Upstream O&G Costs Rise Anew, IHS CERA Reports

Inflation is again no stranger to the upstream petroleum sector, as the costs of building and operating upstream oil and natural gas facilities continued to increase in the past six months to the highest level since the recession began in 2008, according to two cost indices newly updated by IHS CERA.

And, there's no relief on the near horizon, the company forecasts.

The indices show that upstream construction and operating costs registered their largest increases since 2008 during the third quarter (3Q) of 2010 through the first quarter (1Q) of 2011.

The IHS CERA Upstream Capital Costs Index (UCCI) tracks costs associated with the construction of new oil and gas facilities. Between 3Q 2010 and 1Q 2011, the UCCI rose five percent to a score of 218, the company said. Meanwhile, the UCCI's counterpart, the IHS CERA Upstream Operating Costs Index (UOCI), rose two percent over the same period to register an index score of 178, the company reported.

The indices are proprietary measures of cost changes similar in concept to the Consumer Price Index (CPI) and draw upon proprietary IHS 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 $218 billion. Likewise, the annual operating costs of a field would now be up from $100 million in 2000 to $178 million.

Costs recently began trending upwards during the period studied after falling steadily for a year after their peak in the 3Q of 2008, IHS CERA noted. The strength of the latest increases adds momentum as costs continue their march to pre-recession levels, the company continued.

"The steady rise of upstream costs is a product of confidence changing outlook," said Daniel Yergin, IHS CERA chairman and author of the Pulitzer Prize-winning book, The Prize. "That perspective—reflecting expectations for stronger oil and gas demand—is taking the form of an increased rate of new project construction."

Steel Costs Paramount Factor

The five percent increase in upstream capital costs was driven especially by rising costs of steel, equipment and labor.

Among the indices' highlights:

  • Upstream steel costs rose 13 percent, continuing its year-long rise after falling nearly 34 percent from the 3Q of 2008 through the same quarter of 2009. Costs for all steel-making raw materials rose and steel manufacturers took advantage of low inventories to pass through aggressive price increases, the company reported.

  • Upstream Oil and Gas Costs Rise Anew, IHS CERA Reports
  • Rising steel costs also helped drive the increase (three percent) in equipment costs as suppliers passed those costs along to operators, IHS CERA said. The company added that rising oil prices also led to increased demand as activity levels increase to take advantage of higher prices.

  • Costs for construction labor and engineering and project management posted strong gains, nine percent and six percent, respectively. However, the rise in costs was mostly driven by South America and Asia, IHS CERA noted. Demand was especially strong in Brazil, where the country's aggressive development plans for ultra deepwater pre-salt fields and need to import talent drove rates upward. Growth in North America continues to be slow, IHS CERA said, as the continent deals with the after-effects of the recession and the 2010 Deepwater Horizon oil spill in the Gulf of Mexico.

  • Offshore rig and offshore installation costs were once again the only two of the UCCI's 10 markets to register declines. This was driven by lower activity in the Gulf of Mexico, coupled with increased supply entering the market. However, both of these markets began to show upward movement in the latter half of the six-month period, suggesting a possible change in momentum, IHS CERA said.

CERA noted: "The Upstream Operating Costs Index rose two percent during the 3Q of 2010 through the 1Q of 2011 and is now just two index points below its 2008 peak level. The increase was driven by market fundamentals, personnel costs and markets that are impacted by high oil prices such as chemicals and transportation. Maintenance costs, which were flat, reflected the only market tracked by the UOCI not to register an increase during the six-month period."

Upstream Oil and Gas Costs Rise Anew, IHS CERA Reports

Operating costs rose eight percent, driving the UOCI's overall rise. Sustained high oil prices that resulted in higher gasoline and diesel costs were a major factor. Petroleum-derived products, such as cleaning solvents and feedstocks, also rose significantly. Manpower costs also climbed due to increased production levels and the extension of the life of existing fields in an attempt to take advantage of higher crude prices.

Talent Crunch = Retention Costs

"Companies have had to draw from an ever-tightening pool of talent and this has made retaining personnel more difficult," said Jeff Kelly, a director in IHS CERA's cost consulting group. "Compensation is usually frozen during the year, but businesses are now granting more adjustments out of cycle, among other things, in an attempt to retain talent."

Among the other costs that rose were for logistics and wells, which rose two percent and one percent, respectively. Logistics costs rose despite an oversupply of larger platform supply vehicles (PSVs) in some regions, in the face of rising food and fuel costs. "High demand for PSVs and the departure of some vehicles to other regions kept day rates up," IHS CERA said. "Also, service companies in the U.S. Gulf of Mexico (GOM) have been hesitant to pass along rising food and fuel prices to operators due to competitive pressures. Emergency response and recovery vehicle (ERRV) costs have also held steady despite reduced activity in the U.S. GOM as operators used to the time to send ships to dry dock for routine maintenance.

Rising onshore well services costs, due to higher activity levels in North America, Russia and the Middle East helped generate the increase in overall well costs. An uptick in materials costs also contributed to the overall rise. Demand for proppant and steel tubular was particularly strong, driven by higher per-ton prices from mills in North America, China, Russia and Latin America. Fracturing activity in North America as well as overseas seems to be pulling the weight of this market, IHS CERA observed.

IHS CERA expects costs to continue rising in 2011, driven by competition for labor and the rising costs of steel and consumables such as chemicals, food and fuels.


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