Oil exploration costs rocket as risks rise

LONDON Thu Feb 11, 2010 7:07am EST

LONDON (Reuters) - Finding oil and gas to replace the world's fast dwindling reserves is increasingly risky as rigs probe areas once seen as too difficult or too dangerous, and costs are rocketing, which could imperil future supply.

The cost of discovering each new barrel of oil and gas has risen three-fold over the last decade as technology has pushed the frontiers of exploration into ever more remote areas.

As old fields run dry, oil companies are drilling wells in some of the most inhospitable regions, where political, physical, geological, geographical, technical and contractual risks are high, and they have had remarkable success.

Despite escalating challenges, the annual rate of discovery of new fields has remained remarkably constant at 15-20 billion barrels, more than enough to compensate for the loss of existing reserves that are declining at between 5 and 15 percent a year.

But the cost of this success is staggering, and unless consumers pay more for oil in future, some analysts think we could face an energy supply crunch within a few years.

"The age of cheap oil has gone and it is not going to come back," said Paul Stevens, senior research fellow at the Royal Institute of International Affairs at Chatham House in London.

"The world is not going to run out of oil tomorrow, but it is more and more expensive to find and will continue to be so," he said. "The worry is that investment may be squeezed as risks rise, and that could bring us to a looming supply crunch."

For a Reuters graphic of the escalating cost of discovering new oil reserves, click on:

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For a factbox on the escalating cost and risks of finding new oil reserves, click on:

For a table showing the escalating cost of discovering new oil and gas reserves, click on:

For a map of global oil exploration risks, including political risks, click on:

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ESCALATING COSTS

The search for oil has always been costly and involved risk taking, but the challenges facing explorers have intensified as wells have moved further offshore, into deeper reservoirs and to places with much higher political and physical risks.

Figures from upstream consultant Wood Mackenzie in Edinburgh show the cost of finding oil has almost tripled over the last decade even though the rate of discovery has barely changed.

Each barrel of oil equivalent cost an average of just over $3 to discover last year, compared with just $1.18 in 2001, according to Wood Mackenzie. Data from BP Plc for the cost of finding new oil show an even bigger increase -- more than four fold in the five years to 2008.

Those figures may seem low given that world spot oil prices are close to $75 per barrel, but discovery costs need to be multiplied many times as oil is pumped out of the ground, processed at a refinery and becomes fuel at a service station.

Even established oilfields, such as those in the North Sea, now have breakeven costs of around $50 per barrel.

The new ultra-deep offshore fields that lie beneath oceans more than 3 km (1.88 miles) deep and in positions up to 5 miles from rigs impose even higher costs. Because the rigs work in deeper water, they use more steel, new technology and are operated by highly trained and expensive specialists.

POLITICAL, CONTRACTUAL RISKS

"A piece of seismic, a well, a day of a rig, these things have tripled in cost," said Andrew Latham, of the Exploration Service team at Wood Mackenzie.

"Today's exploration well is a more technically complex animal than one 10 years ago. But the main reason why a rig is more expensive today than it was 10 years ago is that it has 10,000 feet of steel in it."

New exploration is not just more technically difficult, it is also fraught with political risk that may lead to contractual uncertainty which can jeopardize investment projects.

As hunger for energy grows, governments sitting on potential oil and gas fields demand a fair price for their resources in a process economists call resource nationalism.

Britain, Russia, Venezuela and Algeria have all raised their take from oil in the last few years, either by imposing higher taxes or renegotiating contracts. Some developing countries have sought to change the terms of contracts entirely. Uganda has about 2 billion barrels of oil reserves but talks on production have been slow, partly due to a government demand that oil companies build a refinery to meet domestic needs.

"We are now starting to see wells being drilled in countries which have had recent turmoil or civil wars or have an uncertain legal framework," said Chris Wheaton, who runs energy-industry funds for part of insurance giant Allianz.

"Easy oil has been over for a while and the inexorable shift is to places with political, physical or geographical risks, and translates into higher costs. Finding oil is more difficult."

Most oil industry analysts are skeptical of the "Peak Oil" theory that suggests that the world is running out of oil. They argue there is no shortage of oil, but agree it is getting harder and harder to extract and ever more expensive.

"There isn't a 'Perfect Storm' of risks yet but a lot of things are making it more and more expensive to go out and find oil," said Stevens. "As risks rise, the required rate of return goes up, which squeezes the investment pot for new discoveries."

(Editing by Sue Thomas)