BP's Mad Dog 2 Highlights Big Challenge for Oil Majors

British oil giant BP (NYSE: BP  ) recently announced that it may delay Mad Dog Phase 2, its largest new oil project in the Gulf of Mexico, due to market conditions and industry inflation.

The Mad Dog field is located in the southern Green Canyon area of the U.S. Gulf of Mexico, approximately 190 miles south of New Orleans, at a depth of about 4,500-6,800 feet. It is estimated to hold between 200 million and 450 million barrels of oil equivalent.  

BP's current plans for the second phase of Mad Dog include constructing a spar floating system with infield flow lines and other subsea infrastructure that would connect subsea production and injection wells, as well as export pipelines that would link to BP's existing Mardi Grad pipeline system, which moves offshore production to shore.  

Mad Dog 2 is classified as a "mega project" – one that requires gross capital investment greater than $10 billion. Its construction was slated to begin by the end of this year, with BP suggesting the project would begin pumping oil before the end of the decade.  

But now, faced with rising development costs across the oil and gas industry, BP is reevaluating how to proceed with the venture. It is working closely with the project's co-owners, Union Oil Company of California – a wholly owned subsidiary of Chevron (NYSE: CVX  ) – and BHP Billiton Petroleum, to arrive at a decision.

A plunge in the price of oil, which has fallen by about $10 since the start of the year, may also be a reason behind BP's hesitation to proceed with the project this year.

Mad Dog 2 is the company's biggest attempt to revive its once-booming operations in the Gulf of Mexico, which came to a standstill following the infamous Macondo oil spill. If Mad Dog 2 is indeed delayed, BP's Gulf of Mexico business, which accounts for about 10% of the company's global output and was once considered a core growth engine, will likely suffer for a lot longer.  

Cost overruns a big hurdle for oil majors
The issues surrounding Mad Dog 2 are illustrative of one of the biggest challenges facing the oil and gas industry – cost overruns and delays. Projects running over budget and taking much longer than expected are starting to become an industry norm, especially those in deepwater locations and in Canada's oil sands.

For instance, ExxonMobil (NYSE: XOM  ) and its affiliate Imperial Oil Ltd have encountered major start-up problems and cost overruns at the Kearl oil sands project in northern Alberta, which have pushed the project's budget more than 60% above Imperial's initial forecast.  

And Total SA (NYSE: TOT  ) last month announced it would sell its 49% stake in its Canadian oil sands project to Suncor Energy (NYSE: SU  ) , netting the French oil major a colossal $1.65 billion loss on the project. High labor costs, as well as an undersupply of workers and depressed prices for Canadian oil sands crude, are the main reasons Total decided to abandon the project.  

With the era of "easy oil" now a relic of the past, oil majors are venturing into deep, uncharted territories in search of oil. But as BP's Mad Dog 2 illustrates, many of these unconventional projects are plagued by cost overruns and delays. Hence, BP and other oil majors are finding it more difficult to boost production, despite spending tons of money of new development projects.

But while the supermajors are having difficulty boosting production, companies focused exclusively on exploration and production are having better luck. Chesapeake Energy, for instance, has reported nearly 40% year-over-year liquids percentage growth. As the company transitions away from natural gas production, will it manage to meet its oil production target and boost cash flow? Or will it languish under the weight of its heavy debt load? To answer that question and to learn more about Chesapeake and its enormous potential, you're invited to check out The Motley Fool's brand-new premium report on the company. Simply click here now to access your copy, and as an added bonus, you'll receive a full year of key updates and expert guidance as news continues to develop.


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