Offshore drillers face more government and higher costs. But that’s where the oil is.

By Chris Kahn, AP
Tuesday, May 25, 2010

Offshore drilling here to stay, but changes coming

NEW YORK — BP’s massive oil spill in the Gulf of Mexico has focused attention on the petroleum industry’s loose regulation and failure to plan for the worst.

That is going to change, experts say.

Regulators are likely to make permitting, inspections and equipment requirements for rigs more stringent. Lawmakers want to extract more money from the industry to help pay for any future cleanups. And insurers are bound to raise rates for underwriting this risky business.

The increased scrutiny — and cost of doing business — is all worth it, says longtime oil analyst Fadel Gheit of Oppenheimer & Co.

“This is a vital industry, and we just can’t allow it to self-destruct,” Gheit says.

What won’t change, experts say, is the industry’s expanding pursuit of oil and natural gas deposits under the ocean floor. Global offshore oil output has tripled over the past decade — and it is forecast to double in the next five years. The reason is simple: the best prospects lie beneath the ocean floor.

Since the April 20 incident, millions of gallons of oil have leaked into the Gulf despite efforts by BP to stanch the flow. Multiple congressional hearings have been held, and federal investigators are looking into what caused the oil rig Deepwater Horizon to explode. A government report supported President Obama’s accusation of a “cozy relationship” between regulators and the industry.

Regulatory and industry responses that change the future of offshore drilling won’t be known for some time. But experts say the following are likely:

— Tougher permitting and inspections. U.S. regulators may ask offshore companies to present more concrete plans for dealing with blowouts like the one that sank the Deepwater Horizon. Once drilling begins, the frequency of inspections could increase. What the U.S. decides could influence policies in other countries like Brazil that have significant offshore drilling industries, says Christopher Garman, director of Latin American analysis at the Eurasia Group in Washington.

— Higher rates for taxes and insurance. The Obama administration wants to boost by one penny per barrel the tax oil companies pay for the Oil Spill Liability Trust Fund. That could cost the industry several million dollars a year. Also, premiums could jump 25 to 30 percent for property insurance, while the rate on a liability policy could rise up to 200 percent, says Jay Gelb, an insurance analyst with Barclays Capital.

— Additional safeguards on drilling rigs. The Deepwater Horizon’s blowout preventer failed to seal the well. Manufacturers could be forced to overhaul these devices to ensure they function at extreme pressures and depths along the sea floor. The U.S. may require more redundancies, such as remote shut-off switches popular in Norway, to ensure the blowout preventer works, Robert Johnston of the Eurasia group said in a research note.

New safety measures will make drilling more expensive, but oil giants like BP shouldn’t have trouble picking up the tab, analysts say. For example, the additional safety equipment commonly used on rigs off the coast of Norway can cost $30,000 to $50,000 more than what drillers in the Gulf commonly use. To put that into perspective: oil companies routinely pay up to $500,000 a day to lease an offshore rig.

Some companies could be discouraged by more onerous rules, however. Greek shipping company Tsakos Energy Navigation this week said it has dropped plans to enter the deepwater drilling industry in the U.S. The CEO cited the prospect of stricter regulations.

But Big Oil — companies like BP, Chevron and Royal Dutch Shell — won’t pull up stakes anytime soon.

“Over the next decade, we’re not going to have any less cars on the highway,” said John Hofmeister, former president of Shell Oil Company and author of “Why We Hate Oil Companies.”

Worldwide, offshore oil production now exceeds five million barrels per day, according to IHS CERA. That’s 6 percent of global demand, up from 2 percent in 2000. In the U.S., nearly one out of every three domestically produced oil barrels comes from the Gulf — and BP is the biggest player in the region.

Congressional support for offshore drilling has wavered since the April 20 accident, but Obama insists that increased offshore drilling will be an important part of U.S. energy policy.

Oil drilling comes with huge risks, but “we don’t have alternatives ready to be deployed tomorrow,” says Greg Stephanopoulos, an MIT biotechnology professor.

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