Oil industry's cost dilemma

David Knott
London
[email protected]

A confession is in order: Although the concept of outsourcing has been explained to me many times, I have never been fully convinced of its logic.

Somewhere in the explanation there has always been a justification of outsourcing along the lines that "divestment of noncore activities" is imperative. It is at this point that I have always come unstuck.

Call me simple if you like, but I have always had the idea that, for a petroleum company, anything involved in finding and exploiting oil and gas reserves counts as a core activity.

Apparently, this is wrong. In the past 10 years or so, the majors have outsourced "noncore" activities such as engineering and process development in a bid to reduce project costs.

At the same time, U.K. offshore operators have reduced field development costs by 20-30% through their Cost Reduction in the New Era (Crine) initiative with contractors.

Not satisfied

Much of Crine's success has been attributed to outsourcing and to alliances with groups of contractors in which payment is tied to project cost.

Yet with the price of Brent oil at its lowest level ever, in real terms, U.K. North Sea operators are increasingly concerned that their exploration and development costs are still too high.

Francis Gugen, managing director of Amerada Hess Ltd., recently told contractors that, "It is costing us $12/bbl to extract oil from the North Sea. That's as much as we have been selling it for this year."

John Battle, U.K. energy minister, said earlier this month that, "There is now little or no margin between the cost of new production in the U.K. sector and the price of oil in the market.

"A market price is just that-a price that neither governments nor oil companies can control. What can be controlled is the cost of production."

Supply chain

The U.K. government set up a task force aimed at reducing the costs of services and equipment to the operating companies.

Maybe this shows that the operators have realized that many of the skills they outsourced are being charged back to them by the contractors at the price they could have done it for themselves-had they kept the staff-plus a hefty percentage.

That operators are paying more than they would have if they had kept many outsourced skills was shown earlier this year, when Halliburton Energy Development, London, bought a 25.77% share of U.K.'s Northwest Hutton field from Amoco (U.K.) Ltd. and assumed operatorship.

Amoco discussed the sale with other operators along with Halliburton, but Halliburton found it was the only one that could produce this aging field at a profit. The reason that Halliburton could make money but not the operators was that it has all the skills needed to operate the field in-house, and would not have to pay extra to contractors.

With the current epidemic of takeovers, maybe operators will now consider taking over contractors, instead of other operators, to recapture a cost advantage.