by Alex Plough

The offshore drilling platform built for Gulf Oil in the late 1970s was one of the biggest to leave the shipyards of renowned Texas engineering firm Brown & Root. The structure rose four deck levels high, featured a helipad, accommodation for dozens of workers and all the equipment needed to extract vast oil deposits entombed in the earth’s crust. Supporting the deck was a tapered 300-foot steel tower, roughly the size of The Statue of Liberty, with eight giant legs anchored into the seafloor.

In 1980, a transport barge towed by several tug boats carried Gulf Oil’s massive structure to its destination in the Gulf of Mexico, roughly 20 miles from the mouth of the Mississippi River. The relatively shallow waters of the outer continental shelf, a vast undersea plain that slopes into the deep ocean, made the area perfectly suited for oil exploration.

Meanwhile, the 1979 Iranian Revolution had sparked panic among commodity traders and the price of oil more than doubled over the next 12 months. Exploration and production (E&P) companies rushed to cash in and drilling activity peaked in the early 1980s, with up to 250 platforms being erected each year.

Gulf Oil operated its new platform on a lease issued by the US government, later given the official classification of lease number G02177 in what became known as the South Pass 49 oil field. The following year a second fixed platform was installed on the property, since designated by regulators as structure “C” to distinguish it from the earlier eight-legged “A” platform. This slightly smaller but deeper water two-deck facility had four columns driven into the seabed using pairs of skirt piles, giant nails hammered either side of each leg. The extra stability would help protect the platform during the Gulf’s violent hurricane season, but also made it more difficult to remove once the oil reserves ran dry.

Thirty years later, the once innovative platforms have become an albatross for their current operator, an oil exploration and production company called Energy XXI. The two structures also represent a next leg of the widespread sector crisis unfolding three years after the recent slide in oil prices began. Against the backdrop of cheaper and abundant alternatives to offshore oil, namely US shale gas, the volume of unproductive drilling platforms in the Gulf is expected to swell massively in the coming years.

Platform SP 49 A

Now the offshore industry is standing off against the US government, and by extension the US taxpayer, who may ultimately pay to remove the rusting platforms. At a recent hearing of the Congressional Subcommittee on Energy and Mineral Resources, Frank Rusco of the US Government Accountability Office testified that his team found “significant problems” with the Department of Interior’s policies that “put taxpayers at risk of having to make up shortfalls in decommissioning cost”.

Under a federal program called “Idle Iron,” the authorities require that any platform on an active lease that has been unproductive for at least five years must be removed, in a process also known as decommissioning, while disused oil wells have to be plugged and abandoned (P&A). The rules for the process state that structures have to be decommissioned no later than five years after they become ‘idle’ as classified by the federal Bureau of Ocean Energy Management (BOEM).

A recent study by research firm IHS Markit expects the number and cost of decommissioning projects to rise dramatically, as larger and more complex offshore structures reach the end of their useful lives. The researchers found that the Gulf of Mexico had the most platforms slated to be decommissioned of any region in the world.

“Decommissioning is something that was always pushed back as far as possible.” said Bjorn Hem, senior manager at IHS Markit and co-author of its study on the decommissioning market. “It is still being pushed back as low oil prices mean operators are even more reluctant to spend money.”

Extending the lifespan of aging platforms and associated subsea wells is becoming too expensive in the new reality of lower oil prices for longer. With few willing buyers for legacy Gulf of Mexico assets, such as the two platforms in South Pass 49, Idle Iron represents a major expense for their operators. Offshore lease holders left holding the bag have few options. Either they perform the removal work themselves, surrender or ‘orphan’ idle platforms to the government or incentivize someone else to assume the decommissioning liability.

Information about exactly which platforms fall under Idle Iron is not publically available. But a list of such structures, maintained by the Bureau of Safety and Environmental Enforcement (BSEE) and dated in 2015 – was obtained by Debtwire Investigations and originally received via a Freedom of Information Act request. While an attached disclaimer noted that the list “may not be complete or without error”, it reveals for the first time the clearest picture yet of the industry’s challenge.

Working in collaboration with researchers from the Harte Research Institute for Gulf of Mexico Studies at Texas A&M University in Corpus Christi, Debtwire Investigations built a detailed register of every platform targeted by BSEE for removal. By combining multiple government databases, Debtwire tracked down the history, location and current operator of each Idle platform. We then approached offshore decommissioning expert Dr. Robert C Byrd who reviewed the structures and estimated their expected removal costs, drawing from his 35 years of industry experience. Byrd has been the principal investigator for BOEM on a number of projects to estimate the decommissioning cost of Gulf of Mexico and Pacific region offshore facilities.

