Why Deepwater Drilling Could Be Dying

With the largest independent oil company in America abandoning deepwater drilling, it suggests that it could be a long time before the industry returns to its prior peak.

Matthew DiLallo
Matthew DiLallo
Dec 8, 2015 at 12:21PM
Energy, Materials, and Utilities

Deepwater drilling was once thought to be the next big thing driving oil production growth for countries and companies outside of OPEC. However, the high costs and higher risks of offshore drilling recently led ConocoPhillips (NYSE:COP) to join peers Devon Energy (NYSE:DVN) and Apache (NYSE:APA) in abandoning these efforts, especially when the risks and returns are much better onshore.

Counting the costs
At a recent conference, ConocoPhillips was asked to explain its decision to exit deepwater exploration, especially in the context of other opportunities. Reason being, all else equal, the returns earned from deepwater projects are better than those earned from oil sands and LNG, which are assets the company intends to retain. This is pretty clear from the slide below:

Source: ConocoPhillips Investor Presentation.

Here's how Matt Fox, ConocoPhillips' EVP E&P, addressed the question of why it's abandoning deepwater exploration:

So the rationale behind that decision was really relatively straightforward. We realized as we were heading into this new world order that we had to review all of our growth engines and see where is the highest value in the go-forward growth engines. So we reviewed the cost of supply of the whole portfolio and that's what shows up on [the above slide]. As we went through that process it became clear to us as we assessed it that the cost of supply for a deepwater portfolio in aggregate was around $75 a barrel based on our view. Now that's not to say that any individual project development wouldn't have a lower cost of supply than that. But it's when you put together the portfolio from lease acquisition through seismic and only one well out of four being a success and some failing through appraisal all the way through the cycle and you build a portfolio of that it was $75 cost of supply. So high relative to the cost of supply that's already in the portfolio and relatively inflexible. So we've tried to design a portfolio that's got low cost of supply and flexibility and deepwater did not fit either of those criteria so that was why we chose to exit. The oil sands and the LNG projects they are sunk cost, they are behind us now. So what we were looking at was a go-forward view of where should we be directing capital. And that's why we decided that the deepwater we didn't need it and we didn't want it in the portfolio.


Source: Apache Corporation. 

Given the company's view that the industry is moving into a period consisting of increased price volatility and much shorter production cycles, it needs to shift its focus toward projects offering the most flexibility. That's clearly North American unconventional production, which is why that will receive the bulk of its capital going forward.

Joining the club
In one sense, ConocoPhillips is behind the curve, given that many of its independent peers have already abandoned offshore development in favor of North American shale. Devon Energy was one of the early leaders in this shift after it sold off its Gulf of Mexico assets as well as its offshore assets in Brazil to BP in 2010. In exchange, Devon received $7 billion in cash as well as a 50% interest in BP's Kirby oil sands leases in Canada. Devon then used that cash to further its onshore push in the U.S. It's a position that is now expected to drive more than 30% oil production growth in 2015, with robust future potential given the fact that just this week Devon spent a couple billion dollars to enhance its position even further.  

Apache is another company that has been exiting the deepwater. Last year it continued its exit from the Gulf of Mexico after selling its interests in the Lucius and Heidelberg development projects as well as 11 deepwater exploration blocks to Freeport-McMoRan for $1.4 billion. The move was one of a number of transactions the company has undertaken over the past few years to rebalance its portfolio because it prefers to drive predictable growth out of its liquids-focused onshore assets in North American. Predictability is the key outcome that Apache is seeking these days, which was hard to achieve when so many deepwater wells fail to deliver.

Investor takeaway
Despite the new world of opportunity just waiting to be discovered under the sea, oil producers are finding that it's easier and cheaper just to drill on dry land. That's why we're seeing ConocoPhillips join a growing list of independent producers to abandon deepwater offshore exploration in order to focus on North American shale production. It's another sign that production growth from deepwater drilling could soon be dying off.