Upward pricing pressures will make cost savings difficult this year

Imaginima

The cost of developing upstream oil and gas assets, as tracked by the IHS Markit Upstream Capital Cost Index (UCCI), increased by more than 7% in the first half of 2022.

Rising costs were fueled by several factors: the conflict between Russia and Ukraine (resulting in higher energy and commodity prices), the resumption of global project activity, rising inflation and supply chain problems supply. Cost savings will be hard to come by this year as every market faces upward price pressure.

All markets tracked by UCCS grew in Q2 2022, with the largest increase coming from the steel market, up more than 21% between Q4 2021 and Q2 2022.

With rising input costs (iron ore, scrap metal, metallurgical coal, pig iron and semi-finished steel) and the unavailability of certain materials, steel prices continue to rise. Oil & Gas Activity and Supply Constraints Maintain Upward Pressure in Line Pipe and OCTG Markets; on average, these markets grew by around 130% in the first half of 2022.

The land rig index rose 5% in the second quarter, driven by increased drilling activity as oil prices climbed above $100/bbl. Drilling contractors have many outstanding contracts and are incentivized to stick to spot rates rather than futures. International demand for super-specification drilling rigs has increased while supply outside of North America remains limited.

Similar to the land rig market, increased activity has put upward pressure on offshore rigs and vessel rates, up 7.5% so far this year. Most of the positive price development in the offshore rig market was driven by jack-up and deepwater rigs which secured new contracts.

Offshore Vessel Daily Rates increased for all fleets in 2022. The biggest increase was in Offshore Support Vessel (OSV) costs, with the overall market index increasing by more than 7% on average. European vessel rates soared with the onset of the busy summer season, particularly in tighter vessel markets, such as AHTS boats and DSVs.

Costs in the Equipment and Bulk Materials markets both increased by around 6%. The equipment market suffered from higher input costs coupled with growing demand due to rising oil prices and increased project activity. Bulk material prices continued to rise in 2022 due to supply chain disruptions, rising input costs and high inflation.

The submarine market and the shipyard market grew by more than 6% in 2022. As with other markets, high inflation and rising commodity prices contributed to the price increase. Inflation and rising input costs are making shipyards more cautious in selecting and pricing bids in the second quarter after a turbulent first quarter.

Rising input costs have also affected old contracts. Many yards are recording losses on almost all lump sum projects (offshore and shipbuilding) that have been booked in the past two years.

Growth in the engineering and project management (EPM) and construction labor indices was modest relative to other indices and partly due to currency effects.

Inflation has been a key driver of construction labor wages, up 4% so far this year, as a tight labor supply leads companies to raise wages to hire more workers. The EPM index rose 3% over the same period as increased outsourcing activity and high inflation pushed the index higher.

IHS Markit forecasts UCCI to rise 10.1% in 2022 as Russia’s war in Ukraine keeps oil and gas prices high and adds to supply chain disruptions. Commodity prices will remain elevated for most of 2022, driving up energy sector building material prices. The global economic recovery is driving new project activity in the hydrocarbon sector as companies attempt to meet growing demand for fossil fuels.

The global upstream operating cost index (UOCI) rose 6.7% in the first half of 2022, driven by rising commodity prices and continued supply and demand disruptions, which affected iron and steel products, equipment and chemicals. Activity, particularly on the US onshore and offshore markets, is picking up thanks to the rise in the price of oil.

The deal market gained 5% in the second quarter of 2022, driven by a 13% rise in the diesel index. The manufacturing chemicals index saw some relief this quarter, rising just 3%.

As oil activity picked up, encouraged by crude oil prices, labor rates edged up 4% in US dollars in the quarter, but rose 1% in local currency due to the sharp depreciation of European currencies.

The maintenance market increased by 3% in the second quarter of 2022 in US dollars. Overall maintenance demand is rebounding, supported by higher oil prices and the easing of COVID-19 restrictions in some regions.

The progression of the FIM index continued in the second quarter of 2022 with a growth of 4%. The index is being pushed higher by almost all input factors, including the rising cost of steel, materials, equipment and labor.

This is combined with an increasing demand for preventive and corrective maintenance. The DSV/ROVSV index rose 2% in the second quarter and the outlook for offshore activity looks encouraging over the last six months.

The logistics market grew by 3% in the second quarter of 2022 and is expected to end the year up 8%. The aircraft index rose 5% as jet fuel prices rose significantly in the second quarter of 2022.

The index for supply services including food service and warehousing rose 2% this quarter due to escalating food and fuel prices. The continued disruption of the global supply chain continues to drive up costs.

The sink market saw a 4% rise in the second quarter of 2022 in US dollar terms, while growing 13% year-over-year. The oil services sector continues to face high input cost inflation.

Despite renegotiated contractual agreements and increased activity, inflationary pressures show no signs of easing. Cost inflation will continue to impact operators, particularly in segments facing rising raw material costs. We expect steel-dependent segments to see relief in late 2022.

UOCI growth is expected to continue throughout the year, with UOCI ending 2022 up 10%. The increase in activity and the cost of raw materials will support the rise in costs.

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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

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