The resulting analysis found that one of the platforms in South Pass 49, specifically the two-deck “C” facility installed in 1981, likely represents one of the most expensive platforms to remove.

Byrd estimates it will cost Energy XXI approximately $15 million to $20 million to safely remove the structure and its four connected oil well conductor pipes. With the platform marked for decommissioning by BSEE, it represents a major near-term cash outflow for the company.

Platform “C” is one of the 195 structures remaining on Idle Iron that pose a total liability of approximately $335 million, according to cost estimations provided by Byrd. The top three operators by their number of Idle platforms – Fieldwood Energy, W&T Offshore and Energy XXI – represent more than half of that total liability.

Warning symbols show Idle Iron locations, yellow icons show all other standing platforms. Idle Iron data was provided by Elena Kobrinski Keen’s doctoral dissertation at the Harte Research Institute for Gulf of Mexico Studies at Texas A&M University in Corpus Christi, Texas. Decommissioning cost estimates were provided by Dr Robert C. Byrd, platform locations are based on data from BOEM.

These Idle platforms are just one part of the problem. BSEE also requires the removal of structures on expired leases or any terminated by authorities. Operators have just one year to perform the work. Taking the liabilities of such inactive leases into account, we found that two of the biggest Idle Iron owners – Fieldwood and W&T to a lesser extent – appear to be substantially underestimating their near term P&A requirements.

Kevin Karl, Deputy Regional Director, BSEE Gulf of Mexico Region gave the following comment:

"BSEE can require wells and platforms on active leases to be decommissioned when no longer useful for operations. BSEE has established a process under which annual idle iron plans are submitted and reviewed by BSEE to ensure progress is being made consistent with a schedule provided by the operator and agreed to by BSEE. For non-active leases, BSEE is actively enforcing this requirement by issuance of INCs upon failure to comply with the one-year requirement to decommission."

Changing of the guard

The history of lease G02177 is typical of hundreds of similar properties on the Gulf continental shelf. Production rose to more than 19 million barrels in 1984, but over the next two decades dropped sharply as the property changed owners several times. It was a pattern seen across the Gulf. After extracting most of the crude in shallow water leases, major oil companies were moving deeper offshore to the untapped fields in previously hard-to-reach spots.

Companies such as Shell, BP and Chevron sold their stakes and operating rights to a new breed of smaller, more nimble E&P companies. Big Oil had abandoned the shallow waters to so-called independent producers such as Fieldwood, W&T and Energy XXI. The independents grew rapidly as oil prices soared in the 2000s. China’s insatiable appetite for raw materials fueled an economic tailwind that helped the companies raise billions of dollars by issuing high interest debt and equity to exuberant investors.

Their playbook was to acquire vast acreages of oil fields discarded by the majors and squeeze out the last dregs while oil prices were high, hoping to resell the properties before they were completely exhausted. Light touch regulations also spared the independents from raising collateral, in the form of surety bonds, to fund future decommissioning work.

Energy XXI took over operation of lease G02177 in the summer of 2005, a year after its formation via a public stock offering on the London AIM market. The lease had been neglected for over three years but by 2007 was pumping again, supplying roughly 1.6 million barrels that year under its new owner – still a far cry from the 19 million barrel peak in 1984.

Within five years of its IPO, Energy XXI had become the Gulf’s third biggest oil producer. Its ambitions hit a high watermark in March 2014 with the $2.3 billion acquisition of Gulf of Mexico driller, EPL Oil & Gas. The deal swelled Energy XXI’s assets over 70% to more than $7 billion, creating the area’s largest independent producer. It also added an extra $1.6 billion of debt to the balance sheet, increasing total borrowings to roughly $3.6 billion.

Two investment banks, Citigroup Global Markets and Credit Suisse Securities, helped sell the merger to shareholders. A deal prospectus estimated the combined company making in 2014 over $1.2 billion of earnings before interest, taxes, depreciation, depletion, amortization and exploration expenses (EBITDAX) – a metric used by oil explorers to report financial performance. Crucially, these estimates assumed the price of oil would stay at $100 a barrel over the next several years.

