Kent Moors, Ph.D. writes: Although the global energy sector is entering its most-promising stretch in decades - with more new technologies and more investment opportunities than ever before - I just can't seem to get away from BP PLC (NYSE ADR: BP) and its problems.
Take last Thursday, for instance. I began the day at FOX Business News, where the interviewer wanted me to explain what will happen if the BP relief wells fail. Then I spent an hour as the guest on a radio talk show from Johannesburg, South Africa, detailing what options are available to BP. Later still, I served as a consultant to a Wall Street investment crew - via conference call - once again on the status of the BP relief wells.
The BP relief wells are right now the dominant topic on everyone's mind. But there are two potential scenarios - of "nightmare proportions" - that investors need to know about.
Let me explain...
Problem No. 1: The Armageddon Scenario
Although news on BP's early success with a new oil-well cap really helped fuel investor optimism yesterday (Tuesday), the reality is that two other potential problems are unfolding.
And both will certainly affect how you invest in the oil sector.
In the days and weeks to come, the question that will dominate headlines is a simple one: Will the BP relief wells succeed?
I'm still giving the company no better than a 50-50 chance.
Surprised? Don't be. Take a step back and really think about what BP needs to do.
The bottom of the production casing (what's left of it) for the blown Macondo-1 Well is 18,360 feet down - about 5,000 feet of water followed by 13,000 feet of seabed below. The relief wells are going to intersect the current pipe at about 17,500 feet down. The idea is to interrupt the oil flow and then stop the leak by pushing down a considerable amount of drilling mud and fluid. This is called a "dynamic kill." It is not intended to stabilize the well for later production - it's intended to end it for good.
But this outcome is hardly a certainty. To put it in perspective, BP needs to drill down three miles - having to do so blind for the more than 70% of the operation that is below the seafloor - while hitting, at the correct angle, a target no bigger than a salad plate .
What if the leak cannot be plugged?
The relief wells may still siphon off some of the oil flow, but the leak will continue for quite some time.
The legendary oil firefighter Red Adair gave a series of lectures in Scotland, just as deepwater drilling was beginning in the North Sea some 30 years ago. Somebody asked him then the same question people ask me today: What happens if a relief well cannot stop a blowout?
His answer was direct: Nature will ultimately decline the pressure of the leak to a point at which the well can be capped. However, he added, that would take about three years.
Now here's my answer. Based on flow rate and initial BP production estimates, my current projection holds that, should the relief wells fail, a 1,015-day continuous flow awaits before the blowout suffers a natural death. That's about two years and nine months of spilling oil.
Additional relief wells would certainly be attempted in the interim. But each attempt would take two months or more.
Keep in mind, this is all dependent on whether the structure remains intact. And this introduces what is beginning to worry me more and more with each passing day.
I call it the "Armageddon Scenario."
We can see in the video feeds that the blowout preventer (BOP) is intact. It sits on top of the wellhead. The leak comes from the place where the connection between the BOP and the riser pipeline used to be.
What we cannot see is the stability of the production casing below the wellhead. We don't even know how much of that casing remains intact. The increasing oil flow over the past few weeks may provide some concerns about the continuing integrity of the well structure below the surface. If it begins to concave, the pressure will cause it to rupture, with debris and an accelerating oil flow moving into what is already a compromised annulus (the space between pipe and borehole surface) filled with cement. We already know the cement has fissures - that seems to be how the gas bubble reached the surface to cause the initial explosion back on April 20th.
Ruptured casing would cause the collapse of the surrounding ground, producing an implosion, a widening sinkhole, and a rapid rush of oil up to the surface.
Estimates now put the oil flow at as much as 80,000 barrels a day - including the volume being captured by BP. In my "Armageddon Scenario," that figure would immediately double or even triple. And any attempt to combat that kind of spill, either on the surface or at the shoreline, would be futile and pointless.
Let's hope that doesn't happen.
Problem No. 2: A Severe Global Oil Shortage
Even if the production casing remains intact, and Armageddon is avoided, there is another major difficulty coming into focus.
All indications point toward deepwater drilling as the source for a rising amount of crude oil needed internationally. This is the reason companies are assuming the great risk and expense of drilling considerably offshore - because that's where you find most of the major fields left undiscovered. The only net additions to U.S. production through 2015 were to come from deepwater drilling (800 to 1,200 feet) in the Gulf of Mexico. Worldwide, it was expected to accelerate - off of Brazil, Vietnam, Nigeria, Ghana, Russia, and a number of other locations. In five years, deepwater drilling was to have made up 10% to 12% of all global production.
And now, this is where the oil market impact of the Macondo blowout could have its most serious effect.
We are slowly moving out of a financial crisis that significantly cut oil demand. As the economic situation stabilizes, that demand will begin to return. It has already begun in a number of regions.
Total present worldwide crude supply tops out at about 91 million barrels a day (mbd), counting all of the Saudi spare capacity. Current demand is about 86.5 mbd - and rising.
Increased volume from deepwater drilling is an essential part of bringing additional supply online to meet that increasing demand. (Remember, the decline in demand resulted only from an international financial crisis. Not a sudden change in the oil market itself.) The collapse in oil prices in the fourth quarter of 2008, and their leveling off in the first quarter of 2009 - a period of less than six months - actually resulted in delaying new drilling by as much as two years.
Now, as demand levels surge, supply is questionable. That magnifies the problem from the BP spill. It is not the volume lost from that well alone. Rather, as the Macondo experience causes a rethinking of deepwater-drilling-production plans, the tragedy may result in the loss of a far greater volume of supply from elsewhere around the world.
With the demand-supply balance becoming a concern, another BP failure - this time at capping the well - would have widespread impact. And none of it will either lower prices or increase the available oil.
Against my better judgment ... all this leaves me with no choice but to root for BP.
[Editor's Note: Dr. Kent Moors, a regular contributor to Money Morning , is the editor of "The Oil & Energy Investor," a newsletter for individual investors. In a career that spans 31 years, Dr. Moors has been consulting the energy industry's biggest players, including six of the world's Top 10 oil companies and the leading natural gas producers throughout Russia, the Caspian Basin, the Persian Gulf and North Africa. His experiences - as well as his unrivaled industry access, contacts and insights - will serve as the foundation for the Energy Advantage, an advisory service that debuts this week. For more information on that service, please click here.]
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