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) -- On a day when Interior Secretary Ken Salazar said there will be a conditional lifting of the deep water drilling ban, energy companies tied to the Gulf of Mexico are rallying.

Michael Bromwich, the head of the Interior Department's Bureau of Ocean Energy Management Regulation and Enforcement, said at an industry conference on Tuesday morning that a decision was imminent, and that started some oil and gas shares rallying. The decision was even more imminent than Bromwich's comments suggested, with Salazar making the call by the early afternoon.

It's not the first time that the administration has signaled a more positive tone in regards to drilling since the BP Macondo well was capped. However, the decision does coincide with renewed investor optimism about drilling in the Gulf of Mexico, and a feeling that the worst-case scenario post the BP oil spill won't be coming to pass.

The evidence can be seen in a change of fortunes this week for one of the most heavily shorted names among Gulf exploration companies.

ATP Oil & Gas

( ATPG) is up more 6% on Tuesday, continuing a rally that began on Monday. It's an indication that the worst-case scenario for small oil and gas exploration and production companies in the Gulf of Mexico -- being forced out of business as a result of new federal drilling regulation with the liability cap being raised to levels small independents can't afford -- doesn't appear likely to investors.

It's not just optimism about the Gulf of Mexico on which ATP Oil & Gas is rallying, though. There was market chatter this week that

General Electric

(GE) - Get General Electric Company Report

had been considering a bid for the company. The logical extension of the rumors was that if GE was willing to consider a play for ATP Oil & Gas it must have confidence that the situation in the Gulf of Mexico, and the liability cap issue, won't drive small independents out of business. ATP is the smallest pure deepwater play, and investors had been staying away from the story.

Not surprisingly, ATP Oil & Gas has also been one of the most heavily shorted names in the exploration and production sector. The short squeeze is on this week with shares of ATP Oil & Gas. The action over the past two days is a big unwind in the ATP short trade, and it's painful for those betting short on the independent oil and gas company.

At the same time, some long investors are becoming more constructive on ATP Oil & Gas. The company released more encouraging well results on Monday, and coupled with the GE rumors, it began the rally.

The action in ATP Oil & Gas shares was part of a broad energy rally on Tuesday, and the primary drillers were participating as well.


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was up by more than 4% on Tuesday. As always occurs during a bullish day for energy, the more risky rig operators had the highest returns.

Hercules Offshore


was up more than 8% on Tuesday, and shares were changing hands at twice the average daily volume for Hercules.

Said one energy analyst, "the body language from the Obama administration has become more positive in terms of the liability cap, and it now looks like the industry as a whole will come together to support smaller independents, contributing to the change of fortunes for ATP."

One could add that at least for a day it looked like a minor change of fortune for the Gulf of Mexico drilling situation more generally.

--Written by Eric Rosenbaum in New York.


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