The Guardian (UK): Efforts to boost crude output hit by soaring costs: “The situation is particularly acute for Shell, whose 2004 annus horribilis of reserve downgrades has left it under extra pressure to rebuild its asset base quickly.”: Thursday September 22, 2005

Shortages of equipment and skilled staff have added to years of underinvestment

Terry Macalister

A severe shortage of rigs, vessels and people threatens to drive up further the price of oil and is making it harder for producers to secure the future supplies needed to meet soaring energy demand.

Costs across the industry have risen sharply as oil companies compete with each other to grab every available piece of equipment to keep future drilling programmes on track. Rig hire rates have more than trebled.

Oil producers are suffering from the knock-on effect of spending cuts made after the crude price collapse of 1998, which forced some rig operators and other service firms out of business. Fearing the crude price could drop further, BP, Exxon and others had, until recently, been slow to raise their capital expenditure and instead spent billions on share buybacks for investors.

But with crude hovering at $70 a barrel they have opened their purses again only to find service firms charging ever higher prices or not being able to provide equipment and staff at all. The situation is particularly acute for Shell, whose 2004 annus horribilis of reserve downgrades has left it under extra pressure to rebuild its asset base quickly.

Rig brokers report that the Anglo-Dutch oil major is close to beating off competition and signing a deal to charter the Deepwater Pathfinder drillship for work off Nigeria at more than $400,000 (£235,000) a day. Yet the vessel - controlled by Transocean - is currently hired by an oil consortium for $190,000 a day. Similarly escalating rig rates are seen in the North Sea.

Total of France has just paid up to $200,000 for the future use of the Sedco 714 semi-submersible drilling unit, which is currently chartered by Talisman Energy for $45,000 a day.

Paladin Resources, a leading British exploration and production firm, said yesterday that it had been forced to pay $175,000 for a drilling unit that cost just $55,000 two years ago. "Rig rates have gone through the roof but there is also a shortage of diving support vessels and pipelaying vessels. But it's not so much higher prices that worries me as contractors running close to capacity," said Roy Franklin, chief executive of Paladin, as he reported a doubling of interim pre-tax profits to £101.6m.

Rod Hutton, senior rig editor at the industry-watcher ODS Petrodata in Aberdeen, said record rates of up to $500,000 a day were being paid by some oil firms in need of very big deepwater units. And it may not end there. "We have never seen anything like this before but I think there is a possibility they could go even higher," he argues.

It is not just the cost of drilling rigs that is rising. Anchor-handling tugs, the vessels that pull the giant structures to new locations, are also becoming vastly more expensive for oil companies. The spot price for an anchor handler last summer was £8,000 a day but now it is more than three times that amount. A few months ago the spot price even reached £35,000 as oil firms scrambled against a backdrop of supply shortages to secure what they needed.

As the UK Offshore Operators Association (UKOOA) confirmed, it is the same story across the sector: from helicopters needed to ferry crews to platforms in the North Sea to the cost of the employees themselves. Mike Tholen, economics director at UKOOA, said: "When the Rover [car plant] shut in the spring, there were stories of offshore companies going down there to try to recruit skilled workers because there is a major skills shortage."

UKOOA, which represents North Sea operators including BP and Shell, says that in just over a year the cost of exploring for, developing and operating wells has risen from about $10-$15 a barrel to more than $20 in some cases. "Oil companies are sucking their teeth at the current level of prices, which they would not have countenanced paying a few years back, but they are even more worried by fears of not getting hold of a drilling rig they need," Mr Tholen said.

Chris Lloyd, of Asco Europe, which manages the movement of materials to the offshore sector, said: "We have seen an increase in poaching and a particular shortage of highly skilled staff, which has led to some individual cases of people being offered wage increases of 60% to 70%," he said.

Rising costs are bad news for oil firms, and ultimately consumers, but it has increased investor interest in the often-neglected service sector. The Aberdeen-based Wood Group has seen its share price nearly double from 115p in August last year to about 210p now. Last week it reported that first-half profits before tax rose 212% to $56.2m, compared with $18m last year, although this latter figure included restructuring costs.

Petrofac, another privately owned oil and gas services firm, unveiled plans this month to float on the London stock market. It expects to value the company at £550m, bringing a £60m windfall to the chief executive, Ayman Asfari, and rewards for the venture capital group 3i, which has a 16% stake. The Jersey-registered group, which employs 3,300 in Aberdeen and some 2,000 around the world, says it wants the new cash to help it expand at a time of growing demand.

But the cost increases are worrying equity analysts such as Bruce Evers at Investec Securities, who recently expressed concern at the "soaring" costs facing companies such as Shell as it tries to rebuild its reserves base. The Anglo-Dutch firm had to admit recently that the cost of developing the Sakhalin field in eastern Russia had doubled from $10bn to $20bn. The firm blamed the rising cost of raw materials, a shortage of contractors, Russian inflation and currency rate fluctuations. Peter Voser, Shell's finance director, said some problems were the inevitable result of operating in increasingly hostile terrain but warned: "We expect cost pressures facing the industry to continue."

The industry is also having to face up to more volatile weather conditions with Hurricane Katrina sweeping away 40 oil platforms in the Gulf of Mexico, fracturing pipelines and knocking out refineries. This could bring a swath of new work to oil and gas construction and service firms such as Amec, which will only increase the pressure on equipment availability in the market.

Fadel Gheit, of Oppenheimer & Co brokers in New York, said: "I estimate that it is costing 20% more to operate a well globally than it did a year ago. There are rising costs for pretty much everything you need ... Supply firms have got the oil industry by the balls." 

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