Total’s stock pulled back substantially the following day, as investors speculated about how much revenue the company would lose by shutting in the well and about the costs from related fines and remediating environmental damage associated with the leak.
As my colleague wrote in "Shale Oil and Gas: Energizing the US Economy," after the Macondo oil spill in spring 2010, disasters of this nature put the investment community on edge, particularly when they occur in the West. Recall that in the wake of the blowout in the Gulf of Mexico, pundits speculated that the damages associated with the spill would bankrupt BP (LSE: BP)(BP).
Although the recent natural gas leak in the North Sea inevitably led to hasty comparisons to what transpired in the Gulf of Mexico, the two disasters bear scant similarity to one another–save that investors have overreacted to the news. Value investors now have a great opportunity to pick up shares of Total at a bargain price and lock in a dividend yield of roughly 6%.
The G4 well that’s the source of the Elgin leak hasn’t been in production since February 2011. In fact, Total had been working to plug the well for permanent abandonment. More important, the Elgin gas field that the well targeted isn’t the source of the leaking gas, which Total has attributed to a limestone reservoir about 1,000 meters (3,100 feet) above the field.
Management has noted that the “tight” reservoir from which the gas is flowing lacks permeability, which should limit the amount of leakage relative to other major spills. In the case of the Macondo blowout, not only were the hydrocarbons flowing from the primary reservoir, but the geological pressures propelling oil and gas into the Gulf were also much higher because the field had been discovered relatively recently.
The Elgin field, which was discovered in 1991, produces natural gas and condensate that doesn’t contain significant quantities of hydrogen sulfide, a toxic gas that would pose a significant challenge to workers seeking to stop the leak.
The France-based oil company estimates that the leak is emitting roughly 7 million cubic feet of natural gas into the atmosphere each day. High winds in this part of the North Sea help to dissipate the gas more quickly than would otherwise be the case, while the site’s distance from shore poses little immediate threat to any population centers.
That being said, the leak has forced Total and other operators in the region to temporarily abandon activity and shut in production.
In addition to natural gas, Total estimates that the field has leaked between 5 metric tons to 9 metric tons per day of condensate into the water; this liquid hydrocarbon is the source of the sheen on the water that some news outlets have reported. Like gasoline, condensate evaporates more quickly than crude oil.
Assuming that the volume of condensate emitted into the North Sea is at the high end of Total’s estimated range, the flow rate equates to less than 70 barrels per day–not enough to cause significant long-term damage to the environment. To put the spill into context, oil gushing from the Macondo well peaked at 60,000 barrels per day to 70,000 barrels per day–about 1,000 times the rate at which condensate is leaking from the Elgin platform.
Whereas operators struggled to plug the blown-out Macondo because the source of the spill was almost 1 mile below the surface of the Gulf of Mexico, the hydrocarbons leaking into the North Sea are coming from equipment installed on the surface platform. Advanced robotic vehicles won’t be required for this operation.
Total has two plans to control the natural gas leak and is pursuing both courses simultaneously.
In a few weeks, the energy company could pump drilling mud, bits of rubber and metal into the top of the well to counteract the underground pressures that are pushing gas to the surface, enabling engineers to pump concrete into the well for permanent abandonment.
BP attempted this “top-kill” method on the Macondo well in 2010, but the extraordinary geologic pressure forcing the oil into the Gulf of Mexico was too strong to overcome. BP also struggled to achieve a solid seal on the top of the well, so much of the drilling mud spilled outward.
The reservoir pressures at Elgin should be far more manageable. With direct access via the platform, Total should have an easier time pumping mud into the well.
Total’s alternative effort to control the well involves drilling two relief wells that intersect the shaft of the G4 well and then pumping concrete in to plug the leak. BP used this technique to permanently plug the Macondo well. Such an approach would take months to complete.
This brings us to the question of cost. Total estimates that it’s losing about 53,000 barrels of oil equivalent per day of net production because the leak has forced the firm to shut production at nearby platforms. Management has assigned a price tag of about USD1.5 million per day to this lost production, while the cost of responding to the spill has been roughly USD1 million per day. Drilling the relief wells will ratchet up this expense to about USD1.5 million per day.
The firm will also likely face fines from the UK government and could be sued by Royal Dutch Shell (LSE: RDSA)(RDS A, RDS B) and other producers that have been forced to halt operations in the area.
Total shouldn’t have any problems paying these bills. One of the largest energy firms in the world, the company has $19 billion in cash on hand and about $10 billion in undrawn credit lines. In addition, the company has roughly $750 million in third-party insurance coverage for liability and more than $1 billion in coverage for property damage related to the Elgin spill.
Based on management’s initial cost estimates, the company has plenty of cash on hand to maintain its current dividend and fund planned capital expenditures for 2012. Management also indicated that the cause and magnitude of the spill are unlikely to usher in major changes to how wells are drilled in the UK portion of the North Sea.
In the unlikely event that Total needs to borrow money, the leaking well hasn’t affected the company’s bonds: The firm’s 2 7/8% maturing in 2012 currently yield 3.22%, one of the lowest yields to maturity of any 10-year bond issued by a large-cap European company.
In short, the Elgin spill shouldn’t present a major obstacle to Total’s growth story; the recent sell-off in the stock appears overdone, especially when you consider the company’s myriad upstream growth projects around the world.
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