On June 3, 1979, workers aboard the Sedco 135-F semisubmersible
drilling rig located in Mexico's Bay of Campeche removed pipe from
the Ixtoc-1 well to change the drill-bit.
During this routine process, oil and natural gas under
tremendous geologic pressure overcame the weight of the drilling
mud and the well blew out. The blowout preventer--a device designed
to close the well in the event of a just such an
emergency--activated but wasn't powerful enough to shear through
the thick pipe being pulled out of the well.
The result was devastating. Hydrocarbons gushing from the well
ignited at the surface, and the 63 rig workers, some injured and
burned, were rescued before the rig sank. Gas bubbling from the
well continued to burn on the surface long after the rig went
In the late 1970s, the Bay of Campeche was still a relatively
young hydrocarbon-producing region. The largest oilfield in this
area is Cantarell, a giant field discovered in 1976 that produced
more than 2 million barrels per day at peak production in
These young fields offered huge production rates because
reservoir pressures were still high and oil flowed rather easily
into wells. Although that was great news for the Mexican oil
industry, it represented a significant problem for Ixtoc-1; the
well gushed oil and natural gas into the Gulf of Mexico for some
Petroleos Mexicanos ((
)), Mexico's national oil company, made several attempts to plug
the Ixtoc well, including pumping drilling mud, scrap rubber and
other debris into the well under high pressure--the infamous
top-kill. PEMEX also installed a containment cap over Ixtoc in an
effort to collect some of the hydrocarbons flowing from the
But all of these efforts failed, and the well continued to spill
oil into the Gulf of Mexico until PEMEX completed two relief wells
that intersected the blown-out well. At that point the company was
able to pump mud and cement into the well to plug it
The bad news: It took PEMEX nearly 10 months to drill the two
relief wells and stop the spill. Over 290 days, the well gushed oil
at an uncontrolled rate. The Ixtoc spill is estimated at 3.3
million barrels (138.6 million gallons) of oil.
The Ixtoc disaster had a significant environmental impact. The
oil flowing from the well drifted into U.S. waters, and tar balls
washed onto Texas beaches. Mexican beaches also were heavily oiled;
the bird population suffered, and commercial fisheries had to be
closed for a time after the spill. Studies showed that biomass--the
quantity of animal life in the region--fell more than 50 percent
for some species in the immediate aftermath.
But most marine biologists who studied the after-effects of the
spill were surprised at how quickly the Gulf recovered. In the warm
waters of the Gulf, oil degrades at a far faster pace than it does
in colder conditions; the basic rule of thumb is that for every 10
degrees Celsius oil degrades at about twice the speed. Accordingly,
the oil spilled by the Exxon Valdez in Alaska took much longer to
break down than the oil in the Gulf of Mexico.
Oil and gas leaks into the Gulf and have occurred for thousands
of years. Oil naturally seeps from subsea reservoirs all over the
world; producers even look for natural seeps as an indicator of
good regions for further exploration. Although the exact amount of
oil seepage is unknown, estimates suggest that 1 to 1.5 million
barrels of oil (42 to 63 million gallons) leak into the Gulf of
Mexico each year. Here's a satellite image from NASA dated 2006
that shows several oil seeps in the Gulf.
NASA Earth Observatory
Mother Nature has a way of taking care of herself; the Gulf's
waters contain natural microorganisms that break down oil.
By most accounts, local fisheries had recovered to more or
less normal levels within two to three years after the Ixtoc-1
spill. Some believe that fishing bans in the wake of the spill
alleviated overfishing in the region and helped total
From Mexico to Macondo
The parallels between Ixtoc and the Macondo spill are clear,
from the failure of the blowout preventer to the operator's
attempts to slow or plug the well before the relief wells could
U.S. media coverage of the Macondo disaster has been almost
universally negative and sensationalist. And the Obama
administration, admittedly under intense political pressure, has
stepped up the rhetoric towards BP (
) and CEO Tony Hayward. The political rhetoric has become so
extreme that British government officials appear to be asking the
U.S. administration to tone down its comments directed at the
Don't forget that roughly 15 percent of total dividends paid
to U.K. pension funds come from BP. Demands by U.S. Congressmen
that the company eliminate its payout to shareholders until the
spill is cleaned up aren't falling on sympathetic ears in London.