Four months later, however, oil prices crashed and kept falling, all the way down to $29 per barrel in February 2016 before rising moderately to around $50 in June 2016 – setting a new benchmark from which prices have yet to recover. Collapsing revenues and a bulging debt load forced Energy XXI to slash its capital expenditures and look for asset sales, less than a year after its biggest acquisition to date. A series of debt exchanges chipped away at leverage, but failed to avoid the inevitable. The company filed for Chapter 11 bankruptcy protection in April 2016 and emerged eight months later with its debts fully restructured.

Ironically, the bankruptcy put Energy XXI in the strongest position of the independent trio to deal with its Idle Iron platforms. Public filings show the company recently increased its budget for current P&A needs, earmarking $73 million in the latest 1Q17 filings compared with $50 million to $70 million budgeted at the end of 2016. This gives the company some cushion to meet the total $63 million of near-term liabilities found by Debtwire.

Such prudence could be down to the hiring of engineering firm Netherland Sewell & Associates. Previously Energy XXI had estimated its oil and gas reserves internally, but a condition of its bankruptcy plan called for a comprehensive third-party report done each year

Netherland Sewell found that Energy XXI’s PV-10, representing the discounted present value of its oil field reserves net of P&A liabilities, was $27 million lower than the $135 million value previously claimed. The engineers also calculated its total P&A liability at $501 million, more than the $404 million value of its proved and developed oil fields.

Energy XXI did not respond to requests for comment.

Reality bites

The two other major independent oil producers with Idle Iron exposure, Fieldwood and W&T, have so-far survived the prolonged oil downturn. Just like Energy XXI, the two Gulf operators borrowed heavily by issuing billions of dollars in high interest bonds and loans to fuel their rapid expansion.

The private equity firm Riverstone Holdings founded Fieldwood in December 2012 as a partnership with former executives from oil explorer Dynamic Offshore Resources. Its first major deal was the $3.75 billion acquisition of shallow water Gulf assets from Apache Corporation, and in the coming years it surpassed Energy XXI as the largest operator on the Gulf of Mexico shelf. A press release announcing the Apache deal explicitly states that Fieldwood would assume liability for future abandonment costs of the properties it bought.

Unlike Energy XXI however, Fieldwood has chosen not to use the bankruptcy courts to lighten its debt burden and now faces an uneasy challenge repaying lenders. It also has the most pressing debt maturity of the three independents – a $755 million loan due September 2018.

Credit rating agencies have repeatedly lowered their assessments of both Fieldwood and W&T since 2014. The companies are now rated CCC/Caa2 at the corporate level, just one notch above the lowest rating possible for a borrower not already in default.

Against this backdrop of financial weakness, Fieldwood operates the largest number of Idle Iron platforms – at least 42 individual structures which would cost roughly $78 million to safely decommission. The company is also exposed to P&A liability on 129 expired or terminated leases, which represents roughly $92 million of potential near-term decommissioning expense for a combined $171 million liability, Debtwire analysis shows.

By comparison Fieldwood has told investors that it expects to pay between $130 million and $145 million for plugging and abandonment in 2017, according to two sources with access to their financial information.

However, the gap between expectation and reality could be much larger if Apache Corporation’s share of liability from expired or terminated leases is included. According to government records, Apache has ownership stakes in 690 such properties, and Debtwire estimates the company’s proportional exposure could be as high as $230 million.

Heightening the risk, Fieldwood is the weakest of the three in terms of its cash reserves. At the start of the year it had $30 million of cash on hand and partial access to a $150 million letter of credit facility – essentially IOUs that the company can issue which are underwritten by a bank, according to the sources with access to the results.

“The data provided is incomplete and the assumptions are inaccurate,” according to a statement provided by a Fiedwood spokesperson. “We conduct our business in accordance with all federal, state, and local regulations. Fieldwood Energy has the most robust decommissioning program in the Gulf of Mexico. We are fully capable of and committed to continuing to fulfill our decommissioning obligations.”

All eyes on cash flow

NYSE-listed W&T has a longer operating track record that stretches back to its founding by current CEO Tracy Krohn in 1983. Based on the original information received by Debtwire, W&T’s Idle Iron exposure is tied to 11 platforms and includes some of the most expensive structures to remove in the Gulf region. The company claims four of these platforms have been removed and another three are not considered idle as they have oil pipelines still in use. BSEE confirmed that W&T had recently submitted documentation on the removal of three structures and that production has ceased on another three, but the structures were hosting pipelines to help transport oil to shore. Even when the disputed platforms are excluded from W&T’s liability, its ownership of several large 20 year-old platforms means the company still has the third largest idle iron exposure.

