Posted by: bmeverett | September 8, 2008

Myth #4: We shouldn’t open up more of the US for drilling until the oil companies drill the areas already available to them.


Note: My apologies for my silence the last few weeks. Classes have just started at the Fletcher School, and I have had lots of preparation for my roughly 80 students. Anyway, my discussion of Senator Obama’s energy proposals continues.

Myth #4: We shouldn’t open up more of the US for drilling until the oil companies drill the areas already available to them.

Senator Obama tells us in his Lansing speech:

But we should start by telling the oil companies to drill on the 68 million acres they currently have access to but haven’t touched. And if they don’t, we should require them to give up their leases to someone who will.

This argument has been the basis of the opposition of Democrats to increasing domestic oil and gas supplies, but it manifests a complete lack of understanding of the oil and gas exploration process. Here’s how it works.

Geological maps provide a general guide to which rock formations are conducive to oil and gas formation and accumulation. The industry, however, needs way more information to determine whether commercial quantities of oil and gas are actually present. The first step is usually seismic readings, in which advanced sonar systems bounce sound waves off underground rock formations to provide a detailed picture. These data tell us a lot about structures that might contain oil and gas, but relatively little about whether there are actual hydrocarbon accumulations in these structures.

Companies have to drill wells to find out for sure if there are commercial deposits of oil or natural gas.

About 55% of US oil production occurs on publicly owned land with an oil company finding and producing that oil under a lease arrangement with a state or the federal government. These leases are generally offered for competitive bids. The acreage offered for bid may have some seismic data available for review by the bidder. The successful bidder usually carries out a more detailed evaluation of the acreage before deciding whether to drill wells, which are very expensive. A shallow (say, 5,000 feet) onshore well may cost less than $1 million, but wells in the Gulf of Mexico must sometimes be drilled in 5,000-10,000 feet of water and then an additional 15,000-20,000 feet below the seabed at a cost of up to $100 million per well. Companies don’t make these investments unless there is a reasonable chance of a commercial discovery.

Senator Obama’s suggestion that leases be surrendered if the company doesn’t drill is a good idea, but it is already a condition of the lease. Companies are given leases for a specified period of time, generally 5-10 years, and the lease terminates if no oil or gas is produced from the area after that initial period is over.

Why are companies not drilling on come of the leases they currently hold? Are oil companies withholding oil from the market to help sustain the price? Hardly. The share price of most major oil companies depends critically on their ability to increase their oil and gas production. Companies don’t drill until they have at least a reasonable expectation of success. Even if geological evaluations indicate promising structures, it takes some time to get a drilling program organized. If there are no indications of commercial oil and gas deposits, who on earth would expect the companies to throw money away drilling dry holes? The Democrats’ position seems to be “Drill first where there’s no oil, then we’ll let you drill where there is oil.”

A final point concerns the likely impact of drilling. Senator Obama claimed in his Lansing speech that an extensive drilling program is likely to find an amount of oil equal to only about 3% of the world’s reserves, so why bother. First, we really don’t know what we’ll find. It could be very little or much more than we expect. The shareholders of the oil companies are willing to take the risks of finding out, so why not? Current global proved oil reserves are about 1.2 trillion barrels. The 3% that Senator Obama so cavalierly dismisses would be 36 billion barrels of oil. At $100 per barrel, that’s $3.6 trillion dollars worth of oil! That’s not nearly enough oil to make us independent of imports, but it would reduce our balance of payments deficit and keep that money out of the hands of oil exporting countries.

The test for a government policy ought to be that it provides potential rewards greater than its cost, not that that policy alone represents a complete solution to the problem.

Drilling seems to be a no-brainer: it doesn’t hurt, it might help and you don’t have to pay for it.

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