The ingenuity premium

Economic recovery needs, at some point, to become expansion. Where the oil and gas producing industry is in that transition is a question best left to economists. For company managers, a more pressing problem is what the expansion will require. In a word: money.

Nov. 10, 1997

4 min read

Already, oil field costs have jumped. Day rates for land drilling rigs have risen 50% since mid-1995. Day rates for offshore rigs recovered sooner and have risen even faster. As the Houston branch of the Federal Reserve Bank of Dallas explains in a report this month, the surpluses of rigs and parts that subsidized drilling costs for a decade have come to a definite end.

Inevitably, the costs of finding and developing petroleum increased last year after falling impressively through most of the 1990s. They probably will rise again this year.

Prices rise

Prices of $20/bbl and more for crude oil and $2.50-3.50/Mcf for natural gas soften these blows to producer profitability. If recovery is to become expansion, however, capacities of nearly every aspect of oil field work must expand. That means costs must rise further. Day rates don't yet justify construction of land rigs (OGJ, Sept. 22, 1997, p. 62). Construction of offshore rigs is limited to companies with long-term contracts and targeted to niche markets, such as deep water. Yet the industry needs more rigs.

It also needs more people, points out the Houston Fed. While employment in upstream oil and gas activities has fallen back to 1975 levels, drilling has fallen even more. Thanks to technology, it takes fewer feet of hole to find and develop a given quantity of oil and gas reserves than it did before. But-also because of growing reliance on technology-it takes more jobs, wage dollars, and worker-hours to drill each foot of hole.

Using labor more intensively than it did in earlier years, the industry quickly ran into personnel constraints when oil field activity rebounded. "The inventory of excess oil field skills-like that of the surplus rigs from the 1980s-is now exhausted," says the Houston Fed. "Employees are no longer a subsidized and expendable commodity. Expansion from now on would entail higher wages, intensive training, and the development of specific industry skills."

Higher labor costs, in other words, will accompany rising costs of operation.

For an industry living off a financially nutritious mixture of rising sales volumes and depressed costs, reversals to that latter menu item create big challenges. Properly managed, however, they can mean a new phase in, rather than premature end to, the recovery. As the Houston Fed noted, a cost rebound is essential to sustainable expansion.

How are oil companies to remain profitable under conditions of structurally rising costs? Oil and gas prices might rise further and offer some comfort. But too much of that balm would eventually choke demand and erode the sales volumes now feeding recovery.

Recent history provides a better answer. Cost reductions of the past decade didn't come just from layoffs and curtailed operations. They also came from ever-improving seismic images of the subsurface, rapidly growing ability to drill laterally and multilaterally, and a range of new techniques for developing reservoirs and managing production.

Nothing about current industry conditions indicates that technology has drawn close to its point of diminishing returns. New techniques and equipment appear every day. Many company managers nevertheless tend to pinch pennies as much on the development and use of technology as they do on anything else.

Technology incentive

If recovery is to become expansion, that will have to change. With operating and labor costs rising, managers will have more incentive than ever to seek maximum benefit from technology.

The incentive amounts to an ingenuity premium. And it destines oil and gas companies, amid their industry's progress from recovery and expansion, to learn much.