Costs are Holding our Industry Back… Again!

David Bamford, Petromall

This oil & gas industry of ours goes through cycles, tied by elastic to the price of oil and gas. On the back of the decade long rise in oil prices and the corresponding boom in exploration and production activity, costs have escalated – exponentiated some would say – and as a consequence investors can now see that many oil and gas companies are delivering poor returns.

Escalating costs are compounding the other problems experienced by exploration and production companies – disappointing exploration results, delays and cost over-runs in development projects, missed production targets.

Thus we are now entering yet again that phase of the cycle in which companies ‘go to town’ on costs: if this period is anything like previous episodes, we will see both manpower reductions, project cancellations and consolidation.

The UKCS and NOCS as an Example
In the UKCS and NOCS, escalating costs are already leading to delayed or cancelled projects due to poor economics, both for new developments and in-field projects. A further consequence is that decommissioning, and the associated costs, looms larger on the radar screen, leading to even more rapidly declining infrastructure.

Evidence for this can be assembled simply by collecting some news clippings from the last 3 or 4 months:
»     Kristin Gas Export (NOCS; Statoil)
– Project terminated………“unsustainable project economics”
»     Rosebank (WoS, UKCS; Chevron)
– Doubts…..“does not currently offer an economic value proposition that justifies proceeding with an investment of this magnitude”
»     Bressay (NNS, UKCS; Statoil)
– “re-evaluating”….“delay”….“alternative development         options”
»     Recent NPD commentary on NOCS:
– Johan Castberg (Barents Sea; Statoil); Linnorn (Norwegian Sea; Shell); Tresakk (North Sea; Shell)….all delayed…”gas prices, costs, lack of infrastructure”
– “pretty much all of the projects in the Barents Sea are in danger”

The simple cartoon on the next page is an attempt to generalise the value evolution of a basin:
The key points are:
1.    The big simple fields are discovered and developed first, value rises rapidly, cost/boe stay low.
2.    Progressively fields get smaller, deeper, more complex, contain more difficult fluids, costs/boe rise.
3.    Eventually value is being destroyed.

It is exactly this logic that persuades big companies to leave a Maturing region and seek new Frontiers.

Without an urgent response, first the UKCS and later the NOCS are at risk of living out this cartoon.

To dig further into this, I have begun to assemble a small data base of NW Europe projects and some West African examples to compare them with.

The table below illustrates some of the data:

Fields in Red are under threat or delayed; those in Orange are going ahead but not yet producing; those in Black are producing.

I have found it necessary to get away from published economics as these are based on all sorts of typically beneficial assumptions meaning that parameters such as NPV and RoR cannot be compared. What can be compared and what I show for each project are the reported cost in $bn, the reserves these dollars are being spent on, and the target or ‘nameplate’ production level.

It’s a little difficult to make sense of these numbers in tabular form but I find this simple crossplot quite helpful:

The horizontal axis relates to the reserves – S per boe.
The vertical axis relates to production – $ per produced barrel per day.

What quickly becomes apparent is that Frontier, larger, projects plot in the Green area; smaller, more complex, perhaps heavy oil, projects in the UKCS and NOCS plot in the Red or just in Orange.

Interestingly, a big North Sea project – Clair Ridge with over 600 million barrels under the control of a single Operating Group and with the diligent application of technology – plots pretty well on the cross in the middle of the plot.

Also interestingly, note that if the actual spend for the Angola PSVM project is used instead of the projected spend, this moves from the comfort of the middle of the Green zone to being pretty well on the cross in the middle of the plot too!

What Conclusion Do I Draw?
I suggest that the UKCS and NOCS have a serious problem with escalating costs.

However, I believe that these areas can continue to compete with Frontier areas but two things are needed, namely Consolidation and Technology:
»     Consolidation
– To assemble reserves, whether in new or old discoveries, or in producing fields, into bigger agglomerations under a single ‘regional’ operating entity so as to enable the ”hub and spoke concept”.
»     Technology
– To dramatically reduce the number of wells needed to develop a field or part of a field.
– To monitor hydrocarbon production and detect where there are untapped reserves.

I believe the situation is urgent, requiring a rapid response from governments and industry.