HOUSTON, May 8, 2007 – The dramatic cost surge in the oil and gas industry continues, but the rate of growth shows some signs of slowing, according to the latest update of the    IHS/CERA Upstream Capital Costs Index (UCCI). The UCCI, which acts as a key measure of cost inflation for oil and gas projects, reports that costs climbed seven percent to 179 points during the six months ending March 31, 2007. This compares with an increase of more than 13 percent in the previous six-month period.  Since 2000 the UCCI has risen 79 percent, with most of the increase in the past two years, while the Producer Price Index-Commodities for finished goods (excluding food and energy) moved up just 16 percent during the same seven-year period.

“This new point indicates an annual rate of project inflation of 14 percent, which is high, but this is the second consecutive period of deceleration in the rate of increase,” said Richard Ward, senior director for cost research at Cambridge Energy Research Associates (CERA). “In 2006, the UCCI measured annual rate of project inflation was 30 percent. This leads us to think that if this deceleration trend continues, it is possible that a cost plateau may be reached in 2008.

Capacity constraints in the markets continue to be the biggest factor behind the increases, with equipment and service suppliers struggling to meet demand,” Ward added. “Project delays and lengthening of project delivery schedules, often to accommodate later

delivery of equipment is beginning to provide a natural balance. However, the shortage of experienced personnel is still a major factor. No amount of cash injection can increase the number of people overnight.

“Are we at the top of this period of cost increases?” said Ward. “The answer is, not yet. Based upon these trends, any significant relief on cost increases will not be seen until late 2008/09.”

According to the CERA report, even with oil consistently above $50 per barrel providing a strong demand signal, the high cost levels are starting to have an effect on project announcements, scheduling, start-up delays, and, in one or two cases, outright cancellations. This effect is even more pronounced in gas projects. In Canada gas prices have tumbled 50 percent from their peak in December, and local trade associations are reporting drilling activity being down by as much as 30 percent as a result.  

Across the board all types of projects have seen a moderation in the rate of cost increases. In deepwater projects, those in greater than 1,000 feet of water, this is primarily due to the stabilizing of high-end rig rental rates balancing the dramatic increases in the cost of critical subsea piping components known as risers and flowlines. 

On a global basis, the cost of onshore projects has risen 6.8 percent in the recent six-month period, due primarily to a continued rise in drilling rig day rates.  It should be noted that segments of North America have seen a flattening or even a decline in rig day rates. However, the UCCI tracks a global portfolio of projects, and the impact of North America has been more than offset by increases in the cost of land-based drilling in other parts of the world such as Russia and the Middle East

Of the nine primary drivers of project capital development costs tracked by CERA on a global basis, all are continuing to respond to the high level of oil and gas activity; while in some regional markets, there has been a downturn for specific items such as rigs. Additionally, the continued strength of the global economy has maintained pressure on commodities and other generic equipment and services.

An analysis of cost-component performance for the past six months shows continued significant increases in specific areas such as manufactured equipment and experienced personnel. The largest cost increases have been in engineered equipment, such as compressors, turbines, and generator sets (20–24 percent in six months) due to high demand and the limited number of suppliers. Additionally, the shortage of manufacturing capacity for subsea equipment has caused considerable price increases for the highly specialized pipes and tubing used to make flowlines and risers. In many cases these shortages have translated into extended delivery times in addition to cost increases.

Extending project schedules creates further pressure on personnel. When a project is delayed six to 12 months due to equipment constraints, the design and project management staff cannot be released to other projects, otherwise design integrity and decision consistency are lost.  Thus, delays tend to stretch these valuable personnel resources even thinner, rather than make more staff available.

The impact of rising costs on people extends beyond design and project management personnel, as experienced workers are needed throughout the industry. The high number of complex, highly technical projects under construction demands top-flight, seasoned personnel. The market continues to see movement between companies and attempts to bring in staff from parallel industries such as refining and power. Transfer incentives and retention plans continue to affect the cost of personnel. This is seen specifically in onshore rig crew rates, where the influx of new offshore rigs is creating significant competition for experienced rig hands.

Not all components are increasing at significant rates. For the first time since 2005, some areas are seeing relatively moderate increases in cost. Processing and utilities equipment have shown marginal rises in cost. Installation vessel day rate increases have been minor. Yard construction activity remains buoyant worldwide, which means that premiums are being charged for the construction of offshore vessels. However, even this activity shows only moderate levels of increase.

The only area to show some cost decline is rig day rates in specific regions. As mentioned above, rates for land rigs in some parts of North America have flattened or declined. Jack-up rigs used in the Gulf of Mexico have shown the most significant decline, with some contractors reporting decreases of up to 35 percent as a result of additional rigs coming to market.

"Capacity constraints continue to drive project costs," Ward said.  “However, it appears that the industry could be coming to a balance on the seesaw of demand and ability to supply. The delaying of projects, the push-out by manufacturers of equipment delivery times, the waiting on installation vessels—all of this naturally brings some relief to the capacity constraints by forcing projects into longer construction times. The fact that this new 2007 point is showing a lower rate of increase is a result of demand beginning to come into balance with the ability to supply equipment and services, rather than adding further premiums for faster delivery,” he said.

“Analyzing the projects already committed over the next two to three years, we can see that the demand for equipment and services will remain at these levels for the immediate future. Additional market capacity that is currently planned will not be sufficient in most markets to bring very much relief to high costs during this time period. One possible exception is for mobile rigs, where the current new builds planned and the trend of companies committing to longer-term contracts may have an impact,” said Ward.

About the IHS/CERA Upstream Capital Costs Index (UCCI)

The IHS/CERA UCCI tracks the costs of equipment, facilities, construction materials, and personnel used in a geographically diversified portfolio of more than two dozen onshore and offshore oil and gas development projects. It is similar to the consumer price index (CPI) in that it provides an easy to understand tool for tracking and forecasting a complex and dynamic environment. The UCCI is unique in that it leverages the proprietary cost database and cost modeling tools of the IHS QUE$TOR™ suite of software.  It also provides the platform for CERA’s Capital Costs Analysis Forum. The UCCI can be tracked on the IHS Index Web Site: www.ihsindexes.com. For information on the Capital Costs Analysis Forum, cntact Richard Morris at rmorris@cera.com

About IHS (www.ihs.com)

IHS (NYSE: IHS) is one of the leading global providers of critical technical information, decision-support tools and related services to customers in a number of industries including energy, defense, aerospace, construction, electronics, and automotive through two operating segments, Engineering and Energy. IHS serves customers ranging from governments and large multinational corporations to smaller companies and technical professionals in more than 100 countries. IHS employs more than 2,300 people around the world.

Cambridge Energy Research Associates (CERA), an IHS company, is a leading advisor to energy companies, consumers, financial institutions, technology providers, and governments.  CERA (www.cera.com) delivers strategic knowledge and independent analysis on energy markets, geopolitics, industry trends, and strategy.  CERA is based in Cambridge, MA, and has offices in Bangkok, Beijing, Calgary, Dubai, Johannesburg, Mexico City, Moscow, Mumbai, Oslo, Paris, Rio de Janeiro, San Francisco, Tokyo and Washington, DC. 

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