Douglas C. Nester, COO, Prime Offshore LLC
From July to November is that time of the year when the heat of summer transitions into the cold of winter. It is doubtful that anyone in our industry recognized how cold the winter of 2008 would become. As the summer heat peaked in July, we were delirious with the unexpected record oil prices of $140 per barrel and record profits that went along with them. In August and September, we winced as four major hurricanes entered the Gulf of Mexico, with the last one, Ike, causing extensive damage across the shelf. By October, we watched in dismay as the record prices of summer tumbled at ever-increasing velocity to $55 by the beginning of November. On Nov. 4, the United States elected its 44th president, a man who holds much promise but who supports an energy policy that may impede our industry. As the cold winds of impending winter blow across us, we sit numb and witness the world as it suffers through a global economic recession whose bottom has not yet been defined.
So in less time than Mother Nature can snap her fingers, our world and our industry are changing. While we do not know to what extent our industry will ultimately be affected, we can look at the last four months and identify existing conditions that are impacting independents presently working in the Gulf of Mexico.
Extensive hurricane damage. News concerning the amount of offshore and onshore damage caused by Hurricane Ike moved to the back page as the crumbling economic crisis began to dominate headlines. As a result, few outside of our industry appreciate the severity of destruction and production disruption that this storm has caused. The Minerals Management Service (MMS) reports 54 platforms destroyed. Another 35 have extensive damage, and 60 more have moderate damage. One oil pipeline and eight gas transmission pipelines are also damaged. Based on salvage and repair requests made to offshore construction companies, these numbers are expected to rise over the next few months.
Two months after the storm, nearly 19% of oil production and 28% of gas production in the GOM remain shut in. While the existing damage will provide business growth for some service companies, the impact of lower production volumes at a time of lower commodity prices will significantly hurt producers. This impact will become more evident as companies present their fourth-quarter 2008 financials in early 2009. In an effort to manage expectations, companies are already providing press releases concerning the lowering of performance projections for 2009.
Hurricanes Dolly, Eduard, Gustav and Ike will also reverse the favorable trend of declining insurance rates that we have enjoyed after consecutive years of no storm damage in the Gulf. Already the largest loss-of-earnings expense carried by offshore operators, these storms will cause insurance premiums to increase during 2009 renewals.
Credit crunch especially hard on independents. The ongoing credit crisis has already taken down some of the largest and most prestigious financial institutions in the US. Gone are the likes of Lehman Brothers, Merrill Lynch and AIG. Remaining financial bellwethers such as GE and Goldman have scrambled and restructured to protect their AAA ratings.
As the crisis cascades down to corporate banks, our industry’s access to new capital has all but disappeared. The few remaining bankers available to GOM independents are all holding similar lending positions. They will maintain existing portfolios but are not looking to take on new customers, and will only consider funding projects whose capital requirements occur in 2009, or preferably 2010.
Without access to clearly defined sources of financing, companies are beginning to scale down, delay or abandon planned projects for 2009.
For independents that use reserve-based lending to finance ongoing operations, the tightening capital markets could not come at a worse time. Already suffering from lower revenues due to the combination of storm damage and lower commodity prices, some companies are now facing a reduction in their borrowing base. This is occurring as banks apply lower price decks to those reserves that remain on production. Companies with significant production losses may have difficulties maintaining the cash flow necessary to service these newly set debt levels.
Opportunities to the patient. For many independents, 2009 will be a time to hunker down and preserve capital. The recent announced stacking of jackups by a major rig company is evidence that companies are indeed following this strategy. I strongly believe, however, that great opportunities occur in times of great adversity. Corporate growth in 2009 therefore remains possible, even in an environment expected to contain tight credit markets, lower commodity prices and a potentially prolonged recession. Companies that are patient, disciplined and have access to capital will find ways to access new opportunities.
Utilizing capital as a competitive advantage, companies will be able to leverage themselves into projects that are being delayed or postponed by others. Those with access to capital will also find acquisition opportunities from those whose are seeking to reduce debt levels and gain better cash positions. As the price collapse of the 1980s stimulated a frenzy of mergers, I expect that 2009 will see a number of mergers as well.
As our industry is bundling up against the cold outside, we can take solace that spring follows even the harshest winter. While today’s financial crisis is unique, our business has been, and will continue to be, cyclical. If springtime is proportionate to the severity of the oncoming winter, I greatly look forward to its arrival. 
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THE AUTHOR
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Douglas C. Nester, COO of Prime Offshore, is responsible for the company’s operations and new venture activities. He previously worked for Pennzoil, 3DX Technologies Inc. and, most recently, Devon Energy. Mr. Nester earned his BS degree in geology from Indiana University of Pennsylvania, and performed his graduate studies in geology at the University of Houston. He earned an MBA in finance from the University of St. Thomas in Houston.
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