Commodity Online
What impact will the 6-month moratorium beginning May 28th on deep water exploration by US government have on crude oil prices? Can we expect a crude oil rally, as predicted by some or will the impact be neutral.

Bank of America-Merrill Lynch (BOFAML) in an analysis pointed out that the impact on crude oil prices would be muted. Since theissue of the production moratorium, long-dated crude oil prices for delivery in December 2013 have increased by 2.1% The moratorium was imposed by the US government after the oil spill in Deepwater Horizon in the Gulf of Mexico.

While environmentally catastrophic, the amounts of oil involved are too small to materially alter global supply/demand balances in the near-term, BofAML said. At 1.7 million b/d, the Gulf of Mexico makes up just 1.9% of total global oil production at 86 million b/d.

While related stocks of oil majors, E&Ps and oil service companies sold off sharply, WTI crude oil initially displayed little impact and then fell on macro concerns over the European crisis.

Globally, it is estimated that offshore production at around 27 million b/d—of which 18.5% is deepwater. Assuming the moratorium does not extend to other parts of the world, BofAML's base case scenario calls for a reduction in average 4Q10 Gulf of Mexico oil production of 55 thousand b/d, a rather small amount in the global context, the analysis said.

Natural gas to get support
The moratorium will have some impact on the natural gas prices as the GOM region accounts for 6.7 bcfpd (10% of Lower 48 gas production) of which 45% is considered deepwater or ultra-deepwater. With decline rates in the Gulf of Mexico running at 28%, volumes from the region should fall for the remainder of the year.

Over the next six months BofAMLs base case scenario is a drop of 0.1 bcf/d by 4Q10, although US production could drop by up to 0.6 bcf/d in an extreme case solely on declines, lending support to NYMEX natural gas prices, BofAML analysis said.

Moratorium elsewhere?
If other countries follow the US lead or if much stricter regulations are set in place,  the long-term impact on hydrocarbons output could be substantial. World offshore proven oil reserves are about 300 billion barrels out of a total of 1.3 trillion barrels,
with roughly 55 billion barrels in deep offshore. However, energy policy may impact demand as well.

Given the public outrage over the spill, governments could well opt to increase taxes on fuels to cover future environmental calamities or even promote other sources of energy. The policy debate has just started and the Gulf of Mexico oil spill is
not an unequivocally bullish event for the oil market. BofAML stated that further increases in long-dated oil prices are not justified at this stage.

According to new estimated flow rates released a few days ago, the damaged BP well in the Gulf of Mexico (GOM) has actually been leaking twice as much oil as  previously estimated. Government scientists now calculate that the well is gushing between 20,000 to 40,000 b/d. Assuming a daily rate of 30,000 b/d, the Macondo well would be repeating the 1998 Valdez disaster, which leaked 257 thousand barrels, roughly every week! So far, the largest spill containment effort in the history of the oil industry has achieved limited success. Permanent solutions to stop the leak are underway, with the most advanced (in the form of
relief wells) expected to hit target depth in early to mid August. In the mean time, the Macondo oil spill is firmly on track to become the worst oil spill and environmental disaster in US history, BofAML analysis pointed out.

Muted impact
BofAML stated that the impact on the global market will be relatively muted as the majority of offshore production takes place elsewhere in places like the Mexican GOM, the North Sea, the Persian Gulf, Brazil and China. Furthermore, in terms of reserves, the US represents a smaller share of world’s holdings, with about 1% contribution of global offshore reserves and 5% of global deepwater reserves.

Of the 33 drill sites suspended, very few are related to projects scheduled to come online in a couple of years. The wells affected by the moratorum are considerably smaller.Great White, which represents 80% of the Perdido’s total production, began producing in early April, while at Cascade-Chinook two of the three planned production wells were completed before the suspension was put in place. The other two projects affected by the drilling ban are considerably smaller—the start up of the 30 mmcfpd Appaloosa project and start up of Santa Cruz with peak capacity of 15 thousand b/d and 35 mmcpf are now likely to be deferred.

The other major project scheduled to come online this year, Droshky, has also not been affected since construction was completed by early May. Furthermore, with only three projects scheduled to come online next year representing a total of 75 thousand b/d of capacity, any delays should not dramatically impact US supply.

Of the four projects scheduled to be added this year, the two largest projects were able to get the majority of their wells in place before the moratorium took effect.

BofAMLs base case scenario calls for a reduction in average 4Q10 GOM oil production of 55 thousand b/d, compared to 27 thousand b/d expected by the EIA. The EIA expects a reduction of oil production in the GOM of 70 thousand b/d for 2011. For natural gas, we have pencilled in lower production of 100 mmcf/d in 4Q10 in our base case scenario. For both oil and gas, BofAML expects slightly lower supply additions from new projects whose wells were not completed before the moratorium and from the heightened decline rate in the region given the suspension of new well drilling.

Output in the Gulf of Mexico will not immediately decline over the next three months due to the ongoing pipeline of projects as well as the potential for increased workover activity to mitigate decline rates. Moreover, the consultancy believes the global oil supply and demand balance is loose enough to absorb the shock of lower, not to mention slower, GOM oil production in the next months.

Medium to long term unpredictable
BofAML states that medium to long term impact of the moratarium is unpredictable. On top of that, there is also uncertainty around timing and juggling of rig contracts and also the likelihood that costs associated with expected regulations
may deem some projects uneconomical. Further confusing the long-term picture, about half of the projects affected by the drilling moratorium are exploratory rather than for development drilling and, even without the suspension, would not have
impacted volumes for another 3 to 5 years. Additionally, more than half the exploratory wells are in water depths greater than 5,000 feet, suggesting even longer leads times and more uncertainty in terms of potential productive capacity.

However, if moratorium is stretched beyond six months imposing stiff safety and industry practices, supplygrowth could be severely constrained and costs would almost certainly move up. Combined with current predictions for a heavy hurricane season which could disrupt clean-up efforts and hot weather in parts of the US, bullish sentiment may
grow.

No doubt, if other countries follow the US lead or if much stricter regulations are set in place, the long-term impact on hydrocarbons output could be substantial. For both oil and natural gas, deep offshore reserves are a large portion of the
remaining hydrocarbons in the Gulf of Mexico.

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