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Federal Responses to the Gulf of Mexico Oil Spill: Developments to Date and What to Watch for in the Future

Van Ness Feldman Alert by By Jonathan Simon, Joe Nelson, Jennifer Owen

June 10, 2010 -- The explosion of the Deepwater Horizon oil rig and subsequent oil spill in the Gulf of Mexico has captured the attention of the general public, as well as government officials, on a historic scale. BP, the lessor of the rig, has become the public focus of the spill. While it is far too early to determine the full environmental, operational and regulatory impact of the spill, and the full range of public and private sector responses, key issues are beginning to emerge that will have significant implications for the energy industry as a whole, beyond those entities engaged in, or supporting, offshore drilling and the manner in which the United States produces, transports and consumes energy.

Containment and cleanup efforts are evolving daily, as are the responses from the Administration and Congress. The release of oil into the Gulf is expected to continue for many months, and the cleanup effort long after that. The installation of a containment cap has allowed some siphoning of oil, with U.S. Coast Guard Thad W. Allen announcing Wednesday that 15,000 barrels per day are being collected from the Gulf. Relief wells are underway, with drilling projected to be completed in August.

With BP CEO Tony Hayward set to testify in front of a House Energy and Commerce subcommittee on June 17, attention to the ramifications of the spill is certain to continue. The political response will include debate on the future of offshore energy development with possible ripple effects throughout the energy industry. While some significant developments have taken place, much more activity is expected, and key questions remain unanswered. We highlight below noteworthy recent developments and identify major issues to watch in the coming months. We will provide updates to our clients as events warrant.

Major Developments - What to Watch For This Summer Structural Changes in the Executive Agencies The Minerals Management Service (MMS) within the Department of the Interior (Interior) is responsible for managing offshore oil and gas and renewable energy leasing and development on the Outer Continental Shelf (OCS), including ensuring that such offshore energy development is done safely and in an environmentally responsible manner. Recently, MMS has received widespread criticism, with claims ranging from inappropriate interactions and relationships with oil and gas representatives to perceived bias toward the industry, leading to the agency's alleged failure to enforce rigorous environmental and safety standards. Most notably, the Interior Inspector General identified a series of problems within the agency in a May 2010 report that has received widespread media attention. This report followed a 2008 report documenting widespread misconduct in MMS's Denver field office.

On May 27, 2010, Interior Secretary Salazar removed Elizabeth Birnbaum from her position as the MMS Director. Robert V. Abbey who serves as the Director of the Bureau of Land Management, now holds the MMS Director position on an acting basis until a new Director is nominated and confirmed by the Senate. In addition, Chris Oynes, Associate Director of Offshore Energy and Minerals Management at MMS, has resigned.

Further, in a May 19 Secretarial Order, Secretary Salazar divided MMS into three separate agencies, recognizing the inherent conflict between effective regulation and revenue collection: a Bureau of Ocean Energy Management, focused on OCS oil and gas and renewable energy project leasing; a Bureau of Safety and Environmental Enforcement, focused on inspections; and an Office of Natural Resources Revenue, focused on royalty collection. To date, congressional response to the reorganization has been tepid, with some questioning whether the Secretary has the authority to undertake the reorganization.

In addition to restructuring within Interior, proposals have been floated to move components of the offshore drilling program to the Department of Energy, the Environmental Protection Agency (EPA), or elsewhere in the federal government. Similarly, concerns about the ability of industry and the government to respond to spills like the Deepwater Horizon have led to the suggestion that the federal government should develop increased technical expertise in deepwater drilling and spill-response.

The potential indirect effect that the oil spill might have on offshore renewable energy development is uncertain. MMS's renewable energy program is relatively new, with the Department's Final Renewable Energy Framework completed only in April 2009, and the level of interest in revisiting aspects of the program at this early date is unclear. On June 9, 2010, unrelated to the oil spill, Interior announced a Memorandum of Understanding (MOU) with Atlantic Coast states focused on offshore wind development. The signing of the MOU will begin a 30-day planning process to coordinate permitting and siting efforts between the states and Interior.