For example, W&T operates two fixed platforms and one well protector platform that were installed in the mid-1990s that have been idle for more than five years. It would cost approximately $12 million to decommission each one, according to Byrd’s estimates.

blueprint of Platform SP 49 A

These structures also highlight the environmental dangers posed by Idle Iron. They stand in a Federally-protected marine sanctuary known as the Flower Garden Banks. Safeguarding the environment from the release of toxic chemicals and other harmful materials from the drilling process was one of reasons why regulators launched Idle Iron in 2010.

Debtwire initially discovered nearly $50 million-worth of Idle Iron clean-up attributable to W&T, but giving them credit for the six disputed platforms lowers this to $38 million. Meanwhile the company’s ownership of 268 expired and terminated leases translates to an estimated $49 million of decommissioning liabilities.

Based on the conservative estimate, W&T’s total of near-term P&A spend comes to $87 million. It appears the company’s $78 million budget for asset retirement in 2017 could need to be revised upwards.

At least W&T is better positioned to meet any unexpected costs with $126.1 million of cash in the bank and a $149.5 million line of credit, according to the most recent filings. Still, with oil prices forecasted to stay lower for longer and P&A liabilities getting more expensive, none of the independents can afford additional drains on cash flows.

“W&T is working aggressively to reduce its asset retirement obligations and has made significant progress over the last few years,” a W&T spokesperson wrote in a statement. “Although the company reports its asset retirement activities to the BOEM as required, it can take many months for the BOEM’s records to reflect the updated activity. Currently, BOEM’s records inaccurately report W&T’s Idle Iron liability.”

Getting rid of ‘garbage’

The Idle Iron headache is only going to grow for E&P independents should low oil prices persist.

In the past, operators could delay permanent P&A of whole oil fields by claiming the assets had some future economic value. That argument is becoming harder to make given the depressed outlook for commodity prices. The impact of lower profits only compounds the problem, giving operators extra incentive to avoid P&A in the short term.

Previously, aging fields were sold to more specialized producers to extract the last reserves of oil and gas. But the oil price crash has disrupted this traditional asset lifecycle and there are now fewer buyers for out-of-favor Gulf of Mexico assets.

“Gulf shelf assets are becoming harder to sell. Now you can only really sell them for a zero cash consideration but [in exchange] for someone to put up surety bonds for P&A,” said Lance Gurley, Managing Director at the financial advisor Blackhill Partners, who has worked with a number of struggling Gulf E&P companies and service providers.

More prosaically, an anonymous energy company executive described operators with “basically garbage oil fields” that they want to get off the books but “in order to remove them you have to pay someone to do the P&A.”

Case in point, Freeport-McMoRan is currently in talks with Alliance Energy Group to offload its remaining Gulf assets, consisting of roughly 23 shallow-water oil fields, in a transaction being brokered by investment banking advisors Lazard. Although, instead of Freeport receiving any money, potential deal economics hinge on Alliance assuming roughly $75 million of P&A liabilities associated with the properties, according to sources familiar with the negotiations.

There is a growing body of evidence from market research companies, including Boston Consulting Group (BCG) and IHS Markit, that decommissioning costs rise significantly once work begins.

“Now that you’re seeing platforms installed in the 1970s and 1980s due for removal, the costs are usually larger than expected as they weren’t designed with decommissioning in mind,” said IHS Markit’s Hem.

The sheer number of variables involved in each enterprise adds massive uncertainty to the final cost to the operator. According to a March 2017 BCG report, many projects experience overruns of 30% to more than 100%.

Meanwhile decommissioning estimates will also increase going forward as larger, more complex and deeper water platforms meet the ‘Idle Iron’ criteria. With little industry experience removing such structures, accurately estimating their P&A costs presents a daunting challenge.

A concentration of aging assets on the books, combined with unreliable cost estimates and fewer options to pass the decommissioning buck, make ‘Idle Iron’ a problem for all investors exposed to the offshore energy industry.

“By the end of this year, I expect to see a lot more operators to be orphaning their conventional Gulf properties or going out of business,” said Gary Siems, Vice President of decommissioning at Montco Oilfield Contractors.