Cost Inflation In Energy Projects 2: The Myth Of The End Of Cheap Oil

Feb 5 2014, 1:53pm CST | by

There is no question that development costs for oil products, as well as LNG plants, gas-to-liquid projects, and others have experienced substantial inflation over the past decade. The source of this increase, however, remains a point of contention.

One school of thought argues that “the easy oil is gone” and that marginal cost of new oil projects is $100 a barrel, meaning prices are unlikely to fall below that level for any length of time. The opposite point of view suggests that these are primarily cyclical, and will be reversed in time.

Research I have done suggests that the latter is the primary cause of recent cost escalation. (More in the next post.) Although massive projects like deepwater oil fields appear to involve much more effort than a shallow, onshore well, they also contain much more oil, so that unit costs ($/barrel) are usually not too dissimilar. And while those who believe that the early days of the industry resemble the title sequence of the Beverly Hillbillies, with Jed striking oil by firing a bullet into the ground, the reality is contained in books like “Hell’s Half Acre” about the early days of the Canadian oil industry (not the cheesy B movie.  Okay, I haven’t seen it, but just look at the poster.)

The perception that the industry has, suddenly in the past decade, moved from “easy” oil to “hard” oil is fallacious. The huge number of oil fields (over 40,000 discovered to date) means that there is a continuum of potential development projects, not a dichotomy. Although geopolitical events such as the upstream nationalizations of the 1970s, can shift the industry from cheaper wells to more expensive wells, that was a one-time event, unlikely to be repeated.

And those who, like peak oil advocate Colin Campbell, believe that most new supplies must come from the Middle East are contradicting themselves, since countries like Iraq and Saudi Arabia typically produce about 10,000 barrels a day from conventional wells, versus a more typical 10-20 barrels a day in North America. Relying more heavily on the Middle East for oil supplies would mean lower costs overall.

It’s true that the industry is using larger and much more sophisticated equipment to access supplies, but this is not so much an indication that the ‘easier’ oil is gone as that the ‘harder’ oil has become easier, and often accessible. After all, no one thinks the use of four engine jetliners is a sign that the ‘easy’ sky is gone, or that skyscrapers mean that there is no land to build upon.

In the end, the reality is that most comments on oil development costs are based on vague impressions, not careful analysis. In the next post, I will argue that cyclical factors, especially high oil prices, are driving up costs.

Source: Forbes Business


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