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CERA: Upstream Building Costs Climb 6% in Six Months

The costs to construct new oil and natural gas upstream facilities have jumped 6% in the past six months and have doubled in just three years, according to the most recent IHS/Cambridge Energy Research Associates (CERA) Upstream Capital Costs Index.

The latest increase raised the index to 210 points from a previous high of 198. The values are indexed to the year 2000, which means that a piece of equipment that cost $100 in 2000 now costs $210. CERA, using proprietary data, measures project cost inflation in a similar way the consumer price index provides a benchmark for comparing costs around the world.

"These costs are a serious concern and a major challenge for oil and gas companies and are contributing to the delays and postponements of many projects," said Pritesh Patel, director for the Capital Costs Analysis Forum for Upstream, a CERA Industry Forum. "Exchange rate fluctuations and the weakening U.S. dollar also contribute. With the dollar the reporting currency of choice, this has a dramatic effect on final construction costs for projects in some regions such as Europe and West Africa."

Cost escalation, however, varies on a regional basis. The Middle East, West Africa, South America and Australia -- all areas with high activity -- have higher-than-average cost increases, while there is "moderate" escalation in North America and Europe.

Rising costs "have become one of the 'new fundamentals' driving the price of oil," noted CERA Chairman Daniel Yergin.

The latest price squeeze is driven by the rising costs for raw materials and transportation, according to CERA data. Raw materials, such as iron ore, that are needed to produce steel have increased by as much as 60% this year as ore contracts have been renegotiated. And rising fuel prices continue to drive the shipping costs upward. The effects of this are seen in the finished steel, which have consequences for equipment prices.

Specialized deepwater equipment that is required for subsea operations, particularly umbilicals and control systems, showed the biggest price jump for any area on the index. Continued manufacturing constraints coupled with higher materials and labor costs led to cost hikes of 12% in the past six months.

The costs of installation vessels -- the ships used to install platforms, lay pipe and support offshore development -- also are on the rise after briefly leveling off in 2007. Their rates rose 2% in the past six months.

"Oil industry construction activity remains high in an already tight market for equipment and personnel," said Patel. "Steel costs continue to increase across all industries. Fuel costs for transportation are rising. The near-term outlook shows no reprieve in increasing construction costs."

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