The costs of building and operating upstream oil and gas facilities — which fell drastically in Q1 2009 after a prolonged period of escalation — hit bottom and were beginning to show signs of an upward trend at the end of Q1 2010, according to two cost indexes developed by IHS Cambridge Energy Research Associates (IHS CERA).
The IHS CERA Upstream Capital Costs Index (UCCI), which tracks costs associated with the construction of new oil and gas facilities remained flat, registering a drop of 0.3% over the past six months. Its index score is now 201. The UCCI’s counterpart, the IHS CERA Upstream Operating Costs Index (UOCI), which measures operating costs for those facilities, rose 3% over the same period to register an index score of 172.
The results reflect costs from Q3 2009 to Q1 2010, which occurred prior to the oil well blowout in the U.S. Gulf of Mexico.
The indexes are proprietary measures of cost changes similar in concept to the Consumer Price Index (CPI) and draw upon proprietary IHS and IHS CERA tools to provide a benchmark for comparing costs around the world. Values are indexed to the year 2000, meaning that capital costs of $1 billion in 2000 would now be $2.01 billion. Likewise, the annual operating costs of a field would now be up from $100 million in
2000 to $172 million.
“The IHS CERA upstream cost analyses for Q3 2009 to Q1 2010 showed costs poised to begin an ascent back to pre-recession levels after a precipitous fall last year,” said Daniel Yergin, IHS CERA Chairman. “However, the onset of the Gulf of Mexico oil spill adds a level of uncertainty to future forecasts owing to the moratorium and liability
limits and as companies struggle to assess the full implications.”
Steel Costs Show Stability
Upstream capital costs bottomed out after falling 9% in 2009 and are holding at early 2007 levels, according to the index. However, the flat trajectory hid volatile up and down movements in the underlying markets that comprise the index.
Upstream steel costs stabilized and ultimately increased for the first time in 12 months as the result of higher raw material costs. Steel rose 3% from Q3 2009 to Q1 2010 after falling nearly 40% in the previous year.
Yards and fabrication costs turned upward and rose 4% after falling 13%
in the previous six-month period. Increased orders for offshore platforms and upward movement in general offshore construction fueled the turnaround.
The costs of labor and engineering and project management were tempered by the strengthening of the U.S. dollar but still rose 3% and 2%, respectively, due to a shortage of skilled labor in the market.
“We can expect to see more volatility in raw materials going forward as supply responds to increasing demand,” said Pritesh Patel, director for the IHS CERA Capital Costs Analysis Forum. “This will be passed through as manufacturers and contractors continue to balance backlogs against new orders coming in.”
The Upstream Operating Costs Index rose slightly after bottoming out over the previous six months. The index rose 2% due to an upswing in onshore service rates, increased material input prices and escalating manpower costs.
Personnel costs for operating companies also increased, rising 5% as demand for skilled production personnel remained firm, particularly for highly skilled managers and engineers. Consumables costs rose 2%, driven by depleted downstream inventories and higher demand for petrochemical feedstock as the economic recovery continued.
Need For Skilled Workers
“Both operators and service companies have shifted away from cutting the workforce to reduce overhead and have shifted back to a train and sustain mind set, investing in developing and retaining highly skilled workers,” said Jeff Kelly, associate director for the IHS CERA Operating Cost Analysis Forum. “The last 12 months have emphasized the importance of retaining knowledge and could have higher cost implications in the future.”
Both the UCCI and UOCI registered increases for onshore rigs while showing decreases for offshore rigs. Capital costs for onshore rigs rose 1.5% during the index period, continuing the markets slow recovery. Offshore rig capital costs fell substantially, falling 13% due to decreased demand for jack-up rigs. Operating costs for well services increased by 3% for onshore rigs, driven by higher utilization rates and upward price movement for the material components, such as tubing, that go into servicing the well. Operating costs for offshore wells continued to reflect a soft market for shallow water or shelf expenditure.
Overall, the Q3 2009 – Q1 2010 results pointed to a continued rise in costs in the near term. But the onset of the blowout in the Gulf of Mexico will very likely place downward pressure on costs. The ultimate impact of the oil spill and the subsequent moratorium on drilling by the Obama administration cannot be known at this time but it has the
potential to be a disruptive factor.
In the near term, the impacts will likely be seen in increased semisubmersible drill availability and discussion around reutilization and possible Force Majeure. As the moratorium continues there will be a reduced demand for tubular goods, oil field services companies and even subsea equipment putting downward pressure on costs.
Spending Likely To increase
In another report, spending on exploration and production (E&P), excluding acquisitions, is expected to rise by 8% to $353 billion in 2010 among more than 110 of the largest publicly traded oil and gas companies, according to the IHS Herold 2010 Global Upstream Capital Spending Report, a comprehensive annual report just issued. An initial IHS Herold study of 65 companies issued in February had predicted a 7% increase.
