Rising Costs And Service Sector Bottlenecks: Will They Persist?

As any oil executive will tell you, usually in a heated tone of voice, Finding and Development (F&D) costs have doubled over the last five years, mostly due to skyrocketing prices from the service sector. Yes, the service sector, that group of providers whose seemingly systemic over-capacity routinely ensured highly competitive bids for their customers, has taken the upper hand in negotiations - raising prices, allocating scarce capacity and, finally, reporting higher profits.

Oil and gas companies are reeling from escalating costs and service sector bottlenecks which are causing project delays and budget overruns. The backlog for virtually every segment, from seismic, drilling, engineering and design, to construction and installation, has risen dramatically. There is anxious concern that in spite of record oil prices, the escalating cost of services will quickly erode margins and lower the return on projects as oil prices soften from current highs.

What is the service sector doing to increase capacity and when will supply pressures and prices ease? Engineering companies are expanding their use of "off-shoring"; new drilling rigs are starting to be delivered; tree capacity is slated to increase; and new installation vessels are on order. At the same time, however, in many segments, the current fleet is old and approaching the end of its efficient working life. A good example is offshore drilling: several hundred rigs were built during the early 1980s, just before oil prices and drilling demand took a large downward dive. Those rigs are now being fully utilized, but depending on the retirement rate for jackups and floaters, the supply/demand balance will remain tight in some water depth segments in spite of the number of newbuilds coming into the market in the next several years.

The balance after 2010, and the resulting impact on service sector utilization and pricing, is critical to estimating new investment opportunities. Unfortunately, the answer is different for each segment and dependent on the mix of global, regional and local suppliers into the market. But one thing seems clear - service companies are unlikely to repeat their past mistakes of building surplus capacity based upon "encouragement" from operations! PFC Energy has projected supply/demand and pricing within each service sector segment, working with clients as they evaluate new investments and assess risks to current and future project execution and profitability.

Key conclusions:

Service sector tightness will continue to influence project execution for the next several years.

Sector prices will ease as new capacity comes on line in some segments and regions.

The rate of retirements and timing of new supply will determine utilization and price pressures.

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