IHS CERA: Falling Costs for Upstream O&G Facilities Bottoming Out

The costs of building and operating upstream oil and gas facilities -- which fell drastically in Q1 2009 after a prolonged period of escalation -- appear to be bottoming out, 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 continued to decline, down 4 percent over the past six months, though costs are approaching their bottom, the report finds. Its index score is now 202. The UCCI's counterpart, the IHS CERA Upstream Operating Costs Index (UOCI), which measures operating costs for those facilities rose by 1 percent in the past six months after falling 8 percent during the prior year. The UOCI index score is now 168.

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 $2.02 billion. Likewise, the annual operating costs of a field would now be up from $100 million in 2000 to $168 million.

"The IHS CERA upstream cost analyses show that some confidence has returned to the industry as oil prices have recovered and expectations rise for a strong economic recovery in 2010," said Daniel Yergin, IHS CERA Chairman. "However, uncertainty related to present low oil demand and large spare capacity continues to hinder many projects."

OPEC spare capacity has tripled in the past 12 months to 6.4 million barrels per day (mbd).

The reduction in capital costs was driven by sustained lower levels of upstream oil and gas activities, which resulted in a sharp decline in the costs of drilling rigs and yards and fabrication.

Upstream steel costs continued to fall through 2009, dropping 12 percent from Q1 to Q3 2009 on top of the 25.2 percent over the previous six months but in the past quarter it now appears to have stabilized around the cost floor.

Costs associated with land rigs declined 7 percent owing primarily to softening activity levels in the United States (28 percent reduction) and the Middle East (10 percent reduction). Costs for offshore rigs fell 3.1 percent, respectively, due to continued weak demand for jackup rigs.

Yards and fabrication, impacted by the sharp drop in general shipping construction saw costs decline 13 percent over the past six months. A decline in new orders compounded with higher funding costs for equipment operators and difficulties obtaining financing fueled the drop.

Contrary to the decline seen in construction costs, the Upstream Operating Costs Index increased one percent since Q1 2009. This was driven primarily by a rise in personnel costs and increases in the consumables market. Operating personnel costs rose 6 percent in the past six months. But this is a somewhat confusing picture as the increase was driven largely by foreign exchange fluctuation when converting local manpower rates into a weakened U.S. dollar. However, the personnel market, always resilient to recessions, is expected to continue to increase as hiring freezes begin to thaw out.

Consumables costs rose, driven by the rebound in feedstock prices and recovery in the global demand for chemicals. Fuel costs -- which registered an increase of 9 percent -- were the largest factor in the rise in consumables costs.

"Upstream capital costs continued to fall due to lower oil demand easing pressure on rigs and oil field related equipment and services," said Pritesh Patel, director for the IHS CERA Capital Costs Analysis Forum. "But the slowing pace of the decline in index suggests that costs are poised for a turnaround as commodity prices begin to recover and labor costs rise."

"Looking at upstream operating costs over the last 6 months, a focus by operators on reducing rates for services continues to be a pervasive theme," said Jeff Kelly, associate director for the IHS CERA Operating Cost Analysis Forum. "But that was somewhat disguised by higher manpower costs from a weaker U.S. Dollar and rising fuel and chemical prices."

Overall, the indexes project an increase in costs in the near term, with relatively stable oil prices in and recovering gross domestic product growth driving capital costs; and rising demand for services and vessels, along with rising materials and feedstock prices escalating operating costs.

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