WoodMac: Return of cyclical inflation could see deepwater cost reduction come to a close

Impending cyclical cost inflation could raise break-even costs in an otherwise healthy deepwater industry, energy analytics company Wood Mackenzie said in its latest report.

In a report published on Tuesday, WoodMac said that the deepwater industry appears in good health, following a sustained cost reduction through the downturn.

However this hard work, according to the company, is in danger of being undone, as impending cyclical cost inflation could raise break-even costs once again.

WoodMac’s data indicates that the cost of developing new deepwater barrels has fallen over 50% since 2013.

The most important steps deepwater operators have taken to achieve lower costs, and therefore better returns, include downsizing projects, a greater focus on subsea tiebacks and brownfield developments over greenfield, reduced project lead times, reduced well counts, and more phasing of larger developments.

Other steps include faster well completions, better project execution, and lower rig/service sector costs.

The most competitive region is the Americas and in particular Brazil, Guyana, and the Gulf of Mexico, where over 50 billion boe of pre- and post-sanction deepwater developments are now profitable under an oil price of $60/bbl, based on break-even costs.

Angus Rodger, research director at WoodMac, said: “One of the key drivers in cost reduction in deepwater projects is lower rig costs, which is a cyclical factor.

“But more importantly, there have also been big structural changes, such as the faster drilling of wells. For example, in the US Gulf of Mexico, it now takes half the time to drill a deepwater well compared to 2014.”

Also, better project execution reduced overspend and improved returns. The average deepwater project sanctioned between 2014 and 2016 has started-up around 5% under budget, compared to projects from 2006 to 2013 when cost overruns between 10 and 15% were the norm.

WoodMac added that, encouraged by this progress and the growing importance of deepwater projects for future growth, the industry was increasing investment in the sector. Total annual deepwater capital expenditure is expected to rise from around $50 billion currently to nearly $60 billion by 2022. The company predicts that the rise will be driven by big projects in Guyana, Brazil, and Mozambique.

But the increase in spend and activities will accelerate a return to cyclical cost inflation in the offshore sector. With total deepwater rig capacity expected to fall over the next few years – as older, less efficient units are scrapped – rig day rates could double by the early 2020s.

“The return of cyclical inflation could see this epic period of deepwater cost reduction come to a close. The question now is how much of the ‘structural’ cost savings we have seen through the downturn will prove sustainable through the investment cycle, and which are just short-term company adaptions,” added Rodger.