Act Now if Your Business is Affected by Gulf Drilling Moratorium

As part of the White House's response to the explosion on the Deepwater Horizon drilling rig on April 20 and subsequent massive oil spill in the Gulf of Mexico, President Barack Obama announced a six-month moratorium on exploratory drilling in the Gulf's deep waters. The moratorium, which went into effect May 30, 2010, requires all Gulf wells drilling in more than 500 feet of water to shut down and prevents any permits from being issued for new deepwater drilling. It does not, however, halt workover drilling or stop the flow of oil coming from existing deepwater wells.

The intent of the moratorium is to assure the nation that further off-shore drilling will proceed only in a safe and environmentally sensitive manner. The Obama Administration also claims the moratorium is limited and "surgical" because it only halts work on 33 wells, leaving thousands of shallow wells unaffected. That description, however, understates the short- and long-term impacts of the moratorium on the oil and gas industry, which accounts for more than half of all economic activity in the Gulf.

Over the last decade, the oil industry has invested billions of dollars to increase development of deepwater sources, and some industry sources estimate that oil companies planned to invest an additional $167 billion worldwide over the next four years on deepwater projects. Because of these investments, deepwater drilling accounts for about 80 percent of the oil production in the Gulf of Mexico.

The six-month moratorium will dramatically impact many individuals and businesses because these large and complex rigs don't operate in a vacuum. It will not only impact the companies that own and operate the floating drilling rigs, but it will also affect the people who worked on the idled drilling platforms. It will also affect many second- and third-tier companies that support the drilling platforms, such as operators of supply boats and helicopters.

The companies that own and operate the floating drilling rigs lease them for $250,000 to $500,000 per day ($1.5 to $3 billion over six months). Therefore, they cannot afford to have them sitting idle for a minimum of six months and, if they can find new waters in which to operate, they may be gone for a long time. There are already reports that some of the drilling rigs will be sent to Africa and Brazil to help develop recently discovered oil fields – development that has been hindered because of a lack of deepwater rigs.

As for workers and suppliers, industry groups estimate that deepwater drilling supports about 26,000 to 46,000 industry workers (1,400 high-paying jobs for each of the 33 idled rigs). That means that suppliers are also going to lose millions of dollars per day in commerce because their services are not needed. For example, the Bristow Group, which provides helicopter services, recently announced that the moratorium will likely cause its revenue from Gulf operations to tumble as much as 85 percent as it is forced to idle seven of its nine helicopters that fly to support deepwater drilling projects. In a letter sent Wednesday to President Obama urging him to reconsider the moratorium, Louisiana Gov. Bobby Jindal said that prohibiting deepwater drilling could cost his state up to 6,000 jobs this month, 10,000 jobs over the next few months, and, if the ban continues for an "extended period," the governor estimated that Louisiana could lose up to 20,000 existing and new jobs by next year. The Louisiana Mid-Continent Oil and Gas Association estimates that the moratorium may cause up to $330 million per month ($2 billion over six months) in lost wages.

It is for these reasons that politicians have been rushing to the defense of the oil-and-gas industry and pleading with Washington to lift the moratorium. While they are angry about the oil spill and its effect on the environment and the fishing and tourism industries, they believe that the Obama Administration's moratorium is an ill-timed, knee-jerk reaction. It is being compared to grounding every airplane in America because of a single crash. For their part, Louisiana lawmakers have passed a bill asking the Administration to shorten the moratorium. Although Interior Secretary Ken Salazar acknowledges the potential damage caused by the moratorium, his solution is for business to demand that BP compensate them for their losses.

Unsatisfied with doing nothing, one Louisiana business, Hornbeck Offshore Services Inc., filed suit in U.S. District Court Eastern District of Louisiana claiming that the Interior Department was without any legal justification when it recommended the moratorium. Hornbeck, which operates a fleet of vessels that haul people and supplies to offshore drilling rigs and production platforms, is asking a federal judge to issue an injunction nullifying the moratorium. According to the complaint, the moratorium violates the law because it was not based on any factual findings about the risks presented by drilling in deepwater and is not supported, as was claimed, by scientists that peer-reviewed the government's report. Thus, the plaintiff claims that the moratorium is arbitrary and capricious, an abuse of discretion, and did not follow the requirements of the law. In response, the Interior Department said the moratorium is needed to provide time to study offshore drilling and make recommendations to the Administration in light of the Deepwater Horizon disaster and oil spill. A hearing is currently set for June 21 in the U.S. District Court in New Orleans before U.S. District Judge Martin L.C. Feldman.

If your company is one of the thousands that will be adversely impacted by the moratorium, now is the time to determine the extent of the impact. One aspect of that determination is to have your contracts reviewed to determine what legal rights or recourse they provide. Specifically, many contracts contain force majeure clauses that may be applicable. A force majeure frees both parties involved of liability or obligation when an extraordinary event beyond the control of the parties prevents one party from holding up its end of the bargain. At least one company, Cobalt International Energy, Inc., invoked the force majeure provision in its drilling contract after the moratorium was announced. All contracts need to be reviewed because each clause is different. However, there are few better reasons for a force majeure declaration than "the government won't let me, or anyone else fulfill their contractual obligations." Ultimately, if the moratorium is upheld and force majeure declarations are allowed, affected businesses may be forced file a claim under their business interruption insurance or pursue recourse against BP. However, when the source of the economic loss is the moratorium, a regulatory decision by the federal government, it is unclear whether BP will be responsible for those losses.

For additional information regarding the deepwater drilling moratorium or other maritime matters, please contact Partner David Jungman ([email protected] or 713.276.5603).