Dramatically higher E&P costs contribute to soaring oil prices

Several members of Congress may try to minimize it. But experts say that one of the most basic underlying fundamentals behind dramatically higher oil and gas prices is dramatically higher production costs.

Several members of Congress may try to minimize it. But experts say that one of the most basic underlying fundamentals behind dramatically higher oil and gas prices is dramatically higher production costs.

"Both the public and policy focus is on [the crude oil] price. But the dramatic increases in costs are bedeviling the industry, delaying new supplies and constitute one of the major reasons for rising prices," Cambridge Energy Research Associates Chairman Daniel Yergin told a US Senate workshop on oil prices on July 17.

"The problem is not only access but building facilities to produce new fields. An attitude has permeated the market that if an oil company says production will begin in six years, it actually will happen in 10 years," observed Roger Diwan, a partner and head of the financial advisory practice at PFC Energy, at the same event.

The oil and gas upstream sector's problems in responding quickly to soaring oil prices now are rooted in plunging prices 20 years ago, the two experts agreed. Companies concentrated on downsizing from 1998 to 2000 because they expected prices to stay low, Yergin said. Manufacturers produced less equipment and universities educated fewer petroleum engineers and geologists, Diwan said.

$100 then, $210 now

The latest Upstream Capital Costs Index compiled by CERA and its parent, IHS Inc., found that costs associated with constructing new oil and gas upstream facilities have doubled since 2005. The index grew reached a record 210, CERA said on May 14. Since the index's values are based on costs in 2000, that means that equipment which cost $100 then would cost $210 now, it added.

A separate study by financial services firm Ernst & Young, as reported in the June 25 OGJ, found that US oil and gas exploration costs climbed 163% and development costs rose 180% from 2003 to 2007.

Rising oil and gas resource development expenses have been driven by raw material costs, CERA's report continued. Iron ore costs for finished steel have gone up by as much as 60% since the beginning of 2008 as contracts have been renegotiated, it noted.

Qualified employees

"Steel costs are a huge issue. So are labor costs. It gets harder to find qualified employees as we get into the Bakken Shale and other less conventional areas. Horizontal wells are more expensive," said Frederick Lawrence, vice president of economics and industry affairs at the Independent Petroleum Association of America.

"Privately held independent producers are drilling about half the new US oil and gas wells. These costs are hitting them hard. They don't have the recruiting resources that large, publicly held companies have. Keeping qualified labor and having the best technology becomes more and more expensive each year," he told me on July 25.

Yet wells keep getting drilled, he continued. "The number of rigs that have been put to work in the Barnett Shale and other active plays has jumped dramatically. It's amazing that Congress says we're not using our leases to their maximum potential when the industry is breaking drilling records around the country," Lawrence said.

Contact Nick Snow at nicks@pennwell.com

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