Oil
Page 5
“Our sandbox has just got bigger,” Rainey exclaimed on July 4, as the drill’s sensors reported oil. Nine months later, the size of the reservoir was confirmed: one billion barrels of oil, the biggest-ever discovery in the Gulf of Mexico. “The prize was beneath the salt,” said Rainey, ordering everyone to secrecy until all the neighboring acreage had been signed up by BP. After weeks of around-the-clock work, the explorers and their families discreetly celebrated their success with champagne and dinner.
Around Houston, BP’s triumph was greeted with mixed emotions. In normal times, the city fathers would have been thrilled. More oil would mean a boom, but at $10 a barrel, that was not going to happen. The American public, seemingly prepared to pay more for a bottle of water than for a gallon of gasoline, were manifestly ungrateful for any Big Oil success. Unaware of the technological achievements involved, the oil industry was taken for granted by a generation of Americans who had grown up regarding cheap gasoline as their God-given birthright. Filling their gas tank did not make anyone feel good. Ever since nearly 11 million gallons of oil had spilled from the tanker the Exxon Valdez into Alaska’s pristine waters in March 1989, the public’s antagonism toward Big Oil had become entrenched. Big Oil had overtaken Big Tobacco as a focus of hatred. Within the American public’s DNA was a belief that oil was a decrepit rust industry unfairly extracting tax from honest citizens. Few appreciated that Thunder Horse would fractionally reduce America’s dependence on imported oil, which provided 60 percent of its daily consumption. “Guns, God and Gasoline” may have represented freedom for many Americans, yet the oil companies, apparently ambitious for ever more power while remaining unresponsive to the public, were neither understood nor trusted.
In that hostile environment, BP’s achievement was acknowledged only by its rivals. The company’s reputation had been soaring since 2000 because of aggressive acquisitions. Exxon, Shell and Chevron anticipated their own successes, although the timing was uncertain. While the kingdoms of the major oil companies were diminishing, BP, the largest oil producer in America, was more admired than hated. David Rainey was proud to have met the architect of that success, BP’s chief executive John Browne.
As the guest of honor at a packed dinner in Houston in August 2002, Browne had been hailed as a hero. BP’s dapper chief executive, regarded as an idealist and a maverick, was loudly applauded for describing the Gulf as the “central element” of BP’s growth. No one in his audience underestimated BP’s importance. The company had become the Gulf’s largest acreage-holder, and owned a third of all the oil discovered there. In the oil business, strong personalities made the difference, and Browne, like an evangelist, was wooing his audience. “We’re going to spend $15 billion here over the next decade,” he promised, “drilling between four and seven wells every year.” His enthusiasm was understandable. Oil that had been inaccessible in 1998 was now, he knew from Rainey, within their grasp. If the Houston team was successful, BP would outdistance its competitors. Only a handful of doubters suspected that Browne loved being treated like a rock star more than he loved rocks and their contents. Older members of his audience knew that oil had always attracted the ambitious and the larger-than-life. The same man who controlled 90,000 employees and pledged to serve mankind could also behave unaccountably. That was the nature of multinationals.
Exploration for new oil had barely increased over recent years. Since the mid-1970s, over 1,800 new wells in the Gulf of Mexico and in the Atlantic Ocean off Brazil, Angola and Nigeria had promised to deliver 47 billion barrels of oil. But, like a herd, the major oil companies assumed that prices would not rise, and feared risking their profits and their share prices. Their investment in the search for more oil was cut, and many wells had been abandoned. Yet, on reflection, Thunder Horse was recognized as marking a small revolution, and formerly abandoned areas were reconsidered. “Elephants” meant big, fast profits. Thunder Horse meant there were at least another 100 billion barrels of oil to be found under the sea in the Gulf and the Atlantic. Those who believed oil supplies would “peak” between 2011 and 2013 were challenged to reconsider their doom-mongering predictions. The only disadvantage was the cost. Convinced that oil would not rise above $30 a barrel, Browne congratulated himself that his sharp reduction of BP’s costs would ensure Thunder Horse’s profitability.