Offshore Drilling Moratoria The Administration has issued a six-month moratorium on the drilling of new deepwater wells in the Gulf (i.e., in depths of more than 500 feet). The Order also halted drilling operations on 33 currently permitted oil wells. In addition, a planned lease sale off the coast of Virginia was cancelled on May 27, and authorization for oil and gas exploration by Shell in two locations on Alaska's OCS has been suspended.

The International Association of Drilling Contractors has estimated that the moratorium could result in 40,000 U.S. jobs lost this summer. The Louisiana Department of Economic Development estimates that the suspension will result in the loss of over 10,000 jobs in Louisiana alone within a few months. The Louisiana Mid-Continent Oil and Gas Association estimates that oil companies will lose $8.2 million to $16.5 million per day because of the moratorium, with related economic losses ranging from $165 million to $330 million. Anecdotal reports of oil and gas producers choosing to move drilling rigs to other parts of the world are beginning to emerge, suggesting that the economic losses could continue for years and potentially increase pressure on the Administration.

Increased Drilling Safety Regulations On May 27, Secretary Salazar provided a series of short-term safety recommendations to President Obama. Among Secretary Salazar's recommendations are an immediate recertification of all blowout preventer equipment and emergency systems, new deepwater well-control and fluid displacement procedures, new well casing and cement design requirements, and a significant increase in federal testing, inspection, and intervention capabilities. Further on June 8, the Department issued a Notice to Lessees, outlining increased safety measures for energy production on the OCS. The Notice largely adopts the recommendations from the May 27 report.

Additional drilling safety recommendations are expected later this year, likely arising from any conclusions or recommendations made by the Presidential commission established to investigate the spill. That commission is led by former Florida Senator Bob Graham and former EPA Administrator William Reilly.

Changes to Liability Schemes In response to the spill, Interior is undertaking a review of liability issues related to offshore oil and gas production. Secretary Salazar has indicated that the Department will propose a new liability regime that differentiates between deepwater and shallow water production. In Congress, multiple bills have been introduced to increase the liability limit for economic damages under the Oil Pollution Act of 1990 (OPA) from $75 million to as high as $10 billion, or to eliminate the cap entirely. The existing cap does not apply to costs of cleanup and restoration of damages to natural resources, and does not limit legal claims outside the scope of OPA.

Small petroleum producers have expressed concern that higher liability exposure would push small producers out of offshore oil and gas development on the OCS. Some law makers have responded to this argument by expressing concerns about the ability of small producers to respond to an event similar to that of the Deepwater Horizon, suggesting that only those entities able to bear consequences of drilling should be permitted.

Congressional Democrats have expressed concerns that existing liability provisions encourage risky behavior in the offshore drilling industry, and are taking a comprehensive look at options. Sen. Lisa Murkowski, Ranking Member of the Senate Energy & Natural Resources Committee, is developing a proposal to establish liability caps on a project-by-project basis.

In addition to congressional efforts to address liability issues, judicial action is likely to shape the debate. Dozens of lawsuits have been filed against BP, Transocean, and related contractors in state and federal court. Judicial responses to requests from potentially liable parties to limit the scope of legal exposure could shape the congressional discussion on appropriate accountability schemes.

Other Potential Legislative & Administrative Developments More than two dozen congressional hearings on the oil spill have been conducted or announced. Simultaneously, there has been a proliferation of legislative proposals as well as Administration efforts to demonstrate leadership and control over the situation. Changes under consideration cover a broad spectrum of issues, including modifications to worker safety requirements and whistleblower protections, changes to revenue sharing provisions and other structural changes to the Outer Continental Shelf Lands Act, increased investment in spill-response technologies and the elimination of tax incentives for the oil and gas industry.

In May, the House of Representatives passed language that quadrupled the tax paid by the oil industry into the Oil Spill Liability Trust Fund, from eight cents per barrel to 32 cents per barrel. Proposals in the Senate would raise the tax as high as 41 cents per barrel. The Senate has passed legislation providing the U.S. Coast Guard increased authority to advance funds from the Oil Spill Liability Trust Fund to pay for the cleanup.

