Koil Energy Solutions Inc. (KLNG)

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Full-Bore Quest For Oil, Gas Alan R. Elliott
Fri Jun 13, 6:00 PM ET

http://news.yahoo.com/s/ibd/20080613/bs_ibd_ibd/20080613industry

When BP announced on June 10 that its massive Thunder Horse offshore oil and gas production facility would ease into operation June 14, the milestone came both ahead and woefully behind schedule.

At 120,000 tons, the Thunder Horse platform is arguably the largest moored semisubmersible vessel in the world. It reaches through mile-deep seas to 25 wells on the ocean floor. Each well bores another three miles down through ice, mud and rock.

Equipment from companies like FMC Technologies (NYSE:FTI - News) links the wells into a subsea complex roughly the size of Houston.

Hurricane Dennis dealt Thunder Horse a critical blow in July 2005, leaving the platform listing wildly into the Gulf. The blow stalled the project's original 2005 start date.

A year later, further delays. Tests revealed cracks in one of FMC's massive manifolds on the seafloor. Equipment engineered to take on scorching hot oil grew brittle as it sat dormant at super-chilled sea-floor temperatures.

BP (NYSE:BP - News) pulled all its ocean bed hardware and re-engineered it to higher specs. The glitch pushed the planned launch date back to late this year. A startup this weekend would put production well ahead of that delayed timetable.

In spite of costs estimated in the tens of millions of dollars to lift and re-manufacture the equipment, BP said the biggest loss would be in delayed production.

Thunder Horse is designed to process 250,000 barrels of oil a day, worth about $32 million.

The project and its challenges spotlight an industry banking on untested technology.

As super-major oil operators move further into ultra-deep-water projects -- seeking large-scale oil and natural gas reserves beyond the influence of political upheaval -- FMC and its peers are outfitting what is probably the most ambitious undertaking since the space program.

"What we are seeing offshore represents the greatest technical achievement of our civilization," said Richard Mason, publisher of the Land Rig Newsletter. "I think it is actually more complicated than trying to send something to the planet Mars."

1. Business

The race this time is not into space. Oil production in many key regions is declining from dwindling reserves or from exploration and development shortfalls caused by government takeovers.

Large, integrated producers are in a race to provide fuel for heat, electricity and transportation to consumers in the U.S., Europe, China, India and Brazil.

They are racing to increase production, to prevent energy prices from spiraling beyond reach and to keep nations that are net oil importers from becoming more deeply beholden to the oil exporters of the world.

They are also racing to boost profit for their shareholders as oil prices arc into record territory.

FMC and peers including National Oilwell Varco (NYSE:NOV - News), Weatherford International (NYSE:WFT - News) and Cameron International (NYSE:CAM - News) are the enablers of this race. They serve the major oil producers in much the same way that aerospace contractors served the Mercury and Apollo space missions -- providing engineering and research expertise, and the ability to manufacture to demanding specifications.

The group also supplies mid- and smaller-tier producers with the compressors, mud pumps, blowout valves and drill pipe needed to drill and develop oil and natural gas fields.

Name Of The Game: Global reach and best-in-class engineering and manufacturing capabilities are key in the offshore market. The land business is more close-knit, more regional, but still relies on top-shelf technologies, equipment and services.

2. Market

Drilling activity is a huge driver of demand. In North America, about 80% of the active rigs are pursuing natural gas; 20% are chasing oil. Modest shifts in natural gas prices can make or break a boom.

Offshore and overseas, projects tend to be more durable. That's particularly true with the major producers, who set spending plans based on long-term production horizons.

Offshore exploration and drilling have also been the biggest drivers of growth in recent years, especially in the U.S. Gulf of Mexico, Latin America, Asia and the Middle East. West Africa has become a bigger market, too.

3. Climate

We have entered an age where oil price forecasts are worthless. The Energy Information Administration's May 2007 energy outlook called for a steady increase in oil prices to $100 a barrel by 2015. Its short-term outlook, released June 10, called for an average of $122.15 a barrel this year, climbing to $126 in 2009.

Crude oil futures climbed to near $138 a barrel last week.

No one knows what happens next. The real possibility of further declines in the dollar have top-flight investment names like Goldman Sachs (NYSE:GS - News) banking on oil making further gains. But the oil industry is led by old hands that have watched prices crash repeatedly through the years. Once crashed, prices have sometimes taken as long as a decade to recover.

Still, oil companies have to forecast prices to plan investment and book production-sharing contracts. Each operator determines their own price to use as a guideline, says Joseph Stanislaw, senior adviser to Deloitte & Touche's Energy & Resources practice. But all show a healthy skepticism toward the current boom.

"If I had to plan future developments, I would plan a field around $75 oil," Stanislaw said. "If I were budgeting my current cash flow for this year, I would say $85 maybe $90."

4. Technology

Deep-water development may be the industry's most inspiring feat. But evolving technology and grasp of geology are also fueling dramatic onshore advances.

Drillers once limited to boring straight down can now drill down a mile, out horizontally another mile and nail a target the size of a coffee can. This means reserves once chased through multiple, straight-down well bores can be drained from a single shaft.

In addition, the industry is rapidly gaining experience in extracting gas and oil once thought inaccessible in "unconventional" formations like shale.

The Barnett shale beneath Houston became a kind of laboratory for shale production research, spinning off technologies and techniques now being put to use across North America.

Those include fracture and stimulation methods that require equipment, materials and services supplied by companies in the machinery and equipment group.

"We are still very early on the learning curve," Mason said. "Our ability to produce natural gas from ever-crummier rocks and more difficult formations is going to improve, and maybe improve dramatically over time."

5. Outlook

Soaring energy prices have launched a bonanza among drillers in North America and overseas. Explorers and producers are sinking more wells. Drilling contractors are building more rigs.

"Initially we were estimating the (land rig) fleet would add four or five dozen units this year," Mason said. "Now it looks like it's going to nearly double that."

Supplies are tight and prices are climbing for rigs, materials and, above all, skilled labor.

The latest Upstream Capital Cost Index -- the consumer price index for the oil field -- from IHS/Cambridge Energy Research Associates shows the costs of developing a new oil or natural gas field more than doubled in four years.

The cost of a deep-water drill ship rose from $125,000 per day four years ago to more than $600,000.

That inflation is cramping the expansion of many smaller players.

A stream of new offshore rigs set to come on line later this year will give the shallow-water segment of the market its biggest boost in 15 years, placing downward pressure on rig rates, according to offshore rig analyst Jeremy Antonini with Rigzone. But supply of and prices for deep-water rigs and equipment will remain tight for the foreseeable future.

In the land market, new shale finds and more producers entering the game have kept pricing firm.

But Mason cautions that demand hinges on natural gas prices. Natural gas prices are tightly linked to supply vs. demand.

And the threat of oversupply increases as rig counts swell and producers crowd into the market. That balances the North American natural gas industry on a tight rope between boom and bust.

"The difference between a tight market and $12 gas vs. a very loose market and $6 gas is really about four weeks of activity," Mason said.

Upside: Most analysts see continued demand for hard-to-reach oil and gas as emerging economies such as India and China grow.

Risks: Oversupply remains a concern among many oil-industry veterans, especially as more rigs and producers crowd the market.