Deutsche Bank analyzes oil production costs

March 16, 2009
A recent Deutsche Bank analysis finds that in the short term, oil prices likely would have to fall to $20/bbl and below for nonmembers of the Organization of Petroleum Exporting Countries to shut in a large amount of production.

A recent Deutsche Bank analysis finds that in the short term, oil prices likely would have to fall to $20/bbl and below for nonmembers of the Organization of Petroleum Exporting Countries to shut in a large amount of production.

However, with investment now falling, the downside risks to supply forecasts are increasing. This suggests that upside price risks, once demand recovers, are considerable.

Deutsche Bank used research partner Wood Mackenzie’s country-by-country database to gain a better understanding of the potential impact of the current global economic turmoil on oil supply in both the short and medium term.

To assess the volume of current production that may be vulnerable to falling oil prices, the analysis started with a review of the cash costs (operating expenses plus royalties) of extracting oil within the world’s main producing regions and reviewed the risks to current production in mature basins.

With the costs of developing new fields substantially higher and new investment decisions sharply reduced, the analysts also looked at what oil price would be required for projects to deliver an economic return in today’s growth markets of Angola, Brazil, the US Gulf of Mexico, and Nigeria’s deep waters.

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Deutsche Bank analysts Lucas Herrmann, Elaine Dunphy, and Adam Sieminski said four simple observations can be made. First, cash operating costs are very low. On average the cash cost of extracting a barrel of oil in the mature and higher-cost, non-OPEC markets of Russia, UK, Norway, and Alaska is about $15/bbl—greatly below the current oil price. Only in the Canadian oil sands do average cash costs of about $28/bbl approach the prevailing $35-40/bbl price of West Texas Intermediate.

Second, the analysis found that lower oil prices would shut in much oil production. Looking at the marginal cash cost curves within these mature regions, a modest 700,000 b/d of production would be cash negative with an oil price of $30/bbl, including 400,000 b/d of oil sands production. However, at a $20/bbl WTI oil price this rises towards a more substantial 3.5 million b/d shut in.

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The third observation is that decline rates could curtail supply quickly. Past oil-price collapses have been associated with a sharp increase in the decline rates observed in mature basins.

Using past production curves as a proxy, Deutsche Bank estimates that as much as 1.5 million b/d of supply could be lost to accelerated decline over the next 2 years within the US onshore, Alaska, Canada, UK, Norway, and Russia.

Deutsche Bank believes that few supply estimates allow for these decline rates. Non-OPEC decline rates have averaged 7% over the 2000-2008 period, led by mature regions, according to the analysis. The decline rate over the period was about 21% in the UK and about 18% for the US offshore, the report shows.

Finally, the analysts see that new supply projects are being postponed. Within the growth regions, the rise in costs and taxes in recent years suggests that the average oil price necessary to achieve a 15% rate of return is now $68/bbl in Angola, $62/bbl in the US Gulf of Mexico, $60/bbl in deepwater Nigeria and in Brazil, although this depends heavily on the scale of the development considered.

“Whilst this is in line with our estimate of the companies’ long-run planning price, against the current economic backdrop, it comes as little surprise that 2008 saw fewer final investment decisions taken than in any year since 1989 despite the surge in the oil price,” the analysts said.