In a comprehensive analysis looking at the impact of cost deflation on the global upstream oil and gas sector, Wood Mackenzie concludes that, while operators are seeking an average cost reduction of 20–30% on projects, supply chain savings through squeezing the service sector will only achieve around 10–15% on average.
To ensure that projects are economically viable, operators will also need to focus on project optimization and adopt smarter ways of working with the service sector. Illustrating the need to reduce costs in the industry, Wood Mackenzie's analysis estimates that $1.5 trillion of uncommitted spend on new conventional projects and North American unconventional oil is uneconomic at $50 a barrel.
James Webb, upstream research manager for Wood Mackenzie, said, “As the upstream industry responds to the low oil price, investment is down $220 billion in 2015 and 2016 compared with our pre-oil price crash projections. In addition to reduced activity onshore North America, a total of 46 projects have been deferred as a result of the oil price fall. We estimate that as much as $1.5 trillion of investment spend destined for new (pre-sanctioned) and US tight oil projects is now out of the money, or in starker terms, uneconomic at a $50 oil price. This spend is very much at risk.”
Obo Idornigie, principal upstream research analyst, commented, “The implications of this level of reduced investment is huge for the industry's service sector which is of a size to comfortably accommodate an average of 40–50 new projects globally a year. We expect just six new projects to go ahead in 2015 and around 10 in 2016. The weak pipeline of new projects is resulting in very competitive bidding from the service sector as E&P companies negotiate hard on pre-sanction projects. We believe that pre-sanction offshore projects could benefit from 10–15% cost reductions through supply chain savings alone. However, the industry needs to strike a balance between near- and long-term drivers. Pushing the service sector too hard now is only likely to shore up problems once more attractive fundamentals return: Increasingly, severe job cuts means that the industry is losing skilled resources that will take time to attract back when prices recover.”
So how can the industry achieve cost savings of 20–30%?
“Additional measures are needed to manage costs: re-working field development plans, optimizing project design and more innovative approaches to project management will all play important parts,” Webb responded. “A prolonged period of low oil prices over a number of years is likely needed to bring about profound, structural changes to industry costs. This is unlikely – in our view, oil prices will begin to recover from 2017, and there is a real risk that cost inflation pressures then return. Stronger collaboration between operators and service companies will be key in driving efficient practices. The winners, therefore, are likely to be operators with a strong pipeline of near-term projects close to sanction which are able to take advantage of the trough in costs through 2015/2016."