Oil firms may put projects on hold until costs fall

Published on Sunday 11 January 2009 20:59

OIL companies may soon begin delaying projects in an attempt to take advantage of an expected fall in services costs, senior executives have told The Scotsman.

Several executives at exploration companies have predicted that the cost of oil services – such as well drilling – could fall by as much as 50 per cent in large open markets such as the North Sea.

Since peaking near $150 a barrel in late July, crude oil prices have fallen by around two-thirds, a move that is expected to lead to a fall in exploration levels.

This in turn is likely to force oil services companies – which carry out the projects to explore for oil and bring projects into production – to drop their costs to win projects, industry figures believe.

Graham Stewart, chief executive of Faroe Petroleum, said it was a "likely scenario" that the cost of drilling wells in the North Sea in 2010 and 2011 could fall by 50 per cent as demand for wells drops and oil services companies slash their prices.

Faroe has a large number of relatively small interests throughout the North Sea. Its shares surged last week after further results from a North Sea gas well in which it has a stake showed that there might be a significant gas find. Stewart said the anticipated fall in costs could be significant enough to "add a lot of value" to projects.

Dave Thomas, Melrose Resources' chief executive, said the Edinburgh-based company had already noted the first signs of falling services costs in some regions and the company was investigating delaying projects.

Thomas said: "They are starting to come down, but there's an inertia. It always takes a while for the equipment and services costs to decline, chasing the oil price down, but that's because it takes a little while for the production companies to react and change their plans."

Thomas said the price falls were unlikely to be dramatic in smaller markets, such as the Black Sea, where the company has several gas fields, because the cost of deploying rigs is so high that there has been little scope for additional capacity to build up.

However, falls had already begun in the United States, where Melrose has an onshore drilling programme, and Thomas said costs in some areas of the services markets could fall by half there.

He added: "In the States, I could see well costs falling by that kind of magnitude (50 per cent]. We would expect there would be some fall everywhere, but especially where there's a big, fluid services market."

The fall in demand in the US is well documented. A recent survey by oil services company Baker Hughes found that the number of rigs operating in the US fell by 98 to 1,623 in the week ended 2 January, compared with a year ago.

While the company has not yet made a decision, Thomas said Melrose, a member of the FTSE 250, was considering delaying projects there to take advantage of the anticipated fall in costs.

Melrose does not operate in the North Sea, but Thomas predicted that, because of the relatively high operating costs of the region, oil companies would certainly be considering putting off projects.

He added: "I'm sure in the North Sea there are a lot of operators who have a mind to defer activity to take advantage of lower costs."

Another executive agreed that prices were expected to fall and, while the company had not made plans to delay projects yet, it could see the logic in doing so.

"Crude prices will come back (up], and given that there is likely to be a lot of capacity in oil services in a year or two, holding off doing projects could make sense."

However, the executive said confidence among investors in the sector was already low and shareholders might take fright on news of project cancellations, despite the rationale. This may mean companies wait for others to delay projects before following suit.

ANALYSIS

UNTIL late summer, the UK's oil services firms had experienced a sustained boom period, taking on thousands of staff, raising prices and still struggling to cope with the work available, even in the North Sea, a region widely described as "ageing".

As oil prices surged, oil explorers had told the market of ambitious plans to raise production levels and had little choice but to pay increasing costs to complete projects on time. Venture Production was hammered by the market last year after failing to hit production targets, blaming in part its inability to find service firms to complete projects.

Now the situation is almost in reverse. Crude oil prices have collapsed since hitting $147 a barrel in late July, and some companies now believe it makes sense to delay projects. With crude prices so low that they make some projects marginal, oil services firms are likely to be forced to slash prices to win what contracts are available or to stimulate the market.