Labor Secretary Hilda Solis has been tasked by the President to visit the Gulf region to inspect efforts to ensure the health, safety and well-being of workers affected by the spill and engaged in the spill response. Congress has not yet focused on potential health impacts to workers and volunteers, but will likely begin to do so in the coming weeks.

Finally, the debate over whether and where to drill offshore in the U.S. is expected to continue in the coming months. Even as the economic losses to Gulf States increase with the temporary moratorium, proposals to ban drilling in the Gulf have been introduced, along with bans on drilling off various portions of the Pacific and Atlantic coasts.

Key Questions Going Forward 1. Just How Bad is the Spill? While the federal government is still working to quantify the size of the Deepwater Horizon oil spill, preliminary estimates indicate the volume of oil in the Gulf already drastically exceeds that released in the Exxon Valdez spill, and could potentially exceed Mexico's Ixtoc I spill in 1979 in the Gulf of Mexico before the well is sealed. While BP is now able to capture significant quantities of oil, the availability of vessels to hold the oil is limited, causing new concerns about the likely success of the containment effort. The National Oceanic and Atmospheric Administration (NOAA) has closed off 78,603 square miles, or about 33% of the federal waters in the Gulf of Mexico, from fishing as a result of the spill.

Environmental impacts are expected to be wide-ranging, and may not be clear for some time. Pictures of wildlife covered in oil appear regularly on the front pages of newspapers, but are only a narrow indicator of the broader potential environmental damage. Significant concerns have been raised by Members of Congress and environmentalists related to the toxicity of dispersants used by BP as a part of the spill response. Scientists are discovering that some quantities of oil and gas are remaining below the surface, which can reduce the availability of oxygen and harm fish eggs.

Current estimates of impact are largely anecdotal and evolving daily as the impact of the spill spreads throughout the region. The U.S. Coast Guard has already advanced nearly $100 million in cleanup costs from the Oil Spill Liability Trust Fund, and analysts estimate the cost to BP to be as high as $30 billion. The drilling moratorium alone has a notable economic impact, including the loss of royalty revenues to both the federal government and states.

Impacts to other industries also are beginning to emerge. The Gulf Coast is responsible for over one-fifth of U.S. seafood production. Sport fishing is a multi-billion dollar industry for Gulf States, but fishing events are already being cancelled in Florida. Tourism boards throughout the Gulf Coast region are undertaking aggressive campaigns to encourage travel to the area, but there are signs that visitors may be heading elsewhere.

Even in light of the mounting costs and damages, BP is still promising to pay all reasonable claims, including the costs of the cleanup. At the same time, media reports are questioning the company's long-term viability. BP's stock prices continue to decline, slashing the company's market capitalization from $180 billion in April to $91.4 billion on Wednesday. Rating agencies have downgraded BP's long-term debt, and industry analysts are watching closely to see if BP will announce the payment of a dividend on July 27, when it announces second-quarter financials. The decision will reflect as much about the political climate as the company's financial health; BP is already under pressure to withhold or reduce the first quarter dividend it promised to pay in April.

2. How Will the Spill Impact Oil Prices? Despite the decline of oil drilling and production in the Gulf, oil prices remain stable. Prices at the pump do not yet reflect the usual post-Memorial Day/summer driving season spike, and have not shown a jump due to the oil spill. However, prices could rise over the coming months, as companies with stalled rigs in the Gulf look to move production to other areas of the world.

The cost of oil production may rise as a result of the spill as well. Media reports indicate that insurers already are evaluating an increase in premiums. Current estimates indicate that insured losses, which amount to only about 20% of the harm connected with the spill, could reach up to $3.5 billion.

3. What Does the Weatherman Say? On May 27, NOAA released its annual hurricane report for the Atlantic region, predicting above average activity consisting of 14 to 23 named storms, including eight to 14 hurricanes of which three to seven could be major hurricanes. Secretary Salazar has noted that part of the rationale behind the six-month deepwater drilling moratorium is the possibility of an active hurricane season. A significant hurricane in the Gulf is likely to cause delays in clean up, and may expand the radius of environmental damage by spreading the spilled oil and pushing large quantities of oil onshore.

