IHS CERA: Costs of Building, Operating Upstream Facilities Bottomed Out

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 percent 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 percent 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."

Upstream capital costs bottomed out after falling 9 percent in 2009 and are currently 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 percent from Q3 2009 to Q1 2010 after falling nearly 40 percent in the previous year.

Yards and fabrication costs turned upward and rose 4 percent after falling 13 percent 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 percent and 2 percent, 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 percent 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 percent as demand for skilled production personnel remained firm, particularly for highly skilled managers and engineers. Consumables costs rose 2 percent, driven by depleted downstream inventories and higher demand for petrochemical feedstock as the economic recovery continued.

"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 percent during the index period, continuing the markets slow recovery. Offshore rig capital costs fell substantially, falling 13 percent due to decreased demand for jack-up rigs. Operating costs for well services increased by 3 percent 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.