UK, Norway could benefit from falling costs, analyst claims

Offshore staff

EDINBURGH, UK – Wood Mackenzie expects capital and operating costs in the UK and Norway’s upstream sectors to decrease steadily this year in response to lower oil prices.

Drilling costs could account for the largest reductions, potentially dropping by one-third by the end of 2016, as rig/vessel rates come down to due over-supply.

In the near term, development costs for pre-final investment decision (FID) projects could fall by 10-20%, the analyst adds, while operating costs are set to decrease by up to 15% in UK waters and 10% offshore Norway.

However, the two countries will deflate at different rates, based on distinct rig and labor markets and varying activity levels. Wood Mackenzie cautions that the outlook for upstream costs beyond 2016 remains less clear and will depend on movements in oil prices.

The North Sea industry is emerging from a period of high-intensity development over the past five years that caused costs to spike as operators competed for access to services.

High capital and operating costs are the single biggest issue for companies in the UK and Norwegian sectors of the North Sea today,” said Malcolm Dickson, principal North Sea analyst.

“The drop in oil price has accelerated the need for lower costs, as companies adjust to protect their cash flows, and changes are now required to correct the industry’s cost base.”

Dickson said rig rates in the region have already fallen substantially, with reductions of up to 20% for new contracts agreed in 2015. 40% of mobile rigs in the UK and 23% in Norway are either currently without contract or due to come off by the end of 2015, giving scope for high reductions in future contract renewals.

As upstream capital investment in both countries declines, competition within the supply chain is increasing.

“As well as looking internally for efficiency gains, North Sea operators are now negotiating with contractors,” Dickson said. “This is because the opportunity for cost reductions is highest in uncontracted spend such as pre-FID projects and new brownfield developments.

“In general we expect to see costs fall a little further and quicker in the UK - for instance, lower rig utilization will mean cheaper drilling in the UK. However many of the UK’s new projects are technically challenging and standardized solutions are not an option, meaning there are few contractors capable of supporting them.

“The remaining pre-FID projects are smaller (averaging just $375 million in capex) and are generally operated by independent E&P companies – so economies of scale within the supply chain are harder to achieve.”

Numerous projects set for FIDs in Norway this year mean that investment levels in the country could be around 65% higher than the UK out to 2017, Dickson added.

“Although Norwegian costs are expected to fall less than in the UK in local currencies – the effect of Norwegian kroner depreciation will mean that some costs fall further in dollar terms. This effect will be most sharply felt in operating costs.

“Norway has some of the highest labor costs in the industry, and kroner depreciation will make them more competitive in the global market.”

05/27/2015

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