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Why Was BP Drilling in 5,000 Feet of Water Anyway?

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A brief history of how oil companies got in over their heads in the Gulf.

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Drilling in thousands of feet of water is costly and dangerous. It's also where the oil is. But the real story behind deepwater exploration and production is not so simple an equation.

"Deepwater production is a new frontier," American Petroleum Institute senior economic advisor Rayola Dougher explained in an interview with Minyanville. "The oil companies have been denied access to the outer continental shelf in the past; they haven't been allowed to explore. That's why they're out there now."

Kert Davies, research director at Greenpeace USA, disagrees. He says BP (BP) isn't drilling down a mile deep because environmental groups prevented the company from operating closer to shore. It's because, 15 years ago, oil production off the outer continental shelf was effectively subsidized by the US taxpayer when Congress passed the Deep Water Royalty Relief Act, which exempted oil companies from paying a 12% royalty on oil extracted from wells in federal waters.

In 1995, crude oil was selling for about $16 a barrel. Nobody had any interest in drilling in thousands of feet of water, and companies were beginning to focus overseas.

Until then, drilling in the Gulf was done primarily in depths of 650 feet or less, according to a 2009 Minerals Management Service report. After royalty relief, oil companies suddenly became quite keen on deepwater drilling, which had in the past been seen as too expensive and difficult. But there were massive amounts of oil and gas miles offshore. As noted in the MMS report, "Significant deepwater leasing activities began in 1995 and showed remarkable increases from 1996 through 1998, especially in water depths greater than 800 m (2,625 ft), where the greatest royalty relief was available." During this time, leasing activities on shallow-water blocks diminished."

In the blink of an eye, drilling was incentivized in depths at which the oil industry had never before dealt with spills and blowouts.

"Now you hear the oil industry saying 'We had to go out there, even though it's unsafe,' " Davies points out. "At the same time, they turn around and say, 'Don't put a moratorium on deepwater drilling -- it's perfectly safe. Which is it?' "

Davies notes that royalty relief was supposed to end when crude hit $40 a barrel. However, it never did due to a "paperwork error," and in 2004, Interior Secretary Gale Norton implemented further subsidies to oil companies.

This policy continued under President Bush; in 2005, he signed an energy bill containing $2.6 billion in new tax incentives for drillers and expanded the royalty relief program.

"There's an incredible amount of oil out there," says Davies. "This is huge money at stake. Frontier drilling has tremendous potential for catastrophe, but the payoff is a potential multibillion dollar find. Now there are 30 deepwater wells in the Gulf, including one that's even bigger than the Deepwater Horizon," which BP was operating in conjunction with Transocean (RIG), Cameron (CAM), and Halliburton (HAL). "BP is ramping up production on its Thunderhorse rig, sitting in 6,250 feet of water. This is a platform that happened to flip over during Hurricane Dennis in July, 2005. What makes it all the more outrageous is that drilling every possible square inch of the outer continental shelf will not make a fingernail's worth of difference regarding domestic oil consumption."

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