Positioning the Korean-built steel rig 6,050 feet above a small hole in the seabed caused jubilation among BP’s beleaguered staff. “The serial number of each piece of equipment is 001,” exclaimed Rainey with pride. No one on the platform expected to actually see oil. Gushers of crude soaring into the air were relics of history. Oil produced in the Gulf was diverted as it emerged from wells into the Mardi Gras system, a network of about 25,000 miles of pipelines crisscrossing the seabed from Texas to Florida. BP’s task was to link Thunder Horse to the system. The obstacles were the depth and distance to the terminals: divers could not survive a mile beneath the surface. But finding elegant solutions to apparently intractable problems caused oilmen’s hearts to beat faster. BP’s answer was to use robotic underwater vehicles, powered by batteries and guided by sonar from the Houston control room, to find a route for the pipes to cross the furrowed, steep Sigsbee escarpment of mountains and valleys, and then to lay and weld the pipes and valves. On July 18, 2005, Thunder Horse was nearly ready. But then Hurricane Dennis hit the Gulf of Mexico, and under American regulations every engineer was compelled to abandon the rig.
The team closed the operation down, but those who gave the order from Houston forgot that the complicated procedures had never previously been executed. After the hurricane passed, the returning teams discovered the rig tilting at a dangerous angle. Defective valves in the hydraulic control system had allowed water to drain out of the ballast tanks. Oil was also leaking from equipment on the seabed that linked the well to the pipeline. BP’s engineers attributed the problems to the poor quality of the manufacturers’ work. None of BP’s designing engineers had taken into account the fact that only valves manufactured from nickel could sustain the extraordinary pressures and temperatures on the seabed; and the welding had been faulty. The flaws were superficially simple, and exposed BP to ridicule from its rivals. Sending divers to carry out repairs a mile down was impossible, and the damage was too great to repair with robots. The equipment would have to be brought to the surface. It was not clear where the blame lay, but the sums involved were too large to reclaim from the designers and the Korean shipyard. Publicly, BP reported that the rig would be unusable until 2007, and that the repairs would cost £250 million. Such optimism caused wry smiles across Houston.
In normal times, the employees of the major oil companies cooperated to serve their common interests, but in the competitive atmosphere of the time mischievous gossip raged across Houston, and the spirit of BP’s humiliated team faltered. Thunder Horse was more than just a tilting platform — it was symbolic of the company. “Poor design and supervision,” smiled Shell’s head of design about the calamity. “BP always shoot from the hip,” said a Shell technician, characteristically dismissing the abilities of a rival. “Their technology and engineering is second rate. They’re always coming to us for help.” He dismissed BP as a late arrival, hanging on to Shell’s coattails, copying its rivals or outsourcing. A colleague agreed that BP was a fast follower, depending on “off-the-shelf go-buys.”
David Rainey was indignant at such criticism. History, he believed, undermined Shell’s claims of superiority. He felt the company had rested on its laurels, and that following the success at Mars it had been closed to new ideas in the Gulf. “Deep Mensa,” an $80 million well bored by Shell in 2001, had been a disaster. Technicians monitoring the data witnessed the “crash out” — the uncontrolled vibrations that smashed the drill as it struggled through fractured rock. Even the best explorers risked embarrassment on the frontiers of the industry. Mortified, Shell’s engineers had taken a year to rectify their mistakes.
Shell’s expensive errors had been concealed fr
om the public. But Thunder Horse appeared to be a warning to Russia and other national oil companies not to rely on BP. The company’s explanations were gleefully rebutted by a Chevron vice president: “It’s defeatist to say ‘Stuff happens.’” That criticism was also rebutted by Rainey. During the 1980s, he recalled, Chevron had suffered multiple drilling failures that had crippled the company. Cooperation in the Gulf with Chevron, Rainey said, had caused arguments. In 2001, BP’s explorers had collaborated with Chevron to test-drill the “Poseidon” block. “They’re off the structure,” Rainey had complained, urging Chevron to reconsider the test location. Chevron insisted on its expertise, but missed the oil reservoir. Expressing condolences for the failure, BP negotiated to inherit the “barren” field. Rainey’s team had precisely calculated the top of the reserve’s “hill,” hit a billion barrels of oil, and renamed the well Kodiak.
BP’s engineers were, however, not protected from the reproaches of a leader of Exxon’s exploration team. As the junior partner in Thunder Horse, Exxon was suffering losses caused by BP. Lee Raymond’s jocular description of John Browne as a “bandit” found many echoes among Exxon’s executives, especially from the technical director who recalled a fault at the BP’s Schiehallion oilfield off the Shetland Islands that had compelled BP to lift equipment off the seabed not once, but twice. On two occasions the company’s engineers had failed to spot valves installed upside down by the contractors. While Exxon’s engineers would at worst have spotted the fault and learned the lesson, BP’s management system was not equipped to evaluate the technology, neutralize risks and absorb the lessons.
