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Upstream Capital, Operating Costs Up Sharply

The costs to build and operate upstream natural gas and oil facilities are escalating and should continue to move up, driven by increased costs in drilling rig dayrates, equipment and oilfield services, according to IHS Inc.

Over a six-month period measuring costs from 3Q2011 through 1Q2012, the IHS Upstream Capital Cost Index (UCCI) rose 2.3% to an index score of 227, while the IHS Upstream Operating Cost Index (UOCI) climbed 2.1% to 189.

"The 2.3% increase in the UCCI over the six-month period ending March 31, 2012 is sharp compared to 2011, which registered a 5.3% increase for the entire year," IHS analysts noted. The price gains were attributed to "strong oil prices that exceeded the threshold price of production for most projects, increasing demand for oilfield goods and services." A year ago IHS found that competition for labor, along with rising costs for steel and consumables, would keep 2011 operating costs moving higher (see NGI, July 4, 2011).

The indexes use a cost measurement system that is similar to the Consumer Price Index, drawing upon proprietary IHS tools to benchmark global upstream costs. Values are indexed to the year 2000, which means that capital costs of $1 billion in 2000 now are $2.27 billion. Likewise, the annual operating costs of an oilfield that were $100 million in 2000 today are $189 million.

The gain in the UCCI "can be attributed to increased dayrates for deepwater rigs. Despite new entries into the market these rigs are in high demand and with rising fuel and labor costs can command premium rates." In addition, the "unconventional drive" in the United States "has put pressure on goods and services," even though the plunge in natural gas prices has switched some of the services to tight oil plays. "However, the high duty onshore rigs and hydraulic fracturing crews remain in high demand."

Of the 10 markets tracked by the UCCI, only steel, which showed a 3.6% decrease, and engineering and project management, down 1%, declined. All other markets were higher.

Equipment vendors and subsea manufacturers "continue to respond to the high order levels and were able to pass through the increased cost of shipping both finished products and the sub-components. This was most notable in Brazil and North America," noted IHS analysts. "Skilled labor for construction, drilling crews and operations continues to be in short supply. Local currency movements for construction and operations labor saw large increases in the emerging economies where employers struggle to respond to high inflation levels and retaining their crews."

The IHS Upstream Spending Report "confirms these increased activities levels," which indicate that 2012 capital expenditures (capex) for exploration and production (E&P) will be $641 billion, well ahead of 2011's $586 billion in capex.

Operational spending (OPEX) this year is forecast to be $500 billion, versus $457 billion in 2011. The spending levels exceed the highs of 2008, "even when cost escalation is considered," which demonstrates higher activity levels in both new construction and producing properties, which puts more pressure on vendors and subcontractors.

"Given the increased levels of spending it is not surprising to see a record quarter increase in capex escalation," said IHS CERA's Pritesh Patel, senior director of the Upstream Capital Costs Analysis Forum. "The largest quarter-on-quarter increase was 3Q2008. It is interesting to see how closely escalation of goods and services has correlated to expenditure."

The UOIC increase over the six-month period follows "upward movements of all four of its component markets: operations, maintenance, logistics and well services. Each of the markets were impacted by similar factors, namely an increase in activity due to high oil prices, tightness in supply chains for what can be highly specialized services and equipment, and a worsening labor shortage necessary to deliver these goods and services," noted IHS.

"Without a doubt, labor is the top concern currently for oil and gas field operations," said IHS Associate Director David Vaucher, who heads up the OPEX forum. "Building an extra piece of equipment can be done by negotiating with vendors, reorganizing manufacturing schedules or rediverting existing resources. On the other hand, training and retaining additional, competent workers can take months, sometimes years depending on the position."

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