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Confidence Returning in Upstream, Says IHS CERA

The costs to build and operate upstream oil and gas facilities, which fell early this year following a long period of escalation, appear to have bottomed, according to IHS Cambridge Energy Research Associates (IHS CERA).

Using proprietary data, IHS CERA developed two indexes that measure cost changes in global upstream markets. The indexes, issued last week, are similar in concept to the Consumer Price Index. The latest indexes measured upstream costs from March through September.

Generally the latest indexes suggest that upstream costs will continue to rise in the near term, with relatively stable oil prices and recovering gross domestic product growth driving capital costs. A rising demand for services and vessels, along with rising materials and feedstock prices, is seen pushing up operating costs as well.

"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 demand and large spare capacity continues to hinder many projects," said IHS CERA Chairman Daniel Yergin. "However, uncertainty related to present low oil demand and large spare capacity continues to hinder many projects."

The IHS CERA Upstream Capital Costs Index (UCCI), which tracks costs associated with building oil and gas facilities, continued to decline from 2Q2009 through 3Q2009, down 4% from a year ago. The index, now at 202, appears to indicate that costs are "approaching their bottom," the report indicated.

The UCCI's counterpart, the IHS CERA Upstream Operating Costs Index (UOCI), which measures operating costs for those facilities, was up 1% in the same period after falling 8% in 2008. The UOCI index score is now 168.

The cost analyses' values are indexed to the year 2000, which means that capital costs of $1 billion in 2000 currently would be $2.02 billion. Likewise, the annual operating costs of a field would be at $168 million currently from $100 million in 2000.

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, IHS CERA noted.

Upstream steel costs have fallen since the beginning of the year, down 12% in 3Q2009 from 1Q2009. However, "it now appears to have stabilized around the cost floor," said IHS CERA.

Costs associated with land rigs fell 7% mostly on "softening activity levels in the United States (28% reduction) and the Middle East (10% reduction)," said the report. "Costs for offshore rigs fell 3.1%, respectively, due to continued weak demand for jackup rigs."

Contrary to the decline seen in construction costs, the UOCI has risen slightly since 1Q2009, "driven primarily by a rise in personnel costs and increases in the consumables market," said IHS CERA.

"Operating personnel costs rose 6% in the past six months," said the consultant. "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 were up, driven by the rebound in feedstock prices and recovery in the global demand for chemicals, the report noted. Fuel costs, up 9%, 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 oilfield-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."

Jeff Kelly, the associate director for the Operating Cost Analysis Forum, said "a focus by operators on reducing rates for services continues to be a pervasive theme. But that was somewhat disguised by higher manpower costs from a weaker U.S. dollar and rising fuel and chemical prices."

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