Exxon, as the industry leader, proudly avoided technical disasters. Since the days of John D. Rockefeller, the nineteenth-century founder of Exxon’s forerunner Standard Oil, the corporation had standardized the rigorous management of costs and processes to prevent financial or technical errors. Like God, the system and the company were infallible. Relying on a culture developed since Standard Oil’s creation in 1870, Exxon was built on tested foundations. By comparison, BP in 2004 was a conglomerate including former Standard Oil companies — Sohio, Arco and Amoco — still struggling to replicate Exxon’s excellence and standardization. While Raymond concealed uncomfortable truths by cultivating a mystique and keeping outsiders at a distance, Browne was constantly selling himself and his improvized company. Nevertheless, both men could justifiably claim considerable technical achievements to ameliorate oil shortages; yet their skills were spurned by oil-producing countries.
One manifestation of the mistrust of BP, Exxon and the other major oil companies lay across the Gulf, in Mexico. The country, the world’s sixth-largest oil producer, owned vast quantities of unexplored oil beneath its coastal waters. To Browne’s frustration, Mexico’s national constitution forbade the participation of foreign companies in its oil industry, and 1938 nationalization laws had expelled American oil corporations, damaging Mexico itself. Pemex, the national oil company, mired in intrigue and patronage, had become notorious for its inefficiency, and as a slush fund for local politicians. Like so many national oil companies, Pemex was expected to provide employment — there were 27 workers on each of its wells, compared to the industry’s average of 10. And those employees, lacking technical skills, relied on services provided by Schlumberger, which posed no challenge to Pemex’s sovereignty.
In 2002 Mexico’s president Vicente Fox sought to change that situation. The facts were alarming. Mexico’s oil production was falling. The reserves in Cantarell, Mexico’s biggest field in shallow water, which accounted for 60 percent of the country’s production, were declining by 12 to 15 percent every year. In 2002 the government borrowed and spent $50 billion to pump more oil, but it had spent only $5 billion on exploration in four years, none of which was in deep water. Consequently, Mexico’s proven reserves — the oil that was technically and economically recoverable — had been reduced within three years from 15.1 billion barrels to 11.8 billion. The country had neither the expertise nor the money to undertake deep-sea drilling, and its plight was compounded by its inability to refine sufficient crude for its domestic consumption. Instead, Pemex exported crude oil to the USA and paid mounting prices for the gasoline and other refined products imported from America. Natural gas was flared, or burned, at Cantarell because Mexico could not afford to collect and pipe it across the Gulf. Within a decade, the country would need to import oil. Fox urged the vested interests to change the 1938 constitution and allow foreign investment, with the condition that any benefits would materialize only after a decade. His exhortations were ignored. Mexico’s political leaders cared even less about their introverted and protectionist neighbor than about their own plight, an attitude that weakened the oil majors and encouraged the ambitions of the Chinese and other consuming nations to make unrealistic offers to Mexico and neighboring Venezuela, which was even more beleaguered by falling production. For those governments, local politics and world prices were more important than America’s energy needs.
These seemingly disparate events around the Gulf of Mexico became interlocked in the summer of 2005. In August Hurricane Katrina hit the Gulf, passing over Thunder Horse and devastating New Orleans. Winds of 220 mph destroyed old rigs, and struck the Mars rig and 11 refineries. One quarter of all America’s oil production and one half of its refining capacity were paralyzed. Overnight, Americans understood the vulnerability of oil and gas production in the Gulf. Four weeks later, Hurricane Rita hit the area, damaging deep-water platforms and compounding the difficulties of repairs. Fifteen years of low fuel prices in America were over.
Although BP’s oil traders in Chicago and London rank among the most aggressive, David Rainey was unaware of those who were profiting from these calamities. He had nothing in common with that breed, speculating in the darkness, welcoming the probability of oil shortages.
