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The new IHS Markit Upstream Innovation Index (UII) for the first
half of 2019, which tracks construction and operations costs of 80
oil and natural gas projects, dropped by 15.7% from 2014 to 2018.
This indicates reductions in costs due to innovation, combined with
cyclical cost reductions seen since 2014, where construction costs
have dropped over 40%. IHS Markit forecasts cost reductions because
of innovation will continue with the UII reaching 69.7 by 2022,
translating to an additional 14.6% reduction.
Figure 1: Upstream totex innovation index
While the headline numbers offer guidance to stakeholders,
deep-diving into granular numbers offers insights of how capex and
opex are being affected in different terrains (deepwater, shallow
water, and onshore) or in different regions. The numbers suggest
that trends are replicated, albeit with different magnitudes.
IHS Markit has developed the UII to quantify the effects of
innovation on oil and gas project development, following the oil
price collapse of 2014, which meant that many oil and natural gas
development projects planned prior became unfeasible. This forced
operators to seek new ways to reduce construction and operating
cost to enable projects to become economically viable under a low
oil price environment.
Between 2014 and 2017, decreases in commodities, labour and
equipment contributed to cost reductions in the downturn era, and
substantial cost reductions were achieved via structural cost
reductions, comprising both design changes and efficiency drive to
do things better. The question that investors and operators need to
answer is "are these cost reductions sustainable, how can we
quantify them, and how can we drive changes forward and not
backslide?".
The UII address these questions and can be used as a standalone
index to evaluate and forecast the impacts of innovation on
upstream capital and operating costs in the short term. The UII
tracks only innovative structural cost changes that occurred
historical, and using a proprietary methodology developed by IHS
Markit to forecasts these trends for the next five years. The UII
can be used in conjunction with the Upstream Capital Cost Index
(UCCI) and Upstream Operating Cost Index (UOCI) to assess the total
cost movement of an asset over time.
IHS Markit defines innovation as a new method of executing
projects in a manner different to the old norm used prior to the
2014 oil price collapse. By this definition, innovation includes
technological advances, simplification, standardization, and
modularization adopted to reduce project costs, during construction
and operation.
UII is calculated based on capex and opex of a portfolio of
projects, comprising of 50 oil projects and 30 natural gas projects
across diverse terrains and spanning all geographical regions
worldwide. Global oil and gas total cost (totex) is used as the
reference with the third quarter 2014 set to 100 as the starting
point for generating the indices. Figure 1 shows how Innovation has
reduced totex by up 15.7% up to now and how its forecasted to
provide an additional 14.6% by 2022.The overall impact of
innovative practices will dampen cost increases and maintain cost
reductions for a longer period.
With upstream construction and operating costs already showing
signing of escalation, IHS Markit expect upstream cost inflation
beyond 2018, with expectations of a 2-3% annual increase. We expect
the inflation element of cost changes will be countered by
innovative practices, including greater adoption of efficiencies,
acceptance of using new designs and focus on technology solutions
including digitalization, IoT, AI and additive manufacturing, where
stakeholders strive to optimize processes to achieve significant
cost savings in the near-term.
Besides providing quantitative directions of how innovation
impacted project costs, the UII can illustrate the impacts of
certain practices on cost reduction, and help companies set higher
achievement targets by illustrating best practices and what is
possible for projects to reach their optimal potential. It also
allows operators to perform "gap analysis" for a specific project
or a portfolio of projects.
Posted 20 February 2019 by Basel Asmar, Ph.D., Director, Upstream Capital and Operating Costs Service, IHS Markit
