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GoM Leases Receive Lukewarm Response: Here's why - Zacks.com

The latest auction for offshore drilling rights in the Gulf of Mexico (GoM) — the second under the Outer Continental Shelf program for 2017-2022 — received a lukewarm response. The winning bids raked in only $124.76 million in the auction, which was considered to be one of the largest lease sales in American history.

In the latest U.S. Gulf of Mexico lease sale, a record 77 million acres (31.2 million hectares) was offered for development. The size is equivalent to an area twice the size of Florida.

A total of 33 companies, comprising major players like Royal Dutch Shell Plc (RDS.A - Free Report) , BP plc (BP - Free Report) , Chevron Corp (CVX - Free Report) and Total SA (TOT - Free Report) , placed 159 bids on 148 blocks. Royal Dutch Shell carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Royal Dutch Shell bid for four tracts offered in the remote Alaminos Canyon area that borders Mexican waters and became the highest bidder with $13.6 million. The company offered $6.5 million, $3.8 million, $2.1 million and $1.2 million for the four blocks.

The lease was the largest as a result of the Trump administration’s efforts to increase investment and boost fossil fuels output in the region. The administration offered discounted royalty rates on the shallower tracts as part of a broader effort. However, the results were disappointing as the response was lukewarm.

Usually, the U.S. government offers smaller regional batches for sale in auctions. In March 2017, the government auctioned about 48 million acres in the Central Gulf of Mexico planning region, which garnered $121 million in high bids. The recently raised lease amounts slightly higher than the previous year. However, it was still just one-tenth the amount raised during a smaller lease sale in the central Gulf in 2013.

Per Wood Mackenzie, the comparatively higher oil prices and lower corporate taxes were expected to increase the demand for the acreage. However, the consultancy stated that some factors like competition from Latin America and anticipated impact of U.S. tariffs on steel imports on costs were major dampeners. Additionally, new projects in the deepwater GoM are very expensive and involve major upfront investment.

Another group of critics were of the opinion that the unusually large lease sale was badly timed. There are a few other factors which might have led to such tepid results. Enhanced drilling technology has made available cheaper onshore reservoirs. This has aided the U.S. crude oil and natural gas output to surpass records. Brazil and Mexico, which are in competition for drilling investment in their deepwater acreage, offer better terms. Also, oil majors with huge spending capabilities are attracted by better prospects overseas and comprise just 1% of the total bids that came up for sale. For instance, ExxonMobil Corp (XOM - Free Report) is focusing more on new deepwater projects outside the United States, where royalties and tax structures are expected to befavorable. The company’s project in Guyana is an example.

To beat the price volatility and make projects more competitive, drillers have been lowering costs in GoM for the last few years. Similar efforts by BP resulted in its Mad Dog 2 platform being economic with crude at just $40 a barrel.

In the latest lease sale, BP bid over $20 million for 27 tracts. BP was more inclined toward the deepwater acreage around the existing discoveries or fields as against wildcat drilling, owing to its low risk and short cycle characteristics amid the weak crude environment.

A number of measures have been undertaken to ensure that oil majors’ interest does not wane. The Interior Department lowered the royalty rate that the companies must pay in shallow offshore waters by a third to 12.5%. Per the Bureau of Energy Management, this led to an increase in bids from past lease sales. In 2018, shallow-water tracts received 43 bids.

The administration proposes to open parts of the Arctic, Atlantic and Pacific that will result in vast lease sales offshore. However, this proposition has faced criticism from several governors in U.S. coastal states.

Democratic lawmakers have advised the Interior Department to refrain from raising the lower royalty rates to deepwater acreage, citing that the move will short-change taxpayers.

It is to be seen if oil majors will attracted toward GoM acreage sale in the next round. It will highly depend on the administration’s favorable policies including royalty and tax structure.

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