In addition to the threat of hurricanes, the oil slick has broken into what the U.S. Coast Guard is now characterizing as "thousands" of smaller slicks spreading throughout the Gulf. With or without hurricane activity, some theories suggest that the oil could be carried around Florida and up the Eastern Seaboard.

4. Were the Contingency Planning Obligations Inadequate, or Just Unenforced? Under current law, oil producers and the federal government are obligated to have spill response plans in place. As investigations into the causes of the spill continue, a central question emerging is whether BP or the federal government was fully able to model a worst-case scenario spill and devise appropriate response plans. The adequacy of technology for drilling safely in deep waters, and responding to emergency situations, has also been robustly debated. A June 9 Associated Press report suggests that BP's response plan for both the Deepwater Horizon and Gulf of Mexico drilling was generally deficient for a number of reasons.

In response to the spill, the White House Council on Environmental Quality is undertaking a wide ranging review of MMS's policies and procedures under the National Environmental Policy Act (NEPA), examining the entire decision chain from leasing through production.

While lack of contingency planning has been one issue, some Members of Congress are pointing to a series of internal BP emails indicating that BP was aware of issues related to the well at least six weeks in advance of the explosion as evidence of a more troubling scenario. On June 1, the Department of Justice announced a criminal investigation related to the oil spill. These concerns arise in the context of more questions about BP's general corporate attitude toward safety. In October 2009, the Occupational Safety and Health Administration issued more than $87 million in penalties for a string of deaths, injuries, and worker safety violations at BP's Texas City, Texas, refinery. The penalties are the largest in OSHA's history, and stem primarily from a failure to address worker safety violations following a 2005 refinery explosion that killed 15 and injured 170.

5. What does the Deepwater Spill Mean for Energy & Climate Legislation? As of June 9, there are fewer than 50 legislative days remaining in the current congressional calendar. Attempts to pass single-issue bills dealing with components of the spill generally have not been successful, with the leadership preferring a comprehensive response. The exception has been the four-fold increase to the Oil Spill Liability Trust Fund, recently passed by the House, and an advance on Coast Guard access to the Trust Fund passed by the Senate. Understanding the full range of issues requiring federal attention may take more time than remains in the current calendar, but a new interest in moving energy legislation seems to be emerging.

The quest to address a multitude of issues related to the oil spill could potentially give new life to comprehensive energy legislation. Senate Majority Leader Harry Reid has told committee chairmen that he wants ideas for "comprehensive energy legislation" that would address oil spill liability. President Obama has said he would help round up the 60 votes needed in the Senate to pass some form of energy legislation. The House passed its version of an energy and climate bill last year.

If a comprehensive energy bill remains out of reach, Congress potentially could address oil spill issues through a variety of alternative vehicles, including supplemental appropriations, jobs packages under development, a streamlined energy bill, or a stand-alone oil spill-focused package. Regardless of the ultimate vehicle, oil spill legislation deserves careful attention as it will likely result in important changes to federal law on OCS development with critical implications for the energy industry.

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For energy and financial sector clients interested in following the ongoing federal regulatory and policy developments relating to Gulf of Mexico oil spill, Van Ness Feldman offers significant depth of experience and capabilities. Over half of the firm's 80 lawyers and policy advisors have worked as congressional staff, or at the U.S. Departments of the Interior and Energy, the U.S. Environmental Protection Agency, and the White House (including the Council on Environmental Quality). We have formed a dedicated Oil Spill team that is monitoring developments and providing strategic advice to a range of clients. For more information, please contact Bob Szabo (rgs@vnf.com), Rick Agnew (raa@vnf.com), John Iani (lji@vnf.com), Sam Kalen (smk@vnf.com) or Curt Moffatt (jcm@vnf.com), or your usual Van Ness Feldman point of contact at 202.298.1800.

Authors' Note: This Alert contains information based on developments and publicly-available media reports as of June 10, 2010. This Alert is not legal advice and the opinions expressed in the Alert do not necessarily reflect the views of Van Ness Feldman or its clients. We will produce additional Alerts and analyses as events warrant, including a forthcoming Alert on the Outer Continental Shelf energy exploration & production program.  To receive e-mail alerts on the oil spill, e-mail vnf@vnf.com.

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