Costs of Building and Operating Upstream Oil and Gas Facilities Trending Upwards

Capital costs and operating costs post largest gains since recession

Wednesday, June 29, 2011 9:42 am EDT

Dateline:

CAMBRIDGE, Mass.
"We expect activity to increase driven by high demand and further escalations in all ten markets"

The rising costs of both building and operating upstream oil and gas facilities continued to increase in the past six months, according to two cost indexes developed by IHS. Both cost indexes registered their largest increases since the Great Recession during the Q3 2010-Q1 2011 period.

The IHS CERA Upstream Capital Costs Index (UCCI), which tracks costs associated with the construction of new oil and gas facilities rose 5 percent. Its index score is now 218. The UCCI’s counterpart, the IHS CERA Upstream Operating Costs Index (UOCI), which measures the operating costs for those facilities, rose 2 percent over the same period to register an index score of 178.

The indexes 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 $2.18 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 Q1-Q3 2010 after falling steadily for a year after their peak in Q3 2008. The strength of the latest increases adds momentum as costs continue their march to prerecession levels.

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

The 5 percent increase in upstream capital costs was driven especially by rising costs of steel, equipment and labor.

Upstream steel costs rose 13 percent, continuing its year-long rise after falling nearly 34 percent from Q3 2008 – Q3 2009. Costs for all steel-making raw materials rose and steel manufacturers took advantage of low inventories to pass through aggressive price increases.


Rising steel costs also helped drive the increase (3 percent) in equipment costs as suppliers passed those costs along to operators. 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, 9 percent and 6 percent, respectively. However, the rise in costs was mostly driven by South America and Asia. Demand was especially strong in Brazil, where the country’s aggressive development plans for ultradeepwater presalt fields and need to import talent drove rates upward. Growth in North America continues to be slow as the continent deals with the aftereffects of the recession and the oil spill in the Gulf of Mexico.

Subsea equipment costs rose 6 percent, with new orders continuing to increase over the previous year due to increased activity, leading to longer lead times. Activity in offshore Brazil and the North Sea drove the rise, compensating for limited declines in North America and Asia.

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.

“We expect activity to increase driven by high demand and further escalations in all ten markets” said Pritesh Patel, director of the IHS CERA Upstream Capital Costs Analysis Forum. “We can see construction costs reaching near peak levels (Q3 2008) by the end of the year.”

The Upstream Operating Costs Index rose 2 percent during the Q3 2010- Q1 2011 period and is now just two index points below its Q3 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, was the only market tracked by the UOCI to not register an increase during the six-month period.

 

Operations costs, which rose 8 percent, drove the UOCI’s overall rise. Sustained high oil prices resulting 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.

“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.”

Logistics and wells costs rose 2 percent and 1 percent, respectively. Logistics costs rose despite an oversupply of larger platform supply vehicles (PSVs) in some regions and rising food and fuel costs. High demand for PSVs and the departure of some vehicles to other regions kept day rates up. 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.

A rise in the costs for onshore well services 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.

All operating cost markets are projected to continue to rise 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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About the IHS CERA Upstream Capital Costs Index (UCCI)

The IHS CERA UCCI tracks the costs of equipment, facilities, materials, and personnel (both skilled and unskilled) used in the construction of a geographically diversified portfolio of twenty eight onshore, offshore, pipeline and LNG projects. It is similar to the consumer price index (CPI) in that it provides a clear, transparent benchmark tool for tracking and forecasting a complex and dynamic environment. The UCCI is a work product of CERA’s Capital Costs Analysis Forum for Upstream (CCAF-U). The UCCI can be tracked on the IHS Index Web Site: www.ihsindexes.com. For information on the Capital Costs Analysis Forum for Upstream, contact Pritesh Patel at pritesh.patel@ihs.com

About the IHS CERA Upstream Operating Costs Index (UOCI)

The IHS CERA UOCI measures cost changes in the oil and gas field operations arena. It is similar to the consumer price index (CPI) in that it provides a clear, transparent benchmark tool for tracking and forecasting a complex and dynamic environment. The UOCI can be tracked on the IHS Index Web site: www.ihsindexes.com. The UOCI is a work product of CERA’s Operating Costs Analysis Forum for Upstream. For information on the Operating Costs Analysis Forum for Upstream, contact Jeff Kelly at jeff.kelly@ihs.com

About IHS (www.ihs.com)

IHS (NYSE: IHS) is the leading source of information and insight in critical areas that shape today’s business landscape, including energy and power; design and supply chain; defense, risk and security; environmental, health and safety (EHS) and sustainability; country and industry forecasting; and commodities, pricing and cost. Businesses and governments around the globe rely on the comprehensive content, expert independent analysis and flexible delivery methods of IHS to make high-impact decisions and develop strategies with speed and confidence. IHS has been in business since 1959 and became a publicly traded company on the New York Stock Exchange in 2005. Headquartered in Englewood, Colorado, USA, IHS employs more than 5,100 people in more than 30 countries around the world. 

IHS is a registered trademark of IHS Inc. All other company and product names may be trademarks of their respective owners. Copyright © 2011 IHS Inc. All rights reserved.

Contact:

Energy; Natural Resources
Jeff Marn, +1 202 463 8213
Energy Strategy, Renewable Energy
jeff.marn@ihsmarkit.com