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Deepwater GOM Bucks Low Prices, Big Projects Ramping Up

The deepwater Gulf of Mexico (GOM) is proving to be a haven for big producing projects, and it's bucking the low-price environment, with growth expected to continue through 2016, according to Wood Mackenzie Ltd.

Momentum began in 2014, which marked the first year of production growth since 2009, and that should push growth this year, said senior research analyst Jackson Sandene, of Wood Mackenzie's GOM Upstream Oil and Gas. Six projects are scheduled to come online this year, bringing an additional 177,000 boe/d in new production. The number of rigs contracted also is close to record levels.

For the fifth year in a row, development capital expenditures in the deepwater are projected to increase, reaching a record $14.9 billion, Sandene told NGI. Production is projected to be 23% higher year/year and hit 1.6 million boe/d.

"We're approaching the end of a massive investment cycle in the Gulf of Mexico," Sandene said. Investments "have been trending upward in the past five years."

Last November, Wood Mackenzie projected output from the deepwater GOM to peak at 1.9 million boe/d in 2016, surpassing a previous record set in 2009 (see Daily GPINov. 13, 2014). "What you are seeing is a number of developments that are starting up first production."

In the past six months, deepwater developments starting up have included Chevron Corp.'s Jack/St. Malo and Tubular Bells (see Daily GPIJan. 31Nov. 18, 2014). The Anadarko Petroleum Corp.-operated 80,000 b/d Lucius spar began producing last fall, and its twin Heidelberg spar is on track to achieve first production in 2016 (see Daily GPIJune 30, 2014Jan. 22, 2014). Start-ups this year also include BP plc's two new producing wells at Thunder Horse (see Daily GPI, Feb. 4).

"Operators love the Gulf of Mexico" because of its high volume fields and high margins, among other things. "The question you have to ask yourself is where else are you going to get those different things when you talk about global exploration offshore?"

Several greenfield developments have been sanctioned or are scheduled to come onstream this year and next year, Sandene said. "So really what you're seeing is continued spend on those projects and the resulting production impact for those start-ups."

What makes the deepwater GOM so attractive is the long lead time for development. The projects set to begin operations were sanctioned several years ago, with capex already spent in a higher commodity environment.

For example, Lucius, Jack/ St. Malo and Tubular Bells had breakevens of $10-50/boe at first production last year, Sandene noted. "The advantage in point-forward breakevens for sanctioned projects is significant compared to some projects still in pre-final investment decision (FID) phase. Those projects may now have breakevens as high as $60-80."

The GOM should "defy the overall trend and sentiment in the lower oil price environment," said the analyst. GOM developments "are less impacted by short-term oil price uncertainty because they are for 30-40 years...While onshore shale wells can decline as much as 80% on an annual basis, the typical offshore well decline is 30%."

Producers working in the offshore "pre-drill a number of wells before starting first production so by the time you finally get production, you have all that capital behind you. The point-forward breakevens are relatively low. That's why you see these sanctioned projects continue to move forward even in light of the lower oil price environment."

As it stands in the current price environment, the GOM "is bucking the trend of decreased drilling and massive capital spend reductions. However, if the low oil price persists and operators can't develop unique ways to decrease the capital required for new projects and/or improve recovery rates, projects will slip and it will be difficult for the region to sustain a high level of activity and maintain production growth. "

Deepwater projects that include Kaskida, North Platte, Shenandoah and Tiber "have point forward breakevens in the $70-80 range as currently modeled," according to Wood Mackenzie. "All of these projects possess high development costs, but there is value to be found in the large reserve size." Wood Mackenzie's current price forecast puts the base case valuation for these fields at a price of $6 million to $1.5 billion, net present value at a 10% discount rate (NPV10). "However, if we hold the oil price at $60/bbl permanently, the base case for these fields drops to the range of $1.7-1.1 billion, NPV10."

The Lower Tertiary Trend, where Jack/St. Malo ramped up, is drawing a lot more explorers, based on recent Department of Interior auctions (see Daily GPI,March 18). However, it's still a "mix" of sanctioned projects in different areas of the GOM.

"If you are going to talk about projects that are going to start up toward the end of the decade, the early 2020s, those are predominantly Lower Tertiary projects," Sandene said. "A lot of those fields are pre-FID currently."

A continued low oil price environment could  impact the economics of projects that haven't been sanctioned. "It's very difficult to justify sanctioning some of these projects given the high breakeven costs," he said. Still, there's a window for many of the producers because some in pre-FID still need more appraisal. "Operators aren't necessarily in a rush right now to get these things sanctioned. They are still trying to evaluate the reservoir properties."

Development costs are high and well performance is uncertain, which makes the Lower Tertiary "most vulnerable should the oil price remain low. The reserves potential in the play is high, but if the projects are uneconomic, it's possible that operators won't develop these existing projects, much less continue exploring in the play."

New entrants and smaller explorers may find it rough venturing out "in a place like the Lower Tertiary unless you have the capital and a long time horizon," Sandene said. "Some of these projects are $10 million projects and it takes you 10 years from discovery to first production. When you talk about that type of development, it's typically reserved for your majors and large caps. That's not to say that smaller players can’t get involved in the deepwater Gulf of Mexico. We've seen smaller players…making it work with more of the conventional-type developments, such as through joint ventures.”

Because of the massive influx of newbuild rigs in the GOM, mobile offshore drilling units, or MODUs, "are operating at almost record levels with rigs contracted for development drilling leading the activity." However, the smaller independents "have less flexibility for shuffling rig activity given portfolios limited in scale." The majors "can re-direct rigs globally within the portfolio," but the "GOM is seen as a core area for several players. The current environment presents a counter-cyclical opportunity for players with strong balance sheets that can capitalize on lower rig and service costs."

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