While general inflation is relatively muted, it is endemic in the oil and gas supply chain. Average production costs are rising and service sector capacity is stretched, threatening project timelines and cost estimates.
Combined with a large backlog of major project start-ups, demand for oil services is projected to remain strong.
There are signs of a temporary hiatus in North America, but the industry predicts renewed growth through 2009, while in the background the demographic time bomb ticks quietly away. Ross McCracken reports.
Oil services companies saw another bumper year in 2006, with rising margins and an increased volume of business adding to record profits.
Oil services companies have seen revenues soar since 2002, when crude oil prices started their recent upward trend.
Halliburton recorded total revenue of $22.6 billion in 2006, up 12% from 2005. Schlumberger's total revenues for 2006 amounted to $19.2 billion, a jump of 34.4% from 2005, while Baker Hughes' total revenue leapt 25% from $7.2 billion in 2005 to $9.0 billion in 2006.
However, all warn of spiraling cost inflation within a sector that is struggling to expand its own capacity to deal with the level of demand, while cost inflation is adding to the rising per barrel cost of production for oil and gas companies.
The sector's ability to expand will be a key determinant of how rapidly oil and gas companies are able to invest capital effectively in exploration and production, while rising costs will determine how the industry reacts to any fall in oil and gas prices.
Soaring costs
Speaking at London's International Petroleum Week in February, Mike Bowyer, UK vice president for Halliburton, said that the outlook suggested a continued high level of activity in the sector with increasing production from independent operators and more targeting of unconventional and difficult reserves.
Combined with a large backlog of major project start-ups, demand for oil services is projected to remain strong.
According to the 2006 Lehman E&P spending survey, companies said that on average they would reduce spending if oil prices fell to $42/barrel and natural gas dropped to $5 per thousand cubic feet.
67% of companies indicated higher E&P spending in 2007 with almost 72% of those companies planning double digit increases, said Bowyer.
This means that equipment lead times are not expected to improve in the short term, while utilization rates of people and equipment will remain at peak levels.
In addition, as more complex reservoirs and unconventional resources are tapped, technology spend will have to continue at current increased levels.
Bowyer said that while internal capacity has grown, third-party content remains a critical constraint. Frac acid capacity grew 70% between 2004-2007, for example, but drilling equipment lead times in 2006 were 60-100% longer than in 2004.
In addition, pumping equipment lead times for heavy duty engines and transmissions more than tripled between 2003-2006.
And it is not just that oil services companies have improved their margins; supply costs for service companies have risen too.
Market prices for organic chemicals are up 62% since 2003. Market freight rates are 28% higher than in 2002 and 8% up on 2003.
Composite supply prices for oilfield tools have increased by 15% since 2004. Cement prices have climbed 35% in the last three years.
Metal prices have rocketed, with non-ferrous metals up 147% since 2005 and low alloy steel 174% higher than in 2004, according to Bowyer.
Updated: March 28, 2007
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