CGES: Oil field costs haven’t made crude oil prices rise

About one third of the worldwide supply of crude oil costs less than $10/bbl to produce, and nearly 90% costs less than $20/bbl, according to a study arguing that production costs don’t explain recent crude-price increases.

In fact, concludes the Centre for Global Energy Studies, the price increase of recent years has caused, rather than been caused by, the cost hikes that have occurred.

When the price of oil was $20-30/bbl, the CGES study points out, exploration and development progressed successfully even in the most expensive areas.

Although the rate of cost increase has exceeded inflation, the fully built-up costs of developing and producing conventional oil, excluding taxes and royalties, in most regions do not exceed $30/bbl. For the Canadian oil sands, costs are no higher than $50/bbl, according to the study.

Rising prices for oil field services, supplies, and equipment encourage providers to expand capacity. The new supply moderates moderate costs in a trend that the study concludes has been in progress since 2007.

Marginal cost

Costs, CGES argues, didn’t make crude prices reach nearly $150/bbl between 2004 and 2008 and do not support prices at current levels.

The economic tenet that says price reflects the highest marginal cost doesn’t apply in the imperfectly competitive oil market, CGES says.

Heavy investment requirements and long lead times limit entry into the market, which is subject to strong influence by governments. Access to low-cost producing areas is restricted, and state-owned producers restrict production to support price. Taxes and duties, meanwhile, influence consumption.

Global supply and demand, policy by the Organization of Petroleum Exporting Countries, political uncertainty, and speculation all affect price, CGES notes.

“While of course production cost can influence oil prices over the long term,” the London group writes in a study summary, “in recent years the cost of production has not played a part in the rise of the price of oil.”

New activity

In fact, high oil prices have lifted revenues of oil companies, which have responded by increasing exploration and production, CGES says. The new activity has increased prices and charter rates for rigs and other field materials and services, raising development and production costs.

Cost escalation has been most pronounced offshore, where activity growth was greatest and where the industry needed to design and build expensive capital items such as floating production, storage, and offloading vessels. CGES says in its analysis that the same arguments apply to the Canadian oil sands.

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