High capital and operating costs are the single biggest issue for companies in the UK and Norwegian sectors of the North Sea. Developing and running fields while making a profit has become ever more challenging.
Even during the 'good times' of oil prices around US$100/bbl, project margins were only getting smaller, as costs rose year after year. Radical changes are required to correct the cost base. Now that the price has dipped substantially, companies have been jolted into action. So, what can we expect to change? And why?
Cost deflation has been a key research focus for Wood Mackenzie in 2015. Our main expectations for the North Sea are:
- Capital and operating costs will come down steadily in 2015 and 2016
- We expect the biggest reductions will be seen in drilling, as rig and vessel rates come down based on over-supply
- Nearer term pre-FID projects will see the biggest reductions. We expect development costs for these projects to drop by up to 18% in the UK and 11% in Norway.
- By the end of 2016, we expect operating costs to fall by up to 16% in the UK and 11% in Norway.
- The UK and Norway will deflate at different rates – for instance, lower rig utilisation in the UK will mean cheaper drilling than in Norway.
Upstream operators will determine much of the sustainability of cost reductions. A truly collaborative approach with the service sector would enable suppliers to take a longer term view, delivering more standardised products and services with economies of scale, while also committing to reducing overlap of procedures and documentation. Were this to happen, it would be a win-win for operators and service companies.
As we saw in 2008, if the oil price rebounds sharply, cost deflation will reverse. Service sector capacity is in the process of being cut, and increased activity would stretch it, leading costs to creep up once more.
However, if, as Wood Mackenzie forecasts, the oil price recovers more slowly, there is an increasing chance that adjustments in contracting practices and the cost base will lead to more structural change throughout the sector, and therefore sustained cost deflation.
UK and Norway upstream costs - how far will they fall? [Subscription required]
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Our expertise in upstream oil and gas is driven from our unique databases, economic models and forecasts. We provide comprehensive asset and company valuations, in-depth analysis and insight into key issues.
Key to assessing the impact of changes in costs is our Global Economic Model (GEM), the valuation standard. It provides a vast library of precise, transparent data and fully audited field models that have been built up by our expert analysts every day for the past 40 years.
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