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In the past three years, the oil and gas industry has
restructured to adapt to the low oil price environment, which
turned from a "lower for longer" to a potential "new norm," albeit
with increasing uncertainty owing to geopolitical factors in the
past few months. Thus, operators had to adapt to reduce their
capital costs and lower their operating costs. This led to many
majors announcing further reductions in the breakeven prices.
In a recent study delivered to clients, we categorize project
costs into two broad categories-cyclical and structural-based on
their reliance on market conditions.
Figure 1: Upstream cost structure
We define cyclical costs as the costs that are sensitive to
market conditions, and thus can fluctuate rapidly. These costs
include unit costs (e.g., equipment) and labor rates, and are
incurred as both capex and opex. These costs have fallen materially
since third quarter 2014 until late 2017 where we witnessed
recovery in some of the sectors.
Structural costs, on the other hand, include cost changes that
occur because of other factors, such as efficiency gains and design
changes. Technological advances, including increased use of
automation, digitalization, and widespread drone utilization, are
implicitly included in both these factors and certainly influence
their contribution.
While structural costs were often overlooked in favor of
cyclical costs when oil price was high, these costs are now
scrutinized in the new cost environment, and operators are paying
more attention to control the costs and improve the breakeven
prices. In these conditions, the industry continues to embrace
practices and technologies to improve efficiency so as to lower
costs as a sustainable way to undergo future developments.
Our analysis reviewed a portfolio of 77 projects in offshore and
onshore conventional terrains, and concludes that developments
costs have indeed come down significantly, with structural-cost
reductions driving more than 40% of the typical improvements:
Figure 2: Average deepwater cost change
Overall deepwater costs for this portfolio of fields have come
down by an average of 41% since 2014, with cyclical factors
accounting for approximately 60% and structural factors for the
remaining 40% of total cost reductions since 2014.
Overall shallow water costs for this portfolio of fields have
dropped by an average of 38% since 2014, with cyclical factors
accounting for approximately 55% and structural factors for the
remaining 45% of total cost reductions since 2014.
Overall conventional onshore costs for this portfolio of fields
have decreased by an average of 40% since 2014, with cyclical
factors accounting for approximately 60% and structural factors for
the remaining 40% of total cost reductions since 2014.
Looking forward
Inflationary pressures are creeping up, and the risks from the
US-imposed tariffs on steel and aluminum will have longer-term
effects on the markets, especially in North America. We expect
offshore cost inflation in 2018, with expectations of a 2-3% annual
increase as cyclical factors start to slowly unwind.
As service costs eventually do rise, we expect the deflation
element of cost reductions will be countered by more widespread
efficiencies, greater use of new designs and focus on technology including
digitalization, where companies are realizing significant
savings in the near-term through focused, incremental changes and
optimization of assets.
It is clear also that "design changes" can become the new
standard, where complete redesigns are implemented, albeit many
undeclared.
As we reach a phase where efficiency gains are leveling off,
signs of a new wave of efficiency gains can be around the corner.
Few signs can be detected especially in the areas of AI and
simplification.
Long term, however, the biggest gains will come from
transformative and disruptive technology breakthroughs that have
the potential to dramatically reduce the costs and thus increase
the feasibly recoverable resource base and redraw the competition
landscape. The next question will be how to drive changes forward
and not to backslide.
