Sheila McNulty Rising costs for oil and gas sector ends

BP and Shell have both said it, and now Cambridge Energy Research Associates is saying it, too: the runup in equipment and services in the oil and gas sector in recent years is over.

IHS CERA, the consultancy, says its Upstream Capital Costs Index, which tracks costs associated with the construction of new oil and gas facilities, fell 8.5 per cent over the past six months to an index level of 210 points. The IHS CERA Upstream Operating Cost Index, which measures operating costs for those facilities, fell 8 per cent to an index score of 187.

Values are indexed to the year 2000, meaning capital costs of $1bn in 2000 would now be $2.1bn. And the annual operating costs of a project would now be up from $100m in 2000 to $187m.

This is good news for the sector on two fronts.

Not only is much of the sector suffering from the drop in commodity prices, cutting into their bottomlines. But it had already been under pressure from ever-rising costs before the downturn. The flood of investors into the sector to capitalize on rising oil and gas prices had led to a shortage of equipment, services and manpower, which forced the prices for these things to run up.

The moderation in prices could not come at a better time.

Daniel Yergin, IHS CERA chairman, said the downward shift in capital costs was driven by a reduction in upstream oil and gas activities and a sharp decline in the cost of steel and subsea equipment.

Upstream steel costs, for example, fell 25.2 per cent from the third quarter of 2008 to the first quarter of 2009, after rising an unprecedented 32 per cent over the previous six months.

And subsea equipment costs declined 7.8 per cent as many development projects were placed on hold.

That is not to say the sector is in the clear.

Jeff Kelly, associate director of the IHS CERA Operating Cost Analysis Forum, notes that certain costs, such as talent and deepwater vessel contracts, are more firm.

Wages and salaries are rarely cut to recover costs. And deepwater vessels, because of their limited numbers, are usually contracted out for longer periods, such as 3-5 years.

Yet IHS CERA says further declines in materials costs and slackening demand will likely lead to further drops in both capital and operating costs before too long. More welcome news for the sector.

Related stories:

BP profits down, production rises (FT Energy Source, 28/04/09)
Canadian oil sands: Falling costs kick in, just as production rises (FT Energy Source, 03/06/09)