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Upstream Costs Beginning to Moderate

A jump in oil and natural gas drilling, which required more rigs, which in turn created a tight supply market, has caused upstream costs to more than double in the past eight years, according to a report by IHS and Cambridge Energy Research Associates (CERA). In just the last six months, upstream costs rose 5%, but as the financial crisis bears down on business, prices have begun to moderate.

The latest IHS CERA Upstream Operating Costs Index (UCCI) rose to 203 points in the third quarter, which is 103% higher than the 2000 benchmark year. Similar in concept to the Consumer Price Index (CPI), the UCCI measures project cost inflation and benchmarks comparable costs around the world using proprietary databases and analytical tools. The values are indexed to 2000, which means that a piece of equipment that cost $100 in 2000 today costs $230.

"Hidden in these substantial increases are the first signs of what may be a change in direction," said CERA Chairman Daniel Yergin. "Moderation in the last two months of the third quarter was a response to the unfolding financial crisis and the spending cutbacks and points to a precursor to a downward turn in the direction of the UCCI."

Cost increases were driven by a "continued high level" of upstream activity and a marked increase in the cost of steel and subsea equipment.

"Upstream steel costs have grown by an unprecedented 32% from the first quarter to the third quarter of 2008 because raw material and scrap metal costs," the report noted. "Though significant in comparison with the 10% increase seen in the previous six-month period, this increase is in line with the UCCI report issued six months ago."

All of the projects in the study experienced cost increases in the past six months, "though onshore projects showed the slowest rate of increase in comparison with other groups," said Jeff Kelly, CERA's associate director for the Operating Cost Analysis Forum, an ongoing research project. "Activity in the facilities inspection and maintenance market remained high, but costs were kept under control because labor rate increases were modest, despite personnel shortages."

Skilled labor shortages drove increases in the personnel market, as companies continued to try and simultaneously maintain current operations and invest in production optimization activities, Kelly noted. However, by the end of the third quarter, "currency fluctuations" had begun to ease cost escalation.

The aftermath of hurricanes Ike and Gustav also drove up demand for maintenance services in the Gulf of Mexico, putting pressure on costs by raising the demand level for service and support vessels.

"In the short-term future, the effects of the current credit crunch on the global construction market are not expected to have much impact on the oil and gas operations market," Kelly said. "Fields already in production are unlikely to be shut-in most regions. In time, if low prices persist, they are more likely to move to production optimization, increasing the need for in-field services. This approach should maintain pressure on the already constrained market for skilled personnel, and maintain high utilization rate of the vessels required for inspection and support."

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