According to the latest analysis from Wood Mackenzie capital and operating costs in the UK and Norway's upstream sectors will decrease steadily this year as operators respond to lower oil prices. Wood Mackenzie projects that the biggest reductions will come in drilling costs, which could come down by a third by the end of 2016. Near term pre-final investment decision (FID) projects are expected to be best placed to benefit from reductions and development costs for these projects could fall 10-20%. Operating costs will decrease by up to 15% in the UK and 10% in Norway. Wood Mackenzie says the UK and Norway will deflate at different rates, based on distinct rig and labor markets and varying activity levels. Wood Mackenzie also cautions that the outlook for upstream costs beyond 2016 is much less clear and will be largely driven by what happens to the global oil price.
Wood Mackenzie asserts that upstream cost deflation is inevitable for the North Sea industry, as it emerges from a period of intense development activity over the past five years. This caused severe cost inflation as operators competed for access to services.
Malcolm Dickson, principal North Sea analyst for Wood Mackenzie explained: "High capital and operating costs are the single biggest issue for companies in the UK and Norwegian sectors of the North Sea today. Even before the oil price crash, developing and operating fields while making a profit was challenging and we expected some cost deflation in the sector as activity cooled. 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.
"We expect that there will be a gradual decrease in capital and operating costs in Norway and the UK in 2015 and 2016, the most significant reductions likely to be a 30% fall in drilling costs, as rig and vessel rates come down due to oversupply. "We have already seen rig rates dropping significantly 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."
"We also expect development costs for near-term pre-FID projects to drop by up to 18% in the UK and 11% in Norway. Projects that are already under development are likely to see less deflation, as many of the costs are locked in by existing contracts, " said Dickson.
Upstream capital investment is falling this year in both the UK and Norway. As a result, competition within the supply chain is increasing as operators scrutinize costs and project execution. Dickson continued: "As well as looking internally for efficiency gains, North Sea operators are now negotiating with contractors. This is because the opportunity for cost reductions is highest in uncontracted spend such as pre-FID projects and new brownfield developments."
Upstream costs in the UK and Norway will deflate at different rates according to Wood Mackenzie.
"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 US$375M in CAPEX) and are generally operated by independent E&P companies – so economies of scale within the supply chain are harder to achieve. Norway looks set to be a hotspot for projects which are due to take FIDs this year and will maintain investment levels around 65% higher than the UK out to 2017," Dickson said.
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."
"The outlook for costs beyond 2016 is much less clear and depends to a large extent on what happens to the oil price. Wood Mackenzie assumes steady price recovery, towards Brent reaching flat US$85 real from 2018 onwards. Assuming the oil price rises as we think it will, the lower cost base achieved over this year and next can only be sustained through fundamental changes in practice and increased collaboration between the operators and the service sector," Dickson said.
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