Oil price crash to make widespread impact on upstream costs in 2015

The global plunge in crude prices is having broad repercussions throughout the upstream energy supply chain, with the labor, project management, oil rig, subsea and steel segments all expected to experience cost declines in 2015 and 2016.

In the latest of a series of webcasts entitled "Oil: The Great Deflation," a team of IHS experts this week delivered a presentation called "Changing Costs: Creating the Lower Cost Environment." The upstream market consists of companies and activities involved in oil exploration and production.

Candida Scott, senior director of the upstream research practice at IHS, outlined the impact of the price situation on the upstream segments of the oil market. Scott outlined two scenarios for the duration and severity of the price downturn and projected the impact on various upstream segments in 2015 and 2016.

In the first scenario, predicting a short and sharp decline, the oil price will average $47 per barrel in 2015 and recover to $65 in 2016. In the case of the second scenario, foreseeing a longer downturn, pricing will average only $42 in 2015 and stage a weaker recovery to $59 in 2016.

IHS monitors costs across the upstream oil sector through its Upstream Capital Cost Index (UCCI), which tracks an extensive portfolio of global upstream assets on a quarterly basis. In the event the first scenario occurs, IHS expects the UCCI to decline by 11 percent from current levels. If the second scenario transpires, the UCCI will decrease by 15 percent.

Oil price declines primarily impact upstream activity, as the downstream industries benefit from lower feedstock prices and sustained demand.

The current oil downturn is drawing comparisons with the last downturn in 2008. However, there are significant differences between the two market situations that will have implications for the performance of the upstream oil segments.

One major difference is that the current price plunge already appears to be of greater magnitude than in 2008, when there was a rapid and sharp decline in oil prices. The drop in 2015 is set to last longer and drive greater price declines.

In another distinction, the drop of 2008 was accompanied by a severe recession, negatively impacting the steel and labor markets. In 2015, these segments will be sustained by industrial demand from non-oil segments.

Finally, oil rigs were in tight supply in 2008. Today, there are new rigs both offshore and onshore already seeking contracts, and this is weakening daily rig rates.

In response to the price decline of 2015, most oil companies will pause on making investments in selected new projects. The oil equipment market is likely to cut staff. Steel suppliers are unable to cut prices without incurring losses, that would spur a wave of rationalization in the market.

Learn more about IHS cost-related consulting services.

The next presentation in The Great Deflation Framework Series will be entitled "M&A Onshore North America: Nowhere to run?"

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.