As gas prices fall and service costs inflate, there are signs that the North American market at least is beginning to see some supply-chain bottlenecks starting to ease.
"The fundamental driver of the North American E&P challenge is the relative maturity of the natural gas resource base." - Michael Bodell, CERA director
Land driller Pioneer said in February that it had lowered dayrates for a few of its rigs by between 10-20% as E&P companies, responding to oversupply, have begun to apply pressure to force down prices. Pioneer Ceo Stacy Locke admitted that the adjustment was "more material" than the company projected three months ago.
The lower dayrates are expected to result in an average revenue drop of 4% to 6% in first-quarter 2007.
Locke said that both dayrates and rig utilization are likely to soften in 2007, utilization dropping by as much as 1% to 2% per quarter for the next several quarters.
Pioneer's revenues from contract drilling in fourth-quarter 2006 were $112 million, up from $74 million the year before. Moreover, the company's average drilling margin per revenue day jumped 44% year-on-year to $9,649 from $6,687.
The world's largest land rig contractor, Nabors, also predicts that drilling operations in the US and Canada will decline in 2007, owing to falling natural gas prices and high service costs.
Chief executive Gene Isenberg said in a conference call with analysts in February that Canadian operations will drop by 20% in 2007, and margins on Nabors rigs will fall by a similar figure.
US activity and prices would experience a smaller downturn, excluding Alaska, Isenberg said. The softer market reflects statements by major producers in Canada that they would start to limit their 2007 exploration spends. At the same time, over 300 new land rigs are expected to enter the market by end-2007.
Nevertheless, Nabors' fourth-quarter 2006 profits were up 31% from 2005 at $276.1 million.
According to CERA's Candida Scott, the costs of gas and oil projects have spiked dramatically in the past two years, causing some exploration and production companies to postpone projects now deemed uneconomic.
Scott said that taking into account increases in the cost of steel, drilling rigs, vessels and personnel "in the past 12-month period we have seen cost increases of well over 30%." This rapid cost inflation has caused many E&P companies to announce delays of some projects, particularly those that are more technically challenging and therefore higher cost, she said.
Scott said that while the cost of all upstream gas and oil projects have been going up, within the last six months the costs of LNG projects have seen the lowest rise among all other kinds of projects.
In addition, other markets "are showing a decline in the rate of their rise." While the prices of some inputs, like steel, are driven by world demand, others, such as rig dayrates, which can account for 30-40% of an offshore project's cost, are more closely correlated with oil and gas prices.
Michael Bodell, CERA's director of upstream gas strategies, concurred. He said rising costs and declining production rates were squeezing the margins of many North American gas producers despite lofty wellhead prices.
A study by CERA which examined 2005 cost and volume data for 48,000 wells in 50 North American basins, found "a dramatic shift toward unconventional gas production, which now accounts for a quarter of total output."
According to the report, the weighted-average cost for developing gas reserves in 2005 ranged from about $4/Mcf to $12/Mcf. "Judged against the record prices of 2005, which averaged $8.80/Mcf at Henry Hub, more than 6% of basins had costs high enough that they would fail to achieve a 10% rate of return on investment," said the report.
Bodell added, "it is clear that rising service costs have begun to take away much of the margin in many wells and plays despite historically strong market prices." Meanwhile, the record number of well completions over the past few years is "being totally offset by declining per-well productivity," he added.
"The fundamental driver of the North American E&P challenge is the relative maturity of the natural gas resource base. Although gas resources are available and new plays are being identified and developed, many of these resources are deeper, smaller, technically more challenging or more distant from markets."
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