By John Kemp
LONDON, June 10 Lack of specialist equipment and
skilled personnel have been the biggest barriers to raising the
supply of oil over the last decade, contributing to the steady
escalation in prices.
Exploration and production (E&P) activities have been hit by
shortages of everything from drilling rigs and pressure pumping
equipment to the guar gum used for hydraulic fracturing,
experienced geologists and drill team leaders.
The result has been soaring cost inflation. But with oil
prices now in the eleventh year of a bull market, the supply
situation is starting to improve, shortages are easing and
upward pressure on costs is beginning to abate.
TIME AND MONEY
Oil production is subject to long cycles. Part of the
problem stems from the long lead times for large capital
investments. It can take 7-10 years from discovery to put a
major offshore oilfield into production and a similar time to
design and build a gas-to-liquids plant.
However, some of the most intractable challenges lie in the
supply chain. Oil and gas exploration and production require
substantial amounts of equipment and specialist personnel, few
of which are shared with other industries.
E&P budgets have to sustain a complex eco-system of prime
contractors and sub-contractors to provide drilling, surveys,
chemicals, specialty steel tubing, pressure pumping equipment
and more mundane items like guar gum and fracturing zeolites.
Many of the problems that have hampered production over the
last 10 years stem from decisions made during the prolonged
period of low oil prices in the 1990s to slash budgets, lay off
skilled engineers, drillers and geoscientists, and cut
The result was a rapidly ageing workforce and badly reduced
supply chain which struggled to respond to the sudden return of
demand from E&P companies.
Shell's outgoing chief executive, Peter Voser, explained the
long-cycle dynamic in a recent interview with my colleague Andy
"One learning out of all this, for every person in this
organisation now, is you spend capex through the cycle. Don't
try to read it, don't slow down. It will cost you more when you
want to grow afterwards," Voser warned.
"I know a lot of investors and analysts. They all think they
can read the market ... slow down, grow later, shrink to grow,
all these buzzwords, but one thing in our industry is very
clear; it takes you five to seven years to recover a strategic
slowdown... The market changes its views in three to six months,
and you can't change that fast in our industry."
Rebuilding supply chain takes both time and money.
Fortunately, the oil industry now has plenty of both.
Using Brent as a benchmark, average crude prices have risen
in 10 of the 11 years between 2002 and 2012, with only a brief
decline in 2009 (Chart 1).
High prices mean buoyant cash flows. In 2013, oil and gas
companies will spend a record $678 billion on exploration and
production, up 10 percent from 2012, according to a recent
survey by Barclays Capital.
In the early years of the bull market fears about a return
to low prices restrained capital expenditure. As the boom has
endured, however, E&P companies have become more confident and
shown more willingness to undertake spending programmes that
will take years to pay back.
The drilling boom has been most obvious in the shale plays
of North America, where it has also resulted in a big build out
in the supply chain for everything from modern drilling rigs and
seismic crews to pressure pumps and fracturing sand.
But the drilling boom is gradually going global. E&P budgets
outside North America are predicted to rise by 13 percent in
2013, compared with just 2 percent in North America itself,
according to the Barclays survey.
The gradual globalisation of the E&P boom is reflected in
monthly rig counts published by oilfield services company Baker
The number of onshore rigs actually drilling for oil and gas
outside Canada and the United States has almost doubled to 960
in the first five months of 2013, from just 500 in 2002. (Chart
The biggest increase has been concentrated in the Middle
East, where traditional producers such as Saudi Arabia, Abu
Dhabi and Kuwait are now drilling much harder to replace
declining output from their aging fields.
But drilling activity has more than doubled in both Europe
and Africa, according to Baker Hughes. Onshore drilling in
Europe and Africa is at the highest level since the beginning of
the 1990s and around 80 rigs are now working in both regions
Because wages and prices have been escalating, the activity
has risen more slowly than E&P budgets let alone output, which
has erroneously led some analysts to conclude that the finding
and lifting costs of oil and gas are inexorably rising.
In fact, cost inflation is the inevitable price for
rebuilding a shrunken supply chain and labour pool. E&P firms
have paid premium prices to attract new workers and suppliers
into the oil and gas patch. But as the rebuilding of the supply
chain is completed, cost inflation should slow, and prices in
some areas are likely to come down.
Different elements of the supply chain have been built out
at different speeds.
The volume of pressure pumping equipment in the United
States has grown so rapidly the market was suffering from 25
percent overcapacity by the end of 2012, according to one
estimate by a market intelligence firm. In other areas,
shortfalls persist and prices are still rising rapidly.
Cost inflation therefore remains problematic for the major
E&P companies, but there are signs it has started to decelerate,
and it should slow further in 2014 and 2015 as the investment