Nor is the fact that so many Stateside insist on calling BP
"British Petroleum," though the firm hasn't been known by that
name in 12 years.
Amid all the bad press, anyone who dares to make a comment
that could be construed as vaguely favorable to BP risks being
labeled an apologist for the energy industry. Mindful of that
risk, I'll point out a few facts.
Macondo is likely to be a smaller spill than Ixtoc, though the
latter was technically a much easier spill to manage because the
water was only 160 feet deep and the well could be accessed by
divers and from the surface. Nevertheless, it took PEMEX 10
months to drill the relief wells and bring the gusher under
control. It's a testament to the improvements in oilfield
technology that relief wells located in 5,000 feet of water take
less than half the time to drill as they did in 1979.
And although PEMEX tried unsuccessfully to contain the spill
under a dome, BP's recent efforts to funnel oil to the surface
appear to have worked--an impressive feat given that this
particular containment system had to be installed remotely by
robotic submarines 5,000 feet beneath the surface of the sea.
But the press has made scant mention of Ixtoc. Most prefer to
call Macondo the largest spill in U.S. history and compare it to
the Exxon Valdez. Although this claim is likely true, the media
neglects to mention that BP's disaster isn't the largest spill to
impact the Gulf of Mexico.
Even assuming only modest success with containment and an
August completion of relief wells, the Macondo spill is likely to
be far smaller than Ixtoc.
Of course, differences between the two spills might increase
the Macondo's impact. That list includes the leak's proximity to
sensitive coastal wetlands and the fact that microorganisms that
break down oil are likely more active in shallower waters.
My point is simple: Macondo is an environmental disaster, but
investors must separate pre-election political rhetoric and
sensationalist media coverage from reality and history. Odds are
that Macondo will turn out to be far less of a disaster than BP's
most vocal critics suggest.
Disaster to Opportunity
Fortunately, emotion, widespread panic and misinformation
always create investment opportunities--I discussed some of these
opportunities in the May 7, 2010, installment of
Personal Finance Weekly
If we step back from the political and media circus, there are
two clear conclusions: The U.S. reaction to the spill will have
larger economic impacts than the spill itself, and crude oil
prices are headed much higher over the long haul.
On May 27 the administration extended a drilling 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 would 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
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
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 U.S.
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
). But most drilling contracts contain force majeure clauses that
are triggered if drilling is interrupted for a certain
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
And it's not just the rigs. Deepwater projects are extremely
service-intensive. Companies such as Schlumberger (
) and Baker Hughes (
) 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 (
) 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
Deepwater wells in the Gulf have a high decline rate--as time
passes, the underground pressures diminish rapidly and production
tails off. The near-term impact on output from the Gulf won't be
enormous because existing wells, many in relatively young fields,
will continue producing crude. However, over time the natural
decline rate of existing wells will begin to take over and the
production decline rate will accelerate. This will prove tough to
reverse if much of the deepwater Gulf production infrastructure
exits as a direct result of the moratorium.
More broadly, deepwater is the final frontier for the energy
industry, one of the only areas where there has been a good shot
at actual oil production growth in coming years.
Total U.S. production of oil has declined from 7.38 million
barrels per day in 1990 to around 5.6 million barrels day in
2010. Onshore production in the lower 48 States plummeted 1.7
million barrels per day, and Alaskan output was down 400,000
barrels per day; only deepwater production has grown, up nearly
1.5 million barrels per day. All estimates for current U.S. and
non-OPEC oil production growth will need to be revised lower in
the wake of the moratorium. That means more dependence on OPEC
oil and higher oil prices to come; I expect oil to hit $100 a
barrel by year-end.
As you might expect, the Macondo spill has been an ongoing
focus in my dedicated energy advisory
. The opportunities are enormous. One deepwater drilling firm I
recommend has minimal exposure to the Gulf, but its stock has
sold off with the rest of the sector. Shares of this driller
offer a dividend yield near 12 percent, and I expect this payout
to increase 20 percent over the next 12 months.
And with the deepwater Gulf on the back burner for at least
the next six months, money is flooding into my favorite plays in
the onshore U.S. market.
Wall Street Breakfast: Must-Know News