WATCHING THE WORLD A CLOSE WATCH ON COSTS

with Roger Vielvoye from London With the benefit of hindsight, one old North Sea hand recently proclaimed that a steady $18/bbl for offshore oil since August might have been preferable to the wild fluctuations that sent prices soaring to $40/bbl. Such statements are generated by the fear that offshore operators will have to pay for the high prices of 1990 with a new slump. If worst case scenarios prove correct, returns on North Sea production could fall to single figures for a time this spring.

March 11, 1991

3 min read

With the benefit of hindsight, one old North Sea hand recently proclaimed that a steady $18/bbl for offshore oil since August might have been preferable to the wild fluctuations that sent prices soaring to $40/bbl.

Such statements are generated by the fear that offshore operators will have to pay for the high prices of 1990 with a new slump. If worst case scenarios prove correct, returns on North Sea production could fall to single figures for a time this spring.

STATOIL EXAMPLE

The extent to which North Sea companies benefited from higher prices during 1990 was demonstrated by Norway's state oil company, Den norske stats oijeselskap AS, the largest single trader of offshore oil in Northwest Europe.

Producing and trading Norwegian crude oil dominates Statoil's activities. Last year the company turned in pretax profits of 14.4 billion kroner ($2.4 billion), a 74% increase from 1989 results.

At the moment, operators are waiting to see whether gloomy price forecasts are fulfilled. So far there is no talk of cutting exploration or development budgets because the 1986 price collapse has left the North Sea industry leaner and better able to handle periodic price downturns.

But just the prospect of a new price decline has refocused attention on the need to contain offshore costs for exploration, development, and operations.

David Harding, chief executive of BP Exploration Europe, highlighted the problem of cost containment in a presentation to the Institute of Petroleum's exploration and production discussion group.

He said a recently detailed internal study within BP Exploration produced revealing results. Two costs effects were identified: oil field inflation and cost push.

Harding said oil field inflation is a persistent, underlying trend toward upward pressures on unit costs as a province matures. Unit costs on the U.K. continental shelf and in the U.S. have increased more or less steadily by about 5%/year beyond base inflation for the past 10 years.

Two main reasons have been adduced. Because the easiest, biggest discoveries were made first, prospect size and quality then declined, and exploration and development costs increased. Those factors were only partially offset by technology and improved skills.

As fields came off plateau production, unit operating costs increased due to a higher proportion of fixed costs and increased spending to maximize production.

COST PUSH

Cost push, on the other hand, represents the change in upstream costs caused by sustained adjustment from one equilibrium price level to another.

Cost push is driven by two factors, said Harding. Those are the response of the industry to higher prices, which drove up demand for finite resources, and supply and service companies seeking to recover ground lost in the downturn in the second half of the 1980s.

The BP study shows that oil field inflation boosts operating costs by 36%/year/bbl of oil produced and overall oil field costs by 3-4%/year. Cost push is estimated at about 1% in production operations and 1-2% in overall costs.