Oil Production Costs: Getting the Overruns, Paying the Price

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Continued from Part One.

Schlumberger, the oil services group, is quoted as saying annual capital spending for the industry has more than tripled in the past 10 years, reaching $550 billion in 2011.

Yet even so, the European majors failed to find enough new oil and gas to replace what they had produced, chalking up a reserve replacement ratio of only 92 percent. Not only are new reserves not meeting extraction, but costs are being driven up by budget overruns and delays. A recent study by Independent Project Analysis is cited, saying the average big exploration and production project is 22 percent late and 25 percent over budget.

One such is Kashagan, a vast oilfield in the Kazakh sector of the Caspian Sea that has turned into the world’s most expensive oil development project. Due to technical and environmental challenges, the cost of the first phase alone has ballooned to $46 billion, at least three times more than initially planned and enough to bail out Cyprus three times over!

Over the past 10 years, the top seven oil and gas majors are said to have increased their development capital expenditure by 255 percent, yet compound average growth rate has been practically zero as expensive new production has simply replaced cheap dwindling reserves.

The worst cost overruns are currently in Australia, in part due to a strong Aussie dollar, but as much due to the strain of trying to develop seven LNG projects simultaneously – costs have rocketed. The cost of Chevron’s Gorgon project had ballooned by 41 percent to US $52 billion as labor, materials and energy costs have all risen fast.

Labor is said to be costing $200/hr when accommodation costs are taken into account, due to the difficulty in attracting and retaining workers in such remote locations, compared to $68/hr on the US Gulf Coast.

Such cost pressures will keep oil and gas prices high even if demand growth flattens out, which seems unlikely on the basis of rising Asian demand. As cheaper resources are exhausted, new finds will demand ever-higher prices to justify exploitation.

We may not be at risk of 2008-level prices of $140/barrel in the short term, but it is only a matter of time before such levels are approached again.

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