Pritesh Patel
IHS Markit
Houston
IHS Markit indices are proprietary measures of cost changes similar in concept to the Consumer Price Index (CPI) and draw upon proprietary IHS Markit tools to provide a benchmark for comparing construction costs around the world. Construction costs are tracked on a quarterly basis and then reported as an index value to show how upstream and downstream project cost have changed. Therefore an index of 203.7 represents that construction costs have increased 103.7% since the year 2000.
Downstream and upstream capital and operating costs moved only slightly in third-quarter 2019 from the previous quarter, demonstrating uncertainty operators are feeling when faced with a slow growing global economy and softening oil prices. On the upstream side, however, even marginal increases can potentially derail project plans.
In third quarter-2019, the IHS Markit Downstream Capital Costs Index (DCCI) increased 0.8% with an index value of 203.7 from the end of second quarter to the end of third quarter. Labor and Equipment costs represent 62% of the DCCI project portfolio. During the quarter, Labor and Equipment costs—which represent 62% of the DCCI project portfolio—increased 1.42% and 1.47%, respectively. Labor costs continued to uptick due to strong project activity levels, while the equipment market faced increased demand and inflation in material and inflationary pressures on some materials and manufacturing processes. While market costs are increasing, scheduling issues and strained supply chains are presenting a bigger threat to project costs. Engineering, procurement, and construction firms are struggling to keep up with project activity, leading to scheduling delays, reiterating that proper schedule planning and resource allocation are necessary during the front-end engineering and design and contracting phases. Capex spending in the downstream sector should receive a slight reprieve in the coming years, however, as spending is projected to decline 6% in 2020. While there is annual decline, downstream capex still stands at $148 billion.
The DCCI refining index increased by 0.7% with an index of 209.0 during third-quarter 2019, with the majority of markets increasing during the quarter. Steel and construction as well as civil materials experienced declines during the quarter. The steel market has trended negative due to weak demand and ample supply. Overall refinery spending has been higher in 2019 due to impending International Maritime Organization (IMO) regulations. Turnarounds also were more extensive this year, as refiners attached capital expansion projects to routine maintenance.
The DCCI petrochemical index increased by 1.3% to 193.2 during third-quarter 2019. Petrochemical construction costs increased more than refining construction costs due to higher steel input prices. While steel trended downwards during the quarter, the one outlier was nonferrous metals. Petrochemical projects have a higher percentage of nonferrous metals, which increased due to an uptick for nickel. Petrochemical expansions will continue, with Asia Pacific, the Middle East, and North America leading the way. Increased spending and project activity will keep pressure on supply chains and labor rates.
The IHS Markit Upstream Capital Costs Index (UCCI), which tracks costs associated with the construction of new oil and gas facilities fell by 0.6% between the end of second-quarter 2019 and third-quarter 2019 to an index score of 182.6. Market cost changes were mixed and muted except for the steel market, which experienced strong declines. The rig count has trended downward since second-quarter 2019, resulting in lower demand for oil country and tubular goods (OCTG). Steel yards are lowering product prices to move excess supply. Equipment costs increased the most during the quarter, up by almost 1% on account of modest increases in both spending and upstream activity, marking the twelfth straight quarter of increasing costs in the equipment market. Other upstream markets with higher costs in third-quarter 2019 include offshore rigs and installation vessels, construction labor, and subsea equipment. Markets that experienced lower costs during the quarter include engineering and project management (EPM), land rigs, bulk materials, fabrication yards, and steel.
The UCCI’s counterpart, the IHS Markit Upstream Operating Costs Index (UOCI), which measures the operating costs for those facilities, fell by 0.8% in US dollar terms, resulting in a 0.9% decline year-over-year and an index value of 173.0. In the third quarter, local currency depreciation had a large impact on the UOCI, which in local terms grew by 1%. Weak steel prices in all tracked regions lowered the cost of supply of materials and spares, which fed into end-user pricing.
Despite lingering uncertainty over the global economy and declining oil prices, costs are still at a level that justifies initial investment. IHS expects a slow period in fourth-quarter 2019 as companies wrap up yearend projects, but momentum should then pick up as they move into new budgeting and spending cycles.