Costs to construct new oil and natural gas facilities have nearly doubled since 2005 and have surged to record highs, according to the IHS/Cambridge Energy Research Associates (CERA) Upstream Capital Costs Index (UCCI).

The UCCI, which measures project cost inflation, reached a "new high" of 198 points, well ahead of the 106 measured in 2005, CERA reported. However, there has been a slight decline in one critical cost element: the daily rate for offshore drilling rigs.

Construction costs began to rise dramatically in 2005, driven by a "sudden, sustained increase in the price of steel in 2003 followed by the upward swing in oil prices that began in 2004," CERA noted. "As industry activity levels increased in 2005 and 2006, manufacturers and suppliers of oil and gas equipment and services reached maximum capacity and began to increase their prices."

The cumulative effect of tight capacity because of high activity levels and high raw material costs has reached a "near doubling" in two years in the capital required to build the same volume of facilities, the report said.

"In the first half of 2007, the rate of cost increases moderated slightly when compared with the increases of the previous year," said Pritesh Patel, who is lead researcher for CERA's ongoing research project, the Capital Costs Analysis Forum for Upstream. "This raised an expectation in the industry that cost increases may be coming to an end. The latest data indicate this not to be the case."

The markets reporting the sharpest increases in the last six months are those requiring machining, skilled labor and high-priced raw materials such as nickel, steel and copper. CERA estimated that the costs for upstream oilfield equipment have increased 5-20% in the last six months, with specialized equipment required for subsea installations increasing 15% in the same period.

Some of these continued cost increases come on the back of higher raw material costs such as steel, which is up 8-23% in the last six months, depending upon quality and country of manufacture.

However, Patel said not all of the costs have increased. "Our basket of offshore rig day rates has declined 4% in the last six months. This is important as rig rates often lead swings in project costs."

The UCCI is a global measure of costs, he noted. Some regions, such as the Canadian Gas Market, have seen significant reductions in activity and a decline in costs as a result of the decline in the price of natural gas. However, on a global basis, this has been more than offset by high activity in the Middle East, West Africa, Brazil and other regions.

Patel identified tight manufacturing capacity leading to longer lead times for the machining of large equipment such as pumps and compressors. "Our survey of manufacturers indicates that in the last six months lead times have increased between 30-50% for specialized oil and gas equipment such as the flexible flow lines used in offshore projects."

The near-term outlook is for continued high costs, according to CERA, because high oil prices stimulate drilling and project development activity in an already tight market for equipment and personnel. While new rigs, mines and factories are being built to provide more industrial capacity, many of these expansions are not scheduled to come on-line until the second half of 2008 or later, it noted.

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