Business Week - 15 May 95

Prof. Robert B. Laughlin
Department of Physics
Stanford University, Stanford, CA 94305
(Copied 9 Jan 10)

The Undersea World of Shell Oil

By Gary McWilliams
May 15, 1995

Just a few years ago, Shell Oil Co. looked like it was running on fumes. A string of dry U.S. wells and curbs on overseas exploration were draining its oil reserves. After missing out on Prudhoe Bay and coming a cropper in offshore Alaska, Shell saw its oil production begin to slide rapidly: From 531,000 barrels a day in 1988, it pumped out just 398,000 a day last year. As executives began to fear for its future, even Shell's choice for a last stand, the Gulf of Mexico, seemed ill-fated. From its heyday in the early 1970s, production had declined so sharply by 1992 that oilmen derided the gulf as the "Dead Sea."

The gulf's treacherous depths had already knocked one company, Placid Oil, temporarily into Chapter 11 bankruptcy, and oil giants such as Texaco and Mobil had fled the gulf throughout the 1980s for more promising fields overseas. But restricted to the U.S. by its parent, Royal Dutch/Shell Group, and unable to drill off California or the East Coast because of state restrictions, Shell had no choice but to hunt for oil thousands of feet below the gulf's surface. "From an exploration standpoint, we certainly would have faded away without it," says Robert L. Howard, Shell's recently retired vice-president for domestic operations.

Today, no one worries about Shell fading away--or the gulf's role in U.S. oil production. Thanks to a string of discoveries of huge reserves in the gulf's deep waters and technological advances that have made it easier and cheaper to get that oil out, Shell's once bleak fortunes have been revived. Since it began deepwater production last year, the Houston-based company has startled its oil-patch rivals with astonishing reports about the oil it has found in the gulf's depths: In its three most advanced projects alone--two more are set to come onstream by 1997--Shell expects to gain an estimated 150,000 bbl. a day of production. That's worth $1 billion annually at current prices of $20.50 a bbl. When it comes to deepwater drilling, says Amoco Corp. CEO H. Laurance Fuller, "Shell is out in front of the industry."

Hot Spots

Indeed, Shell's success has sparked a feverish black-gold rush in the gulf: New players are rushing to get in, while old ones scramble to return. With the federal government's annual auction of gulf leases--set for May 10--drawing more interest than it has in years, bidding is expected to be furious. Requests for sales kits for the 10-year leases--which are granted for territory up to 200 miles from the U.S. shore--are running nearly 20% higher than a year ago. Says analyst Robert W. Esser of Cambridge Energy Research Associates Inc.: "This is going to be one of the most significant exploration hot spots in the world for the next decade."

Forced to tough out conditions that sent others packing, Shell now sits atop the most prized territories in the region. As other majors fled, Shell and a handful of independents hunkered down. By 1989, Shell hit pay dirt. With its discovery of the giant, 700-million-bbl. Mars field, Shell realized the region's potential was far greater than anyone knew. Over the next two years, it quietly assembled a huge collection of deepwater leases--571 in all. Today, Shell holds 30% of the existing leases in the gulf. Thanks to improved exploration techniques it has since pioneered, those leases may hold more oil than even Shell had anticipated. Although the Interior Dept. estimates that the gulf's deepest waters hold around 4 billion bbl. of oil and equivalents, industry sources say those numbers, based on incomplete company reports, may be out of date. Shell CEO Philip J. Carroll believes the figure is more like 8 billion to 15 billion--greater than Alaska's Prudhoe Bay.

Yet for all the potential apparent today, Shell almost couldn't make it in the gulf. In the mid-1980s, plummeting oil prices forced Shell's engineers to rethink how they worked there. Oilmen then believed deep wells would collapse if too much oil was pumped out at once. But the high costs of working in deep water, combined with meager oil prices, made low volumes uneconomic. "It became apparent we needed high-flow-rate wells," says Rich Pattarozzi, Shell's exploration and production manager.

Troubled Waters

Shell began experimenting with a platform in 1,600 feet of water. By slowly upping the quantities it pumped and by modulating the valves, pipes, and other equipment it used, Shell gradually learned how to boost oil flow. It also developed "modular" components that could be retrieved and reused, bringing down production costs. Its latest twist: using robot vehicles to link deepwater wells to a shared electrical and communications pod.

Unlike the shallower waters of the gulf--where natural gas predominates--the deepwater discoveries have been up to two-thirds oil. That's important because financing for oil development is easier and cheaper to obtain. And the rich flows Shell has attained dramatically improve the profitability of deepwater production. Shell's first deepwater platform cost $1.2 billion and included 32 well slots at an estimated cost of $10 million to $20 million each. Its latest, now in construction, will contain just 24 slots but will deliver twice as much oil.

Shell's perseverance is paying off. Although U.S. offshore wells on average produce just 1,000 bbl. a day, Shell is producing as much as 14,000 bbl. a day in wells at 2,800 feet. The additional production could contribute as much as $1.75 billion annually to operating cash flow by 1998. Nor is Shell alone. On Apr. 3, Enserch Corp. revealed its first deepwater well could start production at 6,000 bbl. a day--far in excess of the 2,500 expected. "It has gotten progressively better and better," says David Biegler, CEO of Dallas-based Enserch.

Of course, trouble is no stranger to these waters. In the mid-1980s, Placid Oil stumbled and its gulf fields were eventually sold off after a series of problems developing the necessary infrastructure thwarted its efforts to develop similar deepwater finds. Conoco and Exxon Corp. spent billions on gulf fields that proved to have little oil. But for Shell--which will have spent over $2 billion on deepwater exploration and production by 1997--the activity has already reversed six years of production declines. In its December quarter, Shell saw oil production rise 3%, while its March quarter brought a 5% jump over year-earlier results. With strong chemical earnings, that helped send Shell's quarterly operating profits up 38%, to $303 million. What's more, the reversal has come with only one of Shell's three big gulf projects in production.

Small Stakes

Shell's gusher of good news has spawned a host of followers. In recent months, Amoco, Texaco, and Mobil have begun developing plans for gulf sites that long sat idle, while France's Elf Aquitaine acquired its first-ever gulf stake in mid-April. Chevron Corp. and Exxon are planning to deploy floating platforms that can be moved from site to site, making drilling smaller fields profitable. "With advances in technology, suddenly a lot of these finds are more economic," says Standard & Poor's analyst Keith Petersen. Indeed, Oppenheimer & Co. estimates that the costs of producing deepwater oil have fallen from $17 a bbl. in 1992 to as little as $10 today, assuring that exploration will continue even if oil prices tumble again.

The improved prospects have also attracted a host of oil-service companies, which in turn are lowering costs. In March, Leviathan Gas Pipeline Partners LP disclosed plans to build a new "gathering" pipeline to collect oil and gas some 200 miles out in the gulf; that will save explorers the roughly $500,000 a mile it costs to snake individual pipelines from fields to shore. "It makes smaller and smaller opportunities increasingly viable," says W. Scott Young, the team leader for Chevron's Green Canyon deepwater exploration project. And in late April, Reading & Bates Corp., a major drilling-services contractor, agreed to take a 20% stake in a deepwater discovery project as part of a deal to drill for Enserch. "Almost every major company has or is formulating a deepwater strategy," says Reading & Bates CEO Paul B. Loyd Jr.

As for Shell, it's going ever deeper. Shell subsea production engineer Dennis C. McLaughlin says the company plans to explore gulf waters as deep as 8,000 feet. "Where we are today is not necessarily deep compared to where we want to be in two to three years," he says. For an oil company once in danger of running dry, Shell is finding there's no place like the bottom of the sea to get really wet.