Period of Sustained Cost Escalation for Upstream O&G Facilities Ends

The costs of building and operating upstream oil and gas facilities fell over the past six months reversing a prolonged wave of cost escalation, according to two cost indexes maintained 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 fell 8.5 percent over the past six months to an index level of 210 points. The IHS CERA Upstream Operating Cost Index, which measures operating costs for those facilities fell eight percent to an index score of 187.

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 $2.1 billion. Likewise, the annual operating costs of a project would now be up from $100 million in 2000 to $187 million.

"The first signs of a downward shift in costs were evident in a moderation that we observed in the last two months of the third quarter," said Daniel Yergin, IHS CERA chairman. "The latest editions of IHS CERA's upstream cost analyses place into clearer view the impact of the financial crisis, spending cutbacks and the fall in crude oil prices."

The reduction in capital costs was driven by a reduced level of upstream oil and gas activities and a sharp decline in the cost of steel and subsea equipment. Upstream steel costs fell 25.2 percent from third quarter 2008 to first quarter 2009, after rising an unprecedented 32 percent over the previous six months.

Subsea equipment costs declined 7.8 percent as many development projects have been placed on hold. Demand is declining in both West Africa and South America -- previously high sources of new development projects -- allowing firms to begin clearing their backlogs. The fall in steel prices has also loosened the market as falling prices are passed on to manufacturers. Lead times, which had remained steady, have decreased by as much as four months since third quarter 2008.

The fall in operating costs were driven by a slackening of project activity and lower levels of resource utilization. Transportation and consumables costs registered some of the largest declines, triggered by falling energy prices and the downturn in the global economy. Costs for well services also dropped significantly due to weakening demand as the economic downturn causes oil and gas companies to lower production costs.

Though costs for both offshore and onshore projects declined, offshore operating costs remained comparatively higher due to sustained activity levels and a limited number of deepwater vessels. Costs for offshore fields in the UOCI portfolio fell six percent in the past six months compared to 15 percent for onshore fields.

The decline in capital and operating costs for upstream projects have not kept pace with the fall in oil prices, however. Average crude prices have fallen 64 percent since the peak in third quarter 2008. While the general trend for upstream costs has shifted downward certain areas have remained relatively firm, thus preventing costs from following oil prices lower.

"By their nature certain operating costs, such as personnel costs and deepwater vessel contracts are more firm," said Jeff Kelly, associate director for the IHS CERA Operating Cost Analysis Forum. "Wages and salaries are rarely cut to recover costs. And deepwater vessels, because of their limited numbers, are usually contracted out for longer periods such as 3-5 years."

Capital costs have held firm in similar areas, said Pritesh Patel, director for the IHS CERA Capital Costs Analysis Forum.

"Offshore costs, lead by strong demand for rigs continue to challenge the market," Patel said. "And companies have so far been reluctant to shed workers amidst hopes of an economic recovery."

Overall, the reports conclude that further declines in materials costs and slackening demand will likely lead to additional declines in both capital and operating costs in the near term.


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