The costs of major oil and gas production projects have risen on average more than 53% in the past two years, with offshore rigs leading the way with a nearly 310% spike in the past year alone and no significant slowing is in sight, according to a new benchmark index developed by IHS and Cambridge Energy Research Associates.
The IHS-CERA Upstream Capital Costs Index (UCCI), which tracks nine key cost areas for offshore and land-based projects, climbed 13% to 167 during the six months ending October 31, 2006, compared with an increase of more than 17% in the previous six months. Since 2000, the UCCI has risen 67% -- with most of the increase in the last two years -- while the Producer Price Index-Commodities for finished goods (excluding food and energy) moved up just 7.5% during the same period.
This continuing cost surge is central to every energy company's strategic planning and to every energy user's expectations for supply security in the coming years, CERA Chairman Daniel Yergin said. He added: "Rising capital costs rank right alongside more widely recognized issues such as world market trends, geopolitics, globalization and new technologies at the top of the agenda for the energy industry.
The UCCI tracks the costs of equipment, facilities, construction materials and personnel used in a geographically diversified portfolio of more than two dozen onshore and offshore oil and gas development projects. It is similar to the consumer price index (CPI) in that it provides an a tool for tracking and forecasting a complex and dynamic environment.
If current trends continue, 2007 is shaping up to be a year of further increases, said CERA senior director and UCCI project manager Richard Ward. "Despite a slight slowing in the rate of increase during the six months to October 31, we expect project capital costs to continue reaching new record levels during 2007."
With high oil prices driving new development projects, capacity constraints continue to support increases in the cost of equipment and services. Deeper water projects have experienced the largest cost increases, according to the UCCI data, rising 15% in the recent six month period, primarily due to drill rig rates, technology limits and skills requirements, and are expected to continue to rise due to tight industry capacity.
Onshore facilities, including LNG, have seen the slowest rates of increase, 12%, but are still only slightly behind the overall averages.
"Higher costs, combined with the recent drop in gas prices, have made some projects uneconomical and triggered a re-evaluation of plans," Ward said. "This has produced a slight relaxation of tight support service or commodity markets, particularly in the U.S. And most noticeably for natural gas projects, where development costs have remained high. However, the slight additional capacity made available was rapidly mopped-up by other geographical areas where these resources were required."
Of the nine primary drivers of project capital development costs, steel is the only segment to decline over the past 12 months, primarily because steel prices began accelerating globally prior to the recent increase in oil prices and demand. Most of the others -- except equipment and bulk materials -- are specifically focused on the oil and gas business and are at near maximum capacity.
With oil industry steel less than 2% of total steel production and special mill runs required for oil industry grade steels, the industry faces premium pricing and constrained capacity, according to CERA . A rush by drilling contractors to expand their fleets has produced plans for construction of more than 100 new rigs over the next four years. If demand stays high, the majority of these rigs will come to market and some additional rigs may begin construction. This should ease rates, but not until mid-to-late 2009. Because drilling accounts for 40% to 50% of development costs, a 25% rise in the rig rate can produce a 10% or larger increase in total project cost.
