Lead Forward

Commentary
Bad Policy Fallout From BP Spill
Eric Smith, 06.25.10, 3:30 PM ET

The Obama administration has indicated it will appeal the verdict of a U.S. district judge that overturned its six-month moratorium on deep-water drilling in the Gulf of Mexico. Meanwhile, Interior Secretary Ken Salazar has announced his intention to establish a new moratorium to replace the one that the judicial action has ended. Too bad. The judge gave the administration a way out of a deeply flawed policy that will worsen the nation's energy problems while weakening the economy and increasing the risk of a double-dip recession.

A certain air of unreality envelops the administration's U.S. Gulf policy and public discussion of it. Public discourse mainly concerns what the administration will decide to do and how it will affect the Gulf economy. Largely ignored is the question of what the oil companies and their contract drillers will do. Anyone knowledgeable about the oil industry understands that companies drilling in deep water will not wait around for six months while a presidential commission devoid of anyone with firsthand experience of the offshore oil business ponders their future.

What the companies will do, quite simply, is leave. People in Washington seem only dimly to realize that the deepwater oil industry is, in a sense, bigger than the United States. If multinational companies can't drill in the Gulf of Mexico they will seek more welcoming deepwaters in places like Brazil, Nigeria, Ghana or Angola. Yes, there are disadvantages in migrating to some of those places, but this is an industry known for its willingness to deal with anybody. Yes, rogue governments are despicable, but they're preferable to sitting in the deepwater Gulf with idle rigs that operate on multiyear, no-cut leases where the meter clicks over at $500,000 every 24 hours.To my knowledge, the administration hasn't offered to pay demurrage while the White House and its special commission learn how to regulate an industry likely already saddled with more regulations than any other in the world.

Once the rigs move to faraway places, they will not return quickly--certainly not in six months. The new contracts the drilling companies sign will not be to drill a single well; they will be long-term agreements lasting three to 10 years. In other words, the departure of the deepwater fleet from the Gulf, the largest new source of petroleum in the continental U.S., will be a problem not for months but for years.

Meanwhile the Gulf's supply of deepwater oil will taper as the flow from existing wells slows and no new wells are added. This will have a dire effect on the regional economy, which depends on oil more than on any other industry. It will probably be less dramatic for the rest of the country, but overall the decline in Gulf production will represent a measurable reduction in worldwide production capacity. When oil was at $147 a barrel, spare capacity was down to 1 million to 2 million barrels per day. Now, in the early stages of a recovery, the world may have as much as 5 million barrels per day of spare capacity available. So assume a bit more economic recovery, a larger oil-consuming world population and the removal of 1 million-plus barrels per day by U.S. administrative fiat, and we are that much closer to oil-price Armageddon.

There likely won't be severe gasoline shortages or long lines at gas stations, like those resulting from Middle East turbulence in the 1970s. But a nation that not long ago was a net exporter of gasoline will become a heavier importer of both crude oil and gasoline, pushing prices up, increasing energy dependence and exacerbating the country's balance-of-payments problem--not to mention creating an increased risk of future spills resulting from increased tanker traffic. Add to these woes an all-but-certain economic slump in the U.S. Gulf region--which until now has been a sturdy exception to the current national downturn--and a double-dip national recession is not hard to imagine.

And what will have been gained? The Obama administration would have us believe a moratorium is required for the sake of safety, but there are clearly ways to achieve safety without risking serious harm to the regional and national economies.

Here is a modest proposal. With the exception of BP, the deepwater oil operators and service industries--including the drilling fleet--have an excellent safety record, and the simplest and most effective way to ensure it stays that way is to mandate full-time stationing of federal inspectors on all rigs that are engaged in drilling new deepwater wells in the Gulf. This initiative could be implemented within 30 days, and it would grant experienced inspectors the power to shut down an operation for significant safety violations.

Inspectors would be rotated from rig to rig and company to company to ensure a continuing arms-length relationship between inspectors and employees. They would function like bank auditors, who have the power to close a bank but also the responsibility to prove their case after the fact. Since such a program would require three to four inspectors per rig, the number of personnel required would not exceed 150, so the cost would fall within the $30 million the Obama administration has allotted to enhance the inspection capabilities of the Bureau of Ocean Energy Management, the newly renamed federal regulatory agency that oversees deepwater oil-company operations.

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Meanwhile BP would be a special case. The company would be banned for at least the next five years from being named "operator" on existing or new leases and would be required to name a partner oil firm that would have full operational responsibility. The dual purpose would be to give BP time to mend its operations without inflicting financial hardship on the U.S. effort and to ensure its considerable capital investment in the U.S. Gulf would remain there.

Common sense suggests that, given the events of the past two months, safety will be a paramount consideration in the Gulf for a long time to come. The enhancement of regulators' monitoring capabilities can guarantee this is the case without depriving the country of its largest domestic source of oil.

Eric Smith, a professor of finance at Tulane University's A. B. Freeman School of Business, is the associate director of the Tulane Energy Institute.