“This is a nice turnaround from the 22% decline in upstream spending in 2009, when the global recession and tight credit markets made companies rein in upstream spending,” said Aliza Fan Dutt, senior equity analyst at IHS Herold.
“The market conditions have improved, which is reassuring, and WTI (West Texas Intermediate) prices have hovered between $70 and $80 per barrel during the past few months. Steadier oil prices, combined with continued uncertainty over the near-term outlook for natural gas prices, are driving some E&P’s to shift their focus from gas to oil,” she said.
“However, this shift comes with a caveat,” she added, “since following the explosion and oil spill in the Gulf of Mexico, there is growing uncertainty in the industry over possible changes in government regulations and taxation relative to oil and gas drilling. As a result, we expect some shifts in E&P spending from deepwater to onshore U.S. and, to a lesser extent, overseas plays, due to increased risks associated with drilling in the deepwater Gulf of Mexico. In addition, the uncertainty over the causes of the Deepwater Horizon oil blast and government restrictions on deepwater drilling will dampen activity in the U.S. offshore waters.”
While the potential long-term impact of the Deepwater Horizon incident on E&P capital spending will not be known for some time, Dutt said, “regulatory and safety requirements will be heavily scrutinized, which will likely translate to higher oil service costs. These higher operating costs, and, hence, increased capital spending, will likely occur gradually, though, over an extended period of time.”
Despite increased costs and related capital spending, Dutt said some good might result from this tragedy in the form of increased transparency, and the implementation of tougher safety measures and emergency response provisions within the oil industry.
Shift To Liquids Production
Despite the situation in the Gulf, the report says that most E&Ps are touting their exposure to liquids production. Many natural gas-focused producers are shifting to oil drilling or are highlighting their exposure to liquids-rich unconventional gas. “Conventional gas development is being severely cut back,” Dutt said, “while prolific shale gas plays such as the Marcellus and Haynesville continue to drive spending among many E&P companies.”
Decreased spending in the last couple of years meant a decline in demand for equipment, which translated into oil field service costs that are now about 15-20% below the peak prices and demand of 2007-2008. Lower oil service costs should help oil and gas companies stretch their dollars even further, although, with increased upstream spending this year, rig prices could increase, which means producers must spend more as this year progresses in order to keep up with reserve replacement rates, the report noted.
Capital Spending Rebounds In 2010
According to the report, the combined Integrated Oils Peer Groups cut capital spending by 14% in 2009, due in large part to big cuts by the North American integrated oil companies. However, spending by the integrated oil companies is expected to rebound 5% in 2010. And after being slashed nearly 40% in 2009, capital spending by E&P companies is slated to jump 21% in response to higher oil prices and the need to increase production. An improved credit market has helped small U.S. E&Ps increase capital spending, and the largest North American E&Ps are looking to boost spending by a healthy 24%.
More economical gas shale plays and liquids continue to be red-hot, driving much of this year’s upstream spending for this group. Particularly attractive are shale plays that yield significant oil and liquids, such as the Eagle Ford shale play in South Texas.
Slammed by the nearly non-existent credit market last year, small U.S. E&Ps slashed capital spending by 61% in 2009. “What a difference a year makes,” Dutt said. “The improved economy has opened up new sources of capital, which should result in a 62% increase in spending for these small companies, which is the most dramatic rise in spending among all peer groups.”
Global integrated oil companies, representing about 28% of the total spending among companies in the IHS Herold study, are expected to cut capital spending by a modest 2% in 2010. However, the integrated companies outside North America are expected to increase capital expenditures by 12% in 2010 on stronger spending in Russia, Latin America and Asia. Offshore development will fuel a 23% increase in spending at Petrobras.
After falling by 26% in 2009, upstream spending among the U.S. integrated oils is slated to rise 13%, primarily due to brightening prospects in the North American upstream. Hess plans to boost spending by 26% in 2010, much of which will be committed to the Bakken shale play.
Capital budget rationalization from the Suncor/Petro-Canada merger is the primary reason for the expected 8% drop in upstream spending among the Canadian integrated companies. The Canadian E&P Trusts should boost capital spending by 44% this year, a reversal of the 5% decline last year. All companies in this peer group are expected to increase spending.
The only peer group to boost spending in 2009, companies in the E&Ps Outside of North America Group, should increase capital spending by 9% in 2010. Spending by CNOOC remains strong as it explores in new areas, such as the Philippines and Vietnam.
While E&Ps are enjoying a healthy increase in spending this year, depressed natural gas prices affected the U.S. Pipelines, Power and Diversified Group, said the report, which is expected to reduce its spending by 8%. On a positive note, this is less severe than the 27% decline in spending the group experienced in 2009.