Chapter Three
The Master Trader
ANDY HALL WAS cheered by the reports from the Gulf of Mexico. Bad news from oilfields usually satisfied the tall, unshaven trader. Moving from his barren cubicle into the adjoining trading area, he gazed at one of the 15 screens and calculated how much he was up that day. As usual, at 5 p.m. he headed off to practice calisthenics for an hour with a ballet teacher in Norwalk, near the Connecticut coast. The rising price of oil in spring 2005 seemed to confirm Hall’s bet that the world was running out of crude. “The trend is your friend,” he frequently told his staff. “Ignore the trade noise. Play it long, because I’ve got ample time to pay.” Anyone, Hall knew, could buy oil. The skill was to sell at a profit. Ever since John Browne had predicted in November 2004 that oil prices would stick at around $30 a barrel — although they had already reached $50 — and had gone unchallenged by oil’s aristocrats, including Lee Raymond, Hall had believed that his massive gamble on soaring oil prices was certain to pay off. Although he was coy about the exact amount, his first stakes were quantified at around $1 billion as oil hovered at about $30, and the price, Hall believed, was heading toward $100 and possibly higher.
Lauded for being “clever as sin, outgunning everyone in the brains department,” and referred to as “God” by rival traders, Hall immunized himself from daily market sentiment because he was not part of the herd. An Oxford graduate and art connoisseur, soft-spoken and deceptively shy, he abided by the old adage, “Oil traders work in a whorehouse, so don’t try to be an angel in this business.” Originally trained by BP, he understood the mentality of Big Oil’s chiefs, and believed that Lee Raymond, John Browne and the rest were in denial. Some of the smaller oil producers, like the Austrian and Italian national oil companies, had even bought hedges pricing oil at $45 to $55 a barrel, which would lead to huge losses as prices rose. In March 2005, two years after Hall had made his first bet, and oil was at $55 a barrel, Arjun Murti, a Goldman Sachs analyst, predicted that the price would reach $105 “in a few years.” This was greeted by widespread skepticism, and Murti was criticized for serving the bank’s interests. Unusually, Henry “Hank” Pa
ulson, Goldman Sachs’s chief executive, was required to defend him. By late spring 2008, as the oil price rose beyond $105, Hall had personally pocketed over $200 million in bonuses, and expected to make even more. Murti was being hailed in some quarters as brilliant.
Hall had traded oil for nearly 30 years. Since he had arrived in Manhattan in 1980, disenchanted by England’s claustrophobic social system, he had metamorphosed into an aggressive trader. “I’m basically interested in one thing — business,” he told his trusted circle. “I come in every day to make money.” Whatever the oil price’s wild fluctuations, and regardless of whether he was earning or losing millions of dollars, Hall coolly controlled his emotions: “This is not a zero-sum game because we’ve been doing it for too long to get excited. Emotionally the ups and downs get evened out.” Over the years Hall had attracted both praise and loathing for perfecting the “squeeze” — causing the oil market to change, and forcing other traders to buy from him at a premium. “We’re not here to help others,” he said. In the old days when trading was carried out on the floor of the stock exchange, and dealers had occasionally yelled, “Am I fucking long or fucking short?” Hall had smiled about the screaming losers who always heaped blame on everyone except themselves.
Experience honed Hall’s pedigree. Unlike his younger rivals, he had started his career in BP’s supply department in the midst of the first oil crisis in 1973. Until then, BP and the other oil majors — Exxon, Mobil, Shell, Chevron, Gulf and Texaco, together known as the Seven Sisters — who controlled 85 percent of the world’s oil reserves, had perfected a cozy arrangement to fix the world price. Their representatives met regularly to discuss their costs and calculate their required profits. Blessed by a near-monopoly and a surplus of oil, the seven chairmen would travel as statesmen to the Middle East and inform the Arab producers the price the cartel would pay for their oil the following year, usually around $25.25 per ton, or $3.60 a barrel. The chairmen acknowledged each other’s “turf” and, acting like governments, used their intelligence agencies and military supremacy to impose one-sided agreements. The Arab producers meekly signed fixed-price contracts, Exxon formally announced the price, and the crude continued to flow from the Middle East to refineries in Europe and America, although the USA could rely on its own plentiful supplies, supplemented by additional oil from Venezuela and Mexico. Before 1939, Europe imported 90 percent of its oil from America, but after 1945 it switched to Middle Eastern oil, which cost 20 cents a barrel to produce compared to 90 cents for oil from Texas. Even American oil companies increased their imports. To placate small US producers, who were protesting about competition from Arab oil, in 1956 President Eisenhower limited imports, thus increasing the glut in the Middle East. Four years later, without consultation, Exxon and the other Sisters unilaterally cut prices for oil producers. Resentful of the cartel, Saudi Arabia and four other leading Middle Eastern oil producers met in Baghdad in 1960 to form OPEC, to challenge the Seven Sisters’ ownership of their reserves.