On January 27, the Obama administration moved to block oil and gas development in large swathes of the Arctic Ocean off the coast of Alaska. The Department of Interior issues five-year leasing plans, and under the next iteration (2017-2022), Obama withdrew areas within 25-miles of the Alaskan coastline in the Chukchi Sea. He also scrapped the Hanna Shoal, a biologically rich section of the Sea, as well as several sections that are used for subsistence by native groups.

The withdrawal of sensitive areas for leasing will not affect current leaseholders. While ConocoPhillips (NYSE: COP) and Statoil (NYSE: STO) still hold some offshore Arctic acreage, they do not have plans to drill in the near future. Only Royal Dutch Shell (NYSE: RDS.A) is actively pursuing Arctic oil. Shell reported disappointing fourth quarter results as oil prices crashed. In order to shore up its balance sheet, the Anglo-Dutch company vowed to leave its dividend unchanged, slash spending by an eye-popping $15 billion over the next three years, and avoid pricey investments. On January 29, Shell announced its sale of the Sean field in the North Sea, and is looking for further divestitures.

Nevertheless, despite cost pressure and shrinking revenues, Shell reiterated its interest in the Arctic. Already having sunk more than $6 billion in the region, Shell hopes that 2015 will prove to be different than past years. It hopes to resume drilling this summer. The Arctic remains a major prize for the industry, even as it poses significant technical challenges. Offshore Alaska holds upwards of 29 billion barrels of oil. The Interior's decision to withdraw sensitive Arctic areas should not affect Shell's drilling plans, but it will take hypothetically productive acreage off the table.

Next, the Department of Interior recommended setting aside 12.28 million acres of the Arctic National Wildlife Refuge (ANWR), advising Congress to designate it as a "wilderness" area, the highest level of conservation. As such, oil development would be off limits. Interior included the Coastal Plains in its proposal, an area thought to hold over 10 billion barrels of oil. Congress has fought over ANWR for several decades. Up until now the battle has been a stalemate, but Obama reignited the fight in January 2015 when he sought to expand federal conservation protection.

Members of Congress representing Alaska reacted with rage, with the powerful Senator Lisa Murkowski (R) calling the administration's move a declaration of war on her state. For now, very little will change - a "wilderness" declaration can only be given by an act of Congress; the White House has limited power over the issue. Still the proposal will dim any chances of drilling in ANWR for the foreseeable future.

Come to the Atlantic Instead

But in characteristic Obama fashion, the administration threw a bone to the industry. Two days after proposing to close off large sections of the Arctic, Interior proposed opening up the Atlantic seaboard to offshore oil and gas development. Obama has tried this before - he proposed opening up the Atlantic to drilling in 2010, which has been off limits for years. But shortly after his announcement, the BP Deepwater Horizon blowout forced him to backtrack.

With the Gulf of Mexico disaster all but a memory, the Department of Interior is once again looking at allowing Atlantic offshore development. They are proposing one big lease sale for an area stretching from the southern tip of New Jersey down to central Florida, excluding a 50-mile buffer zone along the coastline.

For now, there is a large degree of uncertainty about what lies beneath the Atlantic seabed. The Bureau of Ocean Energy Management (BOEM) estimates that the Atlantic holds around 3.3 billion barrels of oil and 31.3 trillion cubic feet of natural gas. However, these figures are outdated and based on crude 2-dimensional seismic surveys from the 1980's. Given the magnitude of innovation in seismic surveying and drilling technologies over the intervening 30 years, it is safe to assume that the volume of reserves that could be recovered in the Atlantic is likely far higher.

With a lease sale several years away at the earliest, drilling may not commence in the Atlantic until the early part of the next decade. That puts first production of oil from the east coast at some point later in the 2020's.

The next step would be three-dimensional seismic testing, to figure out the extent of the resources. To a certain degree, the latest move opening up the Atlantic to drilling was telegraphed last year - the Interior Department green lighted seismic testing in July 2014. The agency has already received several permits by oil companies to begin testing, suggesting that the industry is highly interested in the Atlantic.

It is unclear which companies will jump at the chance to explore in the Atlantic first, but several companies should be taken into consideration. Chevron (NYSE: CVX), ConocoPhillips (NYSE: COP), Statoil (NYSE: STO), Apache Corp. (NYSE: APA), ExxonMobil (NYSE: XOM), Cobalt International Energy (NYSE: CIE), Stone Energy (NYSE: SGY), as well as the floundering Hercules Offshore (NASDAQ: HERO) have all formally expressed interest to Interior regarding Atlantic oil and gas exploration.

The likely launch pads for Atlantic exploration could be the Hampton Roads/Norfolk/Newport News area of Virginia, which already hosts a massive port for international trade as well as a large naval base. The other port that could see an uptick in activity from a newfound oil presence would be the port of Charleston, South Carolina, which offers one of the busiest ports in the southeast.

Don't Forget About the Gulf of Mexico

Finally, the Interior Department decided to open up more acreage in the Gulf of Mexico, the linchpin of offshore oil development. The Gulf accounts for 97% of America's offshore oil production. Unlike in the past, where Interior has offered up periodic lease sales in the Gulf over specific sections, Interior has proposed in its 2017-2022 five-year plan to offer region-wide sales - Western, Central, and in limited parts of the Eastern Gulf of Mexico.

The change will make it easier for companies to plan. Also, as Interior notes in its proposal, Mexico is in the midst of a historic opening up of its energy sector, which is sure to attract significant interest from international companies. That could see a wave of offshore rigs moving from American to Mexican waters. Interior's reforms are meant to streamline lease sales to give companies added flexibility.

Whereas there are a lot of unknowns with Atlantic offshore, the Gulf of Mexico is a known entity. It has some of the most productive offshore acreage in the world, and the infrastructure exists to ramp it up further. Interior's latest proposal is a boon to the region, which should see an uptick in activity over the next lease period. In fact, the EIA predicts that while the shale revolution will begin to fizzle over the next five years, offshore oil production will only grow through 2035 at least (see chart).

Offshore development is costly, so is generally done by the majors. ExxonMobil, Shell, BP, Chevron, and ConocoPhillips have historically been the leaders. BP (NYSE: BP) has seen its position slip since the 2010 disaster, however. It just agreed to team up with Chevron and ConocoPhillips to jointly develop sections of the Gulf. In fact, Chevron, in taking over part of BP's ownership stakes, is emerging as one of the top Gulf of Mexico producers - it has made two major oil discoveries in the Gulf in less than a year.

Conclusion

Shale production has received the overwhelming majority of media attention in recent years, and for good reason. But offshore oil production remains a core part of U.S. output, and will continue to anchor the country's energy portfolio when shale's best days are in the past.

That is why the Obama administration's January 2015 regulatory shakeup in offshore oil will have such large ramifications. It may not alter the energy landscape in the short-term, but by opening up the Atlantic and other sections in the Gulf of Mexico, by the stroke of the pen the administration has altered the course of offshore development for decades to come.