Serious New Regulatory Risks Arise for Oil Contractors (BP, RIG, HAL, CAM, SLB, BHI, NOV)

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Responsibility is going to get spread around for the explosion of the Deepwater Horizon that killed 11 people and poured millions of barrels of oil into the Gulf of Mexico last year. The US Department of Interior’s Bureau of Safety and Environmental Enforcement (BSEE) yesterday issued 15 citations to BP plc (NYSE: BP), Transocean Ltd. (NYSE: RIG), and Halliburton Co. (NYSE: HAL) related to violations at the Macondo well.

The violations, called Incidents of Non-Compliance, against BP were expected. Those against Transocean and Halliburton were not. Each company received four citations in what is believed to be the first time that a sub-contractor has been cited for violations related to a particular incident. Cameron International Corp. (NYSE: CAM), maker of the failed blow-out preventer at the Macondo well, was not cited.

In its announcement of the violations, BSEE noted that “BP, Transocean and Halliburton’s conduct in connection with the operations at the Macondo well violated a number of federal offshore safety regulations under BOEMRE’s jurisdiction.” The BSEE aknowledged that this is the first time that contractors have been held responsible for violating regulatory rules, but cited the “severity of the incident” as the reason to hold all parties responsible.

The oil field services industry, drillers, and other contracted services providers are literally quaking in their shoes over the implications of the BSEE’s announcement. The BSEE charges, if not overturned in the inevitable litigation that will follow the decision, will provoke a major change in the relationship of contractors like Transocean and Halliburton to operators like BP. The ruling will hit other services companies and drillers like Schlumberger Ltd. (NYSE: SLB), Baker Hughes Inc. (NYSE: BHI), and National Oilwell Varco, Inc. (NYSE: NOV) among many others.

The most immediate impact could come in insurance costs. Because contractors have never before been held accountable for operational incidents, their insurance coverage has likely been on the minimal side. That will change, and insurance rates will surely rise.

The second change will be in the rates that contractors charge operators. The added insurance coverage will bump up day rates and other charges, and an “uncertainty premium” will likely also have to be negotiated. That is, if the contractor is merely doing what the operator demands, but is still liable if an accident occurs, contracts will have to reflect the cost to the contractor of possibly casual compliance by the operator with existing regulations. Pricing that will be contentious to say the least.

Whatever happens, the cost to drill a well just went up, which will affect operators like BP and the other exploration and production companies as well. And because the operators are at the mercy of the crude oil markets, their higher costs may not be reflected in the price they can get for their oil. That will affect operator revenues and profits as well.

The logic behind BSEE’s decision is certainly arguable. On one hand, for the contractors to claim they were just following orders is a pretty weak defense. On the other hand, if it can be shown that following orders meant ignoring accepted safety standards, then the contractors should pay. They are under no obligation to violate safety regulations in service of the operators. Quite the contrary, in fact.

Stock prices among the services companies are down about twice as much as the overall market just before noon today. Transocean’s shares are off more than -3.5%, at $47.30, in a 52-week range of $43.15-$85.98. Halliburton’s shares are off about -2.2%, at $34.30, in a 52-week range of $27.21-$57.77. Shares of Baker Hughes are off more than -2.5%, at $52.05, in a 52-week range of $41.91-$81.00. Cameron is off about -1.5%, at $46.76, in a 52-week range of $38.77-$63.16.

Paul Ausick