January 30, 2018 / 3:45 PM / 4 months ago

COLUMN-U.S. oil and gas drilling costs rise as rig count climbs: Kemp

(John Kemp is a Reuters market analyst. The views expressed are his own)

* Chartbook: tmsnrt.rs/2DLHaFC

By John Kemp

LONDON, Jan 30 (Reuters) - U.S. shale producers are facing rising costs for everything from drilling rigs to pressure pumping equipment and labour as the cyclical expansion in oil prices and drilling matures.

The cost of drilling oil and gas wells has increased significantly over the last year, according to the latest provisional estimates from the U.S. Bureau of Labor Statistics.

Drilling costs have increased by more than 10 percent since hitting a cyclical low in November 2016, though they are still 27 percent below the cyclical peak set in March 2014.

Changes in drilling costs tend to follow changes in the number of rigs employed with a lag of around 1-2 months.

The oil rig count itself tends to follow changes in the price of benchmark U.S. crude futures (WTI) with a lag of 4 months (tmsnrt.rs/2DLHaFC).

In the current slump, however, drilling costs have recovered more slowly than normal as the market has absorbed a huge number of idled rigs.

U.S. crude prices hit a cyclical low in February 2016, the rig count reached its nadir in May 2016, and drilling costs fell to their lowest point in November 2016.

Since then, drilling costs have been on a gradual upswing as the number of rigs drilling for oil and gas has more than doubled from 404 in May 2016 to 947 in January 2018.

The number of active rigs is still less than half its peak before the oil prices started slumping in the second half of 2014.

But the rig market is tighter than it appears because many older rigs have been scrapped, cannibalised for spare parts, or are simply unsuitable for drilling the very long wells now favoured by shale producers.

Producers increasingly favour new high-powered horizontal rigs that can drill ultra-long laterals as quickly as possible, so many of the older, lower-powered vertical or directional rigs are of marginal value.

In other parts of the service sector, especially pressure pumping, shortages of equipment and trained crews are even more acute, and prices have been rising even faster.

During the depths of the downturn in 2015 and 2016, many service companies offered deeply discounted fixed-price contracts for 2016 and 2017 to win business.

But as those contracts expire, service companies have been pressing for price increases, and increasingly obtaining them.

Drilling costs have risen over the last 12 months at the fastest rate in almost four years and at rates comparable to the boom between 2011 and 2014, albeit from a depressed base.

Costs in the oil and gas industry have always been strongly pro-cyclical, which is why it makes no sense to talk about a long-run static breakeven price.

During the slump, supposed breakeven prices tumbled as the costs for everything from labour, raw materials, royalties and service contracts were slashed.

In the recovery, however, breakevens are rising as all these cost trends go into reverse, which is in turn offering some underpinning to oil prices at a higher level.

Costs tend to follow oil prices with a lag, especially after a slump, and the relationship is non-linear, so an initial pick up in drilling activity may not have much effect but the impact accelerates as the recovery matures.

If oil consumption continues to rise, while OPEC and its allies maintain their output restraint, and oil prices climb, as expected by many analysts, costs are likely to accelerate.

The continued rise in oil prices and shale production over the next year should spur a further increase in drilling and other service costs in 2018 and 2019.

Cost inflation will in turn dampen the supply response to higher prices and intensify upward pressure on prices during the second half of the oil-price cycle’s expansion phase.

Related columns:

“U.S. drilling costs start to rise as rig count climbs”, Reuters, July 14

“Drilling costs rise as U.S. oil, gas activity picks up”, Reuters, April 26

Editing by David Evans

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