Thursday, October 13, 2005

The Hurricane Scenario

A train ride to D.C. provided an opportunity to catch up on my large backlog of articles, including this one from the New York Times (which alas is now in their paid archives) on the impact of hurricanes on offshore oil production in the Gulf of Mexico. As it happens, the article was written a few weeks before Katrina and Rita swept through the oil patch. The hurricane damage it described was from last year’s Ivan, which caused disruption to oil and gas operations that had not been entirely repaired a year later, but the comments apply to the current storms, as well. After several months, it’s possible to consider the long-term effects of all these storms, including the influence of what I’d call “the hurricane scenario” on future global oil production.

Once a hydrocarbon reservoir has been discovered and its size estimated, the economics of producing the oil or gas it contains must be carefully evaluated. This process has become much more sophisticated over the years, incorporating market and expert assessments of future energy prices and all the risks that could affect a project's economic viability. This kind of detailed analysis is crucial when a billion dollars or more of investment and many hundreds of millions of Net Present Value are at stake.

The Gulf Coast hurricanes of 2004 and 2005, and the prospect of a pattern of such storms for years to come, will explicitly shift the risk assessment for the large platforms required to exploit oil and gas in the deep waters of the Gulf. Developers will have to consider scenarios in which each platform would experience a Class 4 or 5 hurricane every couple of years for the next 10-20 years. This will change the economics of oil platforms in important ways, by increasing the cost and complexity of these projects, as well as elevating the risk of substantial delays in project startup--one of the top influences on project NPV.

Now, this all sounds pretty esoteric, and you might think it’s only important from the perspective of higher insurance rates for oil companies. But it would also shift the economic breakeven point of deepwater oil and gas projects toward the larger end of the size distribution of fields. In other words, some fields that today are just big enough to support development under last year’s criteria would become too small to be economical, even at high energy prices. That would truncate the long-term production potential of the deepwater Gulf, which is the most promising and prolific area in the US oil & gas industry and may contain up to 70 billion barrels of oil equivalent. That means lower future US oil production, higher imports, and more pressure for both conservation and the exploitation of non-conventional resources (see yesterday’s posting.) Not good news for energy consumers.

It’s going to take months to sort out all of the impacts of these storms. In the hierarchy of consequences, the fallout I’ve described above will probably be much less noticeable than the cost of heating our homes this winter. Despite this, it will subtly reshape our options for solving our energy and environmental challenges, in ways we can't predict today.

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