Private-equity-backed players, expiring leases, existing infrastructure, resource potential and stabilizing oil prices could mean slightly more bidding action during the upcoming lease sale for federal blocks in the U.S. Gulf of Mexico (GoM).

This is according to analysts who have been keeping eyes on the offshore region where economics have become competitive with onshore shale plays as operators gain efficiency and lower break-evens.

“Gulf of Mexico deepwater development, generally speaking, is in some of the best shape it can be to compete. It’s very competitive with onshore, and it’s attracting investment dollars,” William Turner, senior GoM research analyst for Wood Mackenzie, told Hart Energy. “I would suspect the majors’ activity to be on par with what they have been—not more, not less. But I think the growth in bidding activity this round will be driven by the smaller independents and private-equity-backed companies like Kosmos, Fieldwood, LLOG—to name a few.”

The Aug. 15 Lease Sale 251 makes available all unleased areas in the GoM—some 14,622 blocks located from three to 231 miles offshore in water depths ranging from 3 m (9 ft) to more than 3,400 m (11,115 ft).

In recent months the industry has witnessed Kosmos Energy Ltd. (NYSE: KOS), an Atlantic Margin-focused E&P, enter the GoM with its acquisition of deepwater player Deep Gulf Energy for about $1.23 billion in cash and stock; Fieldwood Energy LLC emerge from bankruptcy and buy Noble Energy Inc.’s (NYSE: NBL) GoM assets for $480 million cash; and Cox Oil Offshore LLC snap up Energy XXI Gulf Coast Inc. (NASDAQ: EGC) for $322 million.

Turner described the investment climate in the GoM as a “buyer’s market” with smaller players getting access to capital. Though M&A activity is different than a lease sale, Turner said, the activity speaks to opportunity in the GoM.

Eyeing Opportunities

Kosmos, the GoM newcomer, has already indicated interest in lease sales.

Speaking during the company’s second-quarter earnings call, Kosmos Energy CEO Andy Inglis called the GoM a “world-class basin with a huge amount of discovered and yet to be discovered resources across a number of play types.” The company decided to enter the GoM now of all times because of “attractive economics and lack of competition.”

Inglis pointed out the shrinking pool of lease sale participants and declining lease sale bidding, respectively down by more than 60% and 85% over the last 10 years. The drop, he said, led to the departure of large and midcaps that are now chasing shale plays.

“At the same time, Gulf of Mexico production has grown steadily as majors remain consistently active and continue to sanction cost-competitive projects helped by a sustained deflation and supply cost in contrast to shale,” Inglis said. “The attrition of independents created an opportunity for private equity [that] made a number of investments in Gulf of Mexico that are now nearing the end of their fun 10 years [and] as such do not have access to the necessary funding for further growth opportunities. The growth opportunities from lease sales and acreage relinquishments are more attractive now than it’s been for many years.”

Statistics released by the U.S. Bureau of Ocean Energy Management (BOEM) showed Lease Sale 250, which offered drilling rights to nearly 77 million acres in the GoM, attracted about $124.8 million in high bids from 33 companies.

In all, companies placed 159 bids on 148 blocks. That equates to only 1% of the 14,431 blocks made available. By comparison, the Gulf-wide lease sale in August 2017 attracted 99 bids for 90 blocks from 27 companies, bringing in more than $121.1 million in high bids.

When asked by analyst Pavel Molchanov of Raymond James whether Inglis’ allusions to the industrywide lack of interest in leases implies Kosmos will use new GoM assets as a foundation to gain more acreage in sales, Inglis aid: “yes, absolutely.”

“There was a huge amount of leases taken out in the ‘08, ‘09, ‘10 period, which obviously start to become available in the next three years. The combination of that with a lack of capital to go in, there are prospects that are not getting drilling today, even [though] they are close to infrastructure, because of that dynamic of time and capital,” Inglis said. “That in itself is an opportunity, which is the farm-in. And then, of course, some of those won’t get drilled, and they will simply become available for re-leasing. I believe there is a really strong set of prospects that will come forward from that.”

Attractiveness, Competitiveness

While shallow-water blocks saw some increased activity during the last GoM lease sale, deepwater blocks are expected to dominate as usual, according to Turner. He suspects subsea tieback opportunities and areas near infrastructure will drive activity.

However, standalone blocks are also expected to lure companies—“especially blocks that have recently become available again since the 2007-2008 lease sale because folks would’ve studied those blocks.”

Competition could be high for certain blocks.

“If it’s a very competitive block the majors are going to get it if they want it,” Turner said, recalling a competitive bid about a year ago between Total SA (NYSE: TOT) and Cobalt International Energy (before the company went bankrupt) in which Total bid about 10 times more than Cobalt for a block near North Platte. Earlier this year, Total acquired a 20% interest in the North Platte discovery as part of Cobalt’s bankruptcy auction sale.

But bidding strategies are typically different for large and small players, according to Mfon Usoro, a GoM research analyst for Wood Mackenzie.

“In general, the larger players tend to go for more frontier plays—for example, in the Walker Ridge or the Keathley Canyon area,” Usoro said. “In general, the private equity guys don’t really bid in those regions.”

The GoM Outer Continental Shelf holds about 48 billion barrels of undiscovered technically recoverable oil and 141 trillion cubic feet of undiscovered technically recoverable gas, according to BOEM.

“This lease sale is a barometer and a step in the recovering health of the offshore oil and gas industry. While the recovery is neither uniform nor universal, efficiency improvements in the last few years are starting to bear fruit and some offshore sectors are showing profits, although the margins are slim,” Tim Charters, vice president of governmental and political affairs for the National Ocean Industries Association, said in a prepared statement. “Unfortunately, the [Trump] administration’s decision to not lower future deepwater royalty rates to match shallow water and onshore royalty rates does nothing to hasten overall recovery.”

Leases in water depths of 200 m or less carry a 12.5% royalty rate, while the royalty rate for other leases remains at 18.75%.

GoM oil production has been increasing since 2013, having grown from more than 459 MMbbl to more than 612 MMbbl in 2017, according to BOEM statistics. However, Turner said “operational headaches” have brought down oil production for the first five months of the year compared to last year. Such headaches included the Enchilada platform fire that caused several wells to shut down—all of which are back up now.

“I would suspect a strong second half of the year as they sort out some of these operational issues,” Turner said.

Usoro added some new fields are also scheduled to go onstream later this year, contributing to higher production.

Among these are tiebacks from LLOG Exploration Offshore. The Blue Wing Olive and La Femme developments in the GoM’s Mississippi Canyon area are scheduled for first production in third-quarter 2018, while the Red Zinger development is set to begin production in fourth-quarter 2018.

Velda Addison can be reached at vaddison@hartenergy.com.

Offshore