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Upstream Capital, Operating Costs Jump Again

Competition for labor, coupled with rising costs for steel and consumables, should keep operating costs for natural gas and oil projects moving higher in 2011, according to new research by industry consultant IHS.

The costs to build and operate upstream natural gas and oil facilities in the past six months have hit their highest level since peaking in 3Q2008. The IHS CERA Upstream Capital Costs Index (UCCI), which tracks costs associated with constructing new facilities, rose 5%; the 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, climbed 2% over the same period to register an index score of 178.

"The steady rise of upstream costs is a product of confidence changing outlook," said IHS CERA Chairman 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 indexes measure cost changes in a similar way that the Consumer Price Index (CPI) does, using proprietary IHS tools to benchmark cost comparisons around the world. Values are indexed to the year 2000, which means that capital costs of $1 billion in 2000 would now be $218 billion. Likewise, the annual operating costs of a field now would be $178 million, up from $100 million in 2000.

Costs began trending up in 2010 after falling steadily beginning in the second half of 2008, IHS noted. The higher upstream capital costs have been driven by escalating costs for steel, equipment and labor, IHS said. Upstream steel costs rose 13% in the last six months, continuing a year-long ascent after falling by almost one-third between 3Q2008 and 3Q2009.

"Costs for all steel-making raw materials rose and steel manufacturers took advantage of low inventories to pass through aggressive price increases," the IHS researchers said. "Rising steel costs also helped drive the increase (3%) in equipment costs as suppliers passed those costs along to operators."

Higher oil prices also led to more activity as development increased to take advantage of higher prices. Costs for construction labor jumped 9%, while and engineering and project management costs rose 6% in the period -- mostly driven by South America and Asia.

"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," said the IHS team.

Subsea equipment costs worldwide have risen 6% in the past six months, and new orders have led to longer lead times. Activity in offshore Brazil and the North Sea drove the gains, "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, driven by lower activity in the Gulf of Mexico (GOM), coupled with increased supply entering the market. However, both of these markets have begun to show upward movement, suggesting a possible change in momentum.

"We expect activity to increase driven by high demand and further escalations in all 10 markets" said Pritesh Patel, who directs the IHS CERA Upstream Capital Costs Analysis Forum. "We can see construction costs reaching near peak levels (from 3Q2008) by the end of the year."

The UOCI, which has risen 2%, is now just two index points below its 3Q2008 peak level, said IHS.

"The increase was driven by market fundamentals, personnel costs and markets that are impacted by high oil prices such as chemicals and transportation," said researchers. "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%, drove the UOCI's overall rise."

Sustained high oil prices resulting in higher gasoline and diesel costs were a major factor, as well as petroleum-derived products, such as cleaning solvents and feedstocks, which climbed significantly, according to the index. Manpower costs also were up because of higher production levels and as producers worked to extend the life of existing fields 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 IHS CERA's Jeff Kelly, a director in the 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."

Higher activity levels in North America's onshore, as well as increased activity onshore in Russia and the Middle East, caused well services costs to escalate. An uptick in materials costs also contributed to the overall rise, said IHS.

"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," researchers said. "Fracturing activity in North America as well as overseas seems to be pulling the weight of this market."

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