HOUSTON, February 12, 2007 – The costs of major oil and gas production projects have risen more than 53% in the past two years, and no significant slowing is in sight, according to a new benchmark index developed by IHS and Cambridge Energy Research Associates (CERA).

The IHS/CERA Upstream Capital Costs Index (UCCI), which tracks nine key cost areas for offshore and land-based projects, climbed 13% to 167 during the six months ending October 31, 2006, compared with an increase of more than 17% in the previous six months.  Since 2000, the UCCI has risen 67% -- with most of the increase in the last two years -- while the Producer Price Index-Commodities for finished goods (excluding food and energy) moved up just 7.5% during the same period.

"This continuing cost surge is central to every energy company's strategic planning and to every energy user's expectations for supply security in the coming years," said CERA Chairman Daniel Yergin. "Rising capital costs rank right alongside more widely recognized issues such as world market trends, geopolitics, globalization and new technologies at the top of the agenda for the energy industry," he said. "And this will be a central issue at CERAWeek in Houston," referring to the CERA conference that opens in Houston on Tuesday.

Index Data

The UCCI tracks the costs of equipment, facilities, construction materials and personnel used in a geographically diversified portfolio of more than two dozen onshore and offshore oil and gas development projects. It is similar to the consumer price index (CPI) in that it provides an easy to understand tool for tracking and forecasting a complex and dynamic environment. The UCCI is unique in that it leverages the proprietary cost database and cost modeling tools of the IHS QUE$TOR™ suite of software. It also provides the platform for CERA’s Capital Costs Analysis Forum.

"If current trends continue, 2007 is shaping up to be a year of further increases. Despite a slight slowing in the rate of increase during the six months to October 31, we expect project capital costs to continue reaching new record levels during 2007," said CERA senior director and UCCI project manager Richard Ward. "With high oil prices driving new development projects, capacity constraints continue to support increases in the cost of equipment and services."

Deeper water projects have experienced the largest cost increases, according to the UCCI data, rising 15% in the recent six month period, primarily due to drill rig rates, technology limits and skills requirements, and are expected to continue to rise due to tight industry capacity. Onshore facilities, including LNG, have seen the slowest rates of increase, 12%, but are still only slightly behind the overall averages.

"Higher costs, combined with the recent drop in gas prices, have made some projects uneconomical and triggered a re-evaluation of plans." Ward said.  This has produced a slight relaxation of tight support service or commodity markets, particularly in the U.S. And most noticeablly for natural gas projects, where development costs have remained high.  However, the slight additional capacity made available was rapidly mopped-up by other geographical areas where these resources were required."

Cost Drivers

Of the nine primary drivers of project capital development costs, steel is the only segment to decline over the past 12 months, primarily because steel prices began accelerating globally prior to the recent increase in oil prices and demand.  Most of the others – except equipment and bulk materials – are specifically focused on the oil and gas business and are at near maximum capacity.

• Steel – With oil industry steel less than 2% of total steel production and special mill runs required for oil industry grade steels, the industry faces premium pricing and constrained capacity.
• Offshore rigs – A rush by drilling contractors to expand their fleets has produced plans for construction of over 100 new rigs over the next four years.  If demand stays high, the majority of these rigs will come to market and some additional rigs may begin construction.  This should ease rates, but not until mid-to-late 2009.  Because drilling accounts for 40% to 50% of development costs, a 25% rise in the rig rate can produce a 10% or larger increase in total project cost.
• Equipment – The market for long lead time oil and gas equipment – such as generators, compressors, vessels, towers and exchangers – is very tight with extended delivery times and premium pricing.  CERA and IHS estimate current capacity at 185,000 tons/year and have not observed moves by vendors to extend their facilities.  Quality control requirements and local content rules also constrain the supply market.
• Yards & fabrication – In competition with the currently booming general ship building segment, specialized, one-off oil and gas fabrication encounters premium pricing.  Yards are currently at capacity and, even with an expected 15% expansion by 2012, utilization will remain high, as will demand for gas carriers, especially LNG tankers.
• Offshore installation vessels – Plans announced by pipeline installation companies to expand capacity of the current 56-vessel fleet by 8%, or 3 new vessels, is insufficient to meet short-term demand.  The world’s fleet of 26 heavy lift crane vessels is projected to expand by one in 2009, increasing total lift capacity by about 15%.  If demand for installation projects should soften due to a decline in oil prices, previously delayed decommissioning projects are likely to claim the available capacity, but at reduced rates.
• Design & project management – Although vigorous efforts to attract new talent and to open design centers in Asia and the Middle East have brought a potentially large number of personnel into the detailed design arena, at least five years time will be required for the new entrants' experience to reach the level required for lead engineering and project management tasks.  IHS and CERA expect design and project management costs to continue to escalate until then, with additional premium pay required for specialists in deep water, subsea and project management.

"What this analysis tells us is that capacity is tight in all markets," Ward noted.  “The question is, where are the expansions and capacity additions? The answer is that in many markets they are underway. However, much of this requires significant investment and many years to bring on line, in addition to confidence in strong demand. While oil prices stay above $55/bbl CERA expects that confidence to remain. Should prices slip below $50/bbl, the industry should expect some expansion projects to be cancelled or delayed." he said.

"The oil and gas business is at a crossroads. Costs for multiple components of major projects have escalated dramatically in the last three years. An all-in measure of project costs, the UCCI is up 53% since the end of 2004. While commodity prices are still strong, and are expected to continue to be strong in the near future, this rise in costs is causing firms to re-evaluate the economics and viability of many important initiatives. CERA's analysis indicates that for the remainder of 2007 costs should continue to escalate, but perhaps not as rapidly as in previous years, a situation we shall continue to monitor for change," Ward concluded.

IHS (NYSE: IHS) is one of the leading global providers of critical technical information, decision-support tools and related services to customers in a number of industries including energy, defense, aerospace, construction, electronics, and automotive through two operating segments, Engineering and Energy. IHS serves customers ranging from governments and large multinational corporations to smaller companies and technical professionals in more than 100 countries. IHS employs more than 2,300 people around the world.

Cambridge Energy Research Associates (CERA), an IHS company, is a leading advisor to energy companies, consumers, financial institutions, technology providers, and governments. CERA (www.cera.com) delivers strategic knowledge and independent analysis on energy markets, geopolitics, industry trends, and strategy. CERA is based in Cambridge, Massachusetts, and has offices in Bangkok; Beijing; Calgary; Dubai; Johannesburg; Mexico City; Moscow; Mumbai; Oslo; Paris; Rio de Janeiro; San Francisco; Tokyo; and Washington, DC.