Douglas C. Nester, COO, Prime Offshore LLC
Things may be looking up in 2010 for independents operating in the Gulf of Mexico. Whether it was all the knocking on wood, the burning of incense or perhaps the selling of souls, it appears that Gulf operators made it through a complete insurance period without any catastrophic windstorm loss. Combined with bullish oil prices for much of the year, more stabilization in the credit markets and low service costs, the emerging environment seems to be supportive of activity growth. Although this is all very enticing, I wonder which companies will be the ones to step up, dive in and take advantage of the opportunity.
A dangerous one–two punch. Although we had a quiet 2009 storm season, the combination of insurance costs and abandonment liabilities continue to create a one-two punch that is capable of knocking out any company operating in the Gulf of Mexico today. Lingering anxieties associated with tropical storms, high abandonment liabilities and aging facilities on the shelf have resulted in the Gulf of Mexico being considered more “out of favor” by insurance underwriters and bankers than perhaps ever before.
Operators are anxiously waiting to see how the calm 2009 hurricane season will impact their 2010 insurance renewals. The question on everyone’s mind is: Will this past season be enough to help reduce the impact that Ike had on the insurance industry in 2008? Having caused the destruction of 54 platforms and damage to 95 more, that storm produced over $3 billion in claims during a year in which only $1 billion of premiums were collected. As we all know, Ike occurred only three years after Katrina and Rita destroyed 105 platforms and damaged 52 others. Since 2004, there have been over $12 billion in claims in the Gulf of Mexico and only about $4.2 billion in premiums collected.
Due to this history, pricing for windstorm insurance in 2009 increased on average by 75–100% per policy. Based on new asset scheduling requirements, 2009 windstorm policies included a reduction in the aggregate coverage and an increase in retentions or deductibles maintained by the company. The combination of dramatic cost increases and reductions in coverage was more than many in the industry could bear. As a result, only 70–80% of the available 2009 windstorm capacity was actually sold, as companies made the difficult decision to self-insure their assets.
The ability to secure insurance in 2010 will remain in a precarious balance. With underwriters collecting lower than desired premiums in 2009, there is, on one hand, some pressure on the insurance companies to increase coverage and perhaps even reduce rates in 2010. On the other hand, we likely remain one destructive storm away from having a sizeable portion of the insurance capacity leave the Gulf of Mexico entirely.
Little 2009 activity. Beaten down by depressed gas prices, a collapsed credit market and continued facilities damage from Ike, operators executed only minimal exploration and development programs in 2009. Compared with 2008, there was a 46% reduction in the number of wells permitted. Exploratory wells drilled dropped from 51 in November 2008 to 27 in November 2009, a 47% decrease. Development drilling dropped from 53 wells to just 25, a 53% decrease, during the same period.
Jackup utilization at the beginning of November totaled 32%, and the rig count is 42% below what it was for the same period in 2008. Recent contracts and an increase in bid requests suggest that there will be an upturn in Gulf of Mexico drilling during 2010. These early indicators may lend support to the belief that the cost of drilling services has bottomed out on the shelf. The increased activity is also being reflected in dayrates, which are reported to have increased by about 15%.
Access to capital remains tight. One challenge that will continue to hamper independents operating in the Gulf of Mexico during 2010 will be access to capital in the form of reserve-based borrowing. The contraction of available debt lenders has continued throughout 2009. Perhaps the most recent, and certainly the most visible, example of this contraction was the recent collapse of Guaranty Bank, once known as one of the premier offshore lenders. It remains uncertain if the acquiring bank or another lender will step in to fill the void. Acting almost in unison, remaining lenders have shown a reluctance to add new offshore clients or even increase outstanding loans to existing clients in 2009. At this time there are no indications that this trend will change in 2010.
Continued exodus off the shelf. For the last decade, there has been a steady exodus of companies from the shelf. This exodus is clearly going to continue through 2010. Some will remain offshore and transition their focus to the larger reserves found in the deepwater areas. Others will leave to chase the longer-life reserves found onshore. I believe that 2010 will also see some leave simply because they believe the rewards remaining in the Gulf are no longer worth the high operating costs, risk of tropical storms and abandonment liabilities associated with aging properties.
This risk aversion is seen across all sizes of companies. One can assume that Devon’s recent announcement to exit the Gulf was in part driven by this aversion. While this may sound gloomy to many, it is an opportunity call for contrarian thinkers who are financially capable of stepping in to fill the void. In addition to being well capitalized, these contrarians will likely be private independents, which are not tied to the same volume and production replacement matrices by which public companies are measured.
A big question to be answered in 2010 is: Are there enough well-funded contrarians to absorb all the assets and liabilities of those leaving the shelf? While we wait on that answer, some of us who already think the water is fine are looking forward to big things in 2010. 
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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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