Upstream costs heading steadily upward – Quarterly trends

Q2 marks increase in Upstream Oil & Gas costs after 2 years of deflation

After two years of deflation, upstream costs turned upwards in the second quarter of 2016 on higher material prices, most notably in higher steel prices. IHS Energy's MSS Offshore and Onshore Indices* went up 7% and 6% quarter-on-quarter, but are still down 6% and 4% year-on-year, respectively.

*MSS Offshore and Onshore Indices reflect the cost development of contractors' input factors such as raw materials, labour, prefabricated bulks, equipment and other upstream oil and gas costs; they are adjusted for changes in the margin that contractors charge on top of their underlying costs. The indexes are updated quarterly by the IHS Upstream team monitoring oil and gas technology costs.

Although the upturn in material prices is assumed to be a short-term spike, with downward corrections expected in the second half of this year, underlying inflation has moved into positive territory. Annual cost increases are expected from 2017 onwards based on both industry recovery and stronger fundamentals in the global economy, pushing material and labor costs upwards.

Costs within the oil industry have been in decline since 2014, in parallel with the drop in crude oil prices.

• Reduced activity from oil and gas e&p projects has reduced demand and pressed contractors' bargaining powers and margins to historical lows.
• In the offshore vessel markets, day rates have been under pressure from a growing fleet since 2012-13.
• The broad appreciation of the US dollar has pulled down the cost of materials and labor denoted in non-USD currencies.
• Metal prices have been retreating since 2012, reducing material costs.

Costs will rise slowly going forward, but not reach previous historical peaks within our forecast period ending 2020.

• Activity will pick up, but it will take more than demand growth to balance the market.
• Oversupply will still create downward pressure on prices. E.g. there may still be too many offshore vessels, which weigh on day rates
• Material costs will remain stable, due to ample production capacity.
• Cost increases over the next four years will therefore primarily be driven by salaries, which will grow partly due to higher underlying salary growth and partly due to a broad depreciation of the US dollar.

IHS Energy's Upstream Industry Trends report is updated twice a year and tracks oil and gas industry trends for upstream oilfield services and equipment companies and their operator clients.

To learn more about how you can expertly forecast upstream oil and gas spending or understand oil and gas trends, download an excerpt of a report or purchase a one-off upstream cost & technology report immediately from the IHS Markit Online Store.

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.