Capex: Taming the tiger

In the 13 years to the turn of the century oil and gas exploration and production expenditure grew by 48%, between 2000 and 2013 the growth was 374%.

In the 13 years to the turn of the century oil and gas exploration and production expenditure grew by 48%, between 2000 and 2013 the growth was 374%. However, oil production increase was a mere 24%. Welcome to the world of hard oil.

The reason for the rise in prices throughout the oil and gas industry supply chain was quite simply that demand for products and services exceeded the capacity to supply. To consider one key area, subsea production equipment, the order backlog near doubled in the period from 1Q 2010 to 3Q 2013. One investment bank analyst noted, "The industry is currently too busy to be very efficient."

In 2013, Douglas-Westwood (DW) examined nine FPSO projects. The original budget for the nine was $6.8 billion – the cost delivered $9.4 billion, up 38%; and total delay of 146 months. The major reasons for the delays (and cost increases) were difficulties in finalizing the engineering scope and integration.

In early 2014, big oil responded with a series of announcements reigning-in capex, a process DW has termed Capital Compression. Chevron stated that its capex peaked in 2013 but it expects "future spending should stay flattish through 2016;" Exxon Mobil reported "capital spending in 2014 will decrease from $42.5 billion in 2013 to $39.8 billion," a drop of 6.3%; Shell announced that 4Q earnings had "plunged to $2.2 billion and that 2014 capex would be reduced;" and more followed.

However, meeting future global oil and gas demand will require massive numbers of new development wells to be drilled; in 2014 DW estimates some 83,000 in total, of which 80,000 will be onshore and 3,000 offshore. An expected 17% increase in oil and gas demand by 2020 means that annual well completions will need to climb 35%; in all an additional 670,000 wells must be drilled. And as the IOC's reign-in their spending the NOC's drilling will surge.

So what options are available to control costs? The reality is that there is no single solution; however, the operators must understand the capacity of the supply chain. They must endeavor to determine likely future supply and demand pinch points – when and how severe – understand how will this impact individual projects and plan accordingly.

The engineering of projects must be far more based on fit for purpose. The industry needs to end the approach of "gold plating" and where possible standardize – will an existing solution suffice, or if not can an industry-wide standardized solution be developed?

New technologies need to be developed and deployed. But to do that operators' risk aversion and reluctance to pilot them, particularly offshore, needs addressing. Government incentives are perhaps needed based on sharing results industry-wide.

Skills shortages are a major issue that is seriously increasing costs. The industry needs to act together to increase recruitment by changing external perceptions, then work to retain key skills through the down-cycles. It is also important to effectively capture exiting knowledge as older employees retire, and there is a need to use technology to try to reduce people dependence.

Finally, it is necessary to recognize that governments are a key player in the game. They must adopt realistic local content ambitions as present ones can reduce efficiency, add dramatically to costs, increase bureaucracy, and foster corrupt practices. Taxation is also a major factor. Oil and gas is a long-term industry which needs long-term policies that are not subject to change after every election and a few times in between.

The oil and gas industry has, however, woken up to its problem of high costs and is addressing them. On April 16, theFinancial Times noted that Shell's stock price had hit a two-year high as its approach changed to applying capital discipline and focusing on shareholder returns. In the same week, Total announced that it had cut the cost of its Kaombo project off Angola by about one-fifth to $16 billion and decided to proceed with the development.

There will be more spending cut-backs as higher-cost and more economically marginal projects are postponed, but some sectors of the supply chain will suffer less than others. Big oil needs big projects and accordingly deepwater, despite its costs, is one area that is expected to suffer less than others.

Exploration and production is a cyclical business and without doubt the market will eventually self-correct. Any major cut-back in spending will eventually result in reduced oil production in a world where demand is rising, so oil prices will eventually rise, oil company profits increase, and capex continue to grow. But one thing remains certain – the days of easy (cheap) oil are gone.

John Westwood

This page reflects viewpoints on the political, economic, cultural, technological, and environmental issues that shape the future of the petroleum industry. Offshore Magazine invites you to share your thoughts. Email your Beyond the Horizon manuscript to David Paganie

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