Oil chiefs to suppliers: Your prices are too high

HOUSTON — A rising cost-control cry among oil executives has plenty of basis in the economics of the oil patch, but also may be an open message to suppliers that if prices don’t come down, their business will.

The calls for restraint aren’t entirely new, but they resonate as the U.S. industry enjoys a domestic energy boom that has redefined an entire sector of the economy and helped further solidify Houston as the world’s energy capital.

Chevron Corp. CEO John Watson proclaimed at the IHS CERAWeek summit in Houston last week that “$100 a barrel is becoming the new $20.”

His point was that even though the price of domestic oil is relatively high, it costs energy companies so much to extract it that the domestic energy boom is not generating returns on investment producers want to see.

While companies historically have used the annual  CERA­Week conference to announce or highlight big, costly projects, the overriding theme from industry titans this year was the need for restraint.

Executives portrayed their industry as marred by runaway costs that threaten the viability of some of the world’s biggest energy companies.

“We cannot continue to swallow this huge inflation,” said Christophe de Margerie, CEO of Paris-based Total. Lars Christian Bacher, executive vice president for development and production at Norwegian energy company Statoil, put it in existential terms. “The capital intensity of this industry is heading in a direction that’s not sustainable,” he said.

Indeed, over the last decade, global oil companies have increased capital spending more than 400 percent; production is up just 2 percent in that time, Bacher told the audience. Changing that equation, he said, “is a question of whether we will survive or not in the long-term.”

Urgent tone

Certainly the industry has wrung its hands about costs before. But several observers say today the tone is more intense and, notably, coming from the sector’s highest-ranking executives.

“I don’t think I anticipated just how much cost was on people’s minds,” said David Vaucher, a director with IHS, the research firm that hosted the conference. “There’s this idea of an oil industry in transition, from really boom times to a more sustainable pace. The feeling I’m picking up is companies are being more cautious.”

Vaucher pointed to IHS data showing that, since 2000, the industry’s upstream operating costs — dollars spent finding oil and gas and bringing it to the surface — have nearly doubled, and its capital costs have increased more than 130 percent.

Factors pushing costs up include taxes, increasingly expensive raw materials and climbing costs of recruiting and retaining top talent.

But the biggest driver is the push to produce oil from the most challenging and remote places on the planet, from the densest rocks and the deepest oceans. The work requires cutting-edge technology that comes at a hefty price.

Costly in U.S.

The industry’s move to contain costs is especially pressing at home, where domestic unconventional production is particularly expensive. While upstream costs have started to flatten out globally — increasing just 5 percent over the last three years, according to IHS — they’ve soared 48 percent during the same time period in North American unconventional plays.

That rate seems to have plateaued for now, said Pritesh Patel, director of research at IHS, with domestic well counts dropping and gas drilling slowing. But those costs could creep up again, especially if production expands in Mexico as it opens its oil sector to private investment for the first time in decades.

Part of the reason production costs have been high is that oil field services companies that perform the nuts and bolts work of drilling have used the domestic energy boom as “an opportunity to test the ceiling,” Vaucher said. Though that may frustrate the producers that hire them, the market is working as it should, Vaucher said.

Sending signals?

Some suggested producers’ comments about out-of-control costs weren’t just moments of introspection; they were calculated signals to services companies that they want a break on price and are willing to slow down or even delay major projects to get it.

“I don’t necessarily view the production costs as being all that high relative to where crude prices are today,” said Anthony Scott, an analyst with Bentek Energy, who agreed that much of the talk seemed to be a warning shot at servicers.

“Producers always like to say their costs are really high when people are talking about falling prices,” Scott said about oil. “If costs were really high, you wouldn’t keep throwing rigs at the activity.”

Far from losing money

Even in expensive unconventional plays like the Eagle Ford in South Texas and the Bakken in North Dakota and Montana, producers are nowhere near the point of losing money on their activities, even if crude fell considerably below its current price. U.S. benchmark ended Friday trading up $1.02 at $102.58 a barrel. The last time domestic crude was $20 — the level Chevron’s CEO used in his attention-getting quote — was 2002.

Phani Gadde, a senior analyst for North American upstream with Wood Mackenzie, said that much of the work in those types of unconventional plays would survive even if crude fell to $70 or $80, and that some working those plays would survive prices as low as  $40 or $50. Other analysts and academics provided similar estimates, suggesting a little hyperbole in the executives’ remarks.

Pulling back

That’s not to say their comments are just  rhetoric  — oil companies are pulling the reins in on frenetic activity in North America — but that’s not necessarily a bad thing, said Bill Gilmer, director of the Institute for Regional Forecasting at the University of Houston, which studies the industry’s impact on the city’s economy.

From 2002 to 2012, the industry averaged about 20 percent annual increase in expenditures on exploration and production, Gilmer said. That figure has tapered off, largely because of a drop in natural gas prices that prompted a pullback in drilling.

The result for the local economy has been a slowdown in hiring for those working in the business’s upstream side. As recently as late 2011, that sector was experiencing around 15 percent annual job growth; today it’s closer to 5 percent, he said.

But the spending slowdown outlined by industry executives shouldn’t worry Houstonians, Gilmer said, arguing that it’s part of a natural cycle.

“You just don’t get to grow at 20 percent forever,” he said, noting that the industry’s profit margins are still robust.

Not a surprise

David McColl, senior equity analyst at Morningstar, said that the executives seemed to be sending a message to investors, who have had growing concerns about costs.

“They’re definitely telling investors what they want to hear,” he said.

McColl said rising costs didn’t come as a surprise to the industry, as producers compete for the best rigs, facilities, and personnel — often in places that lack infrastructure and workforce to begin with. But now, he said, they’re in a period where they’re focusing more on containing costs rather than being the first to drill.

While they may scrap marginal projects, the core of what they do won’t be affected. “The sky hasn’t fallen yet,” McColl said.