Writer’s prologue: I live on an acreage west of Calgary that sits above the Lochend Cardium light tight oil play. This zone has seen considerable exploitation in recent years. A second well was recently drilled close to my house, adjacent to one drilled three years ago. The leases are visible from my front step and I can hear the diesels. I pass the roadside locations daily and always check what’s going on. Rigging up for the big frack took days. But when all those diesels sat quiet for extended periods my conclusion was the completion wasn’t proceeding quickly resulting in downtime with equipment and personnel on standby and the meter running. The first well quit producing after only two years because it was apparently drilled wrong. The operator couldn’t case the full length of the horizontal section leaving only a portion of the reservoir exploited. Not once in two years with the well on pump did I see a tank truck hauling away oil. I doubt this well ever recovered total cost. Vendor price reductions extracted by oil companies can quickly evaporate when mistakes are made such as standby charges for a completion with operational delays or poor wellbore construction. This is not uncommon.
One major challenge the oil industry must resolve to survive and prosper in a lower commodity price environment is accepting the total cost of the next replacement barrel (or barrel of oil equivalent) should not be determined exclusively by the total sum of the invoices submitted by oilfield service (OFS) vendors. OFS cannot work at prices low enough to keep the entire exploration and production (E&P) industry in business.
Not everyone is going to survive the current low price environment, a massive and probably overdue correction after years of high oil prices that covered a lot of mistakes. Finding and development (F&D) costs must come down but the solution lies in the way the upstream petroleum industry does business, not just prices for goods and services.
Since oil prices started falling late last year, oil companies have demanded and received significant price discounts from all suppliers. But it’s more complicated than that. Consultancy Wood Mackenzie studied this subject and concluded that extracting lower prices from vendors does not always result in commensurate reductions in total costs. The firm noted while oil companies are targeting 20 to 30 percent reductions in direct vendor costs, on average the total cost saving will only be half that, 10 to 15 percent.
A September 21 Daily Oil Bulletin article read, “…operators will also need to focus on project optimization and adopt smarter ways of working with the service sector….Illustrating the needs to reduce costs in the industry, Wood Mackenzie’s analysis estimates that $1.5 trillion of uncommitted spending on new conventional projects and North American unconventional oil is uneconomic at $50 a barrel”.
This makes it imperative that OFS and its customers figure out how to make this work or everybody will be going out of business.
James Webb, research manager for Wood Mackenzie, said, “Additional measures are needed to manage costs – reworking field development plans, optimizing project design and more innovative approaches to projects will all play important parts. A prolonged period of low prices over a number of years is likely needed to bring about profound, structural changes to industry costs”.
What does this mean? Clients should consult with and cooperate more with their vendors to create win/win scenarios. Or at least survive/survive scenarios. One significant example of cost-saving measures gone wrong is Esso/Exxon-Mobil’s Kearl oil sands project north of Fort McMurray. The operator figured an effective way to cap costs was to build processing modules in South Korea then ship them by truck to Kearl from a port in Lewiston, Idaho. However, faced with stiff local opposition to having loads of this size shipped on narrow highways, Imperial was forced to disassemble them into smaller pieces, ship them to Fort McMurray, and then reassemble them on site. Related: Shell’s Loss Is Eni’s Gain
While Imperial has never disclosed exactly what this logistical planning error cost, it was surely expensive. According to the Financial Post on February 1, 2013, Kearl was originally planned to cost $7.9 billion in 2009, a figure that was raised to $10.9 billion after design and scope changes. In the end, the final figure was $12.9 billion with the module transportation boondoggle a major contributor.
This cost overrun was in no way related to vendor input expenses from manufacturers, transportation contractors or the people and companies (crews, cranes, camps) waiting at Kearl for the plant components to arrive for assembly. The one thing Esso/Exxon-Mobil is famous for is engineering and logistics for major capital projects. These are the folks who invented horizontal drilling in Canada and built islands in the middle of the Mackenzie River to fully exploit the Norman Wells oilfield.
The Kearl story and the prologue are three examples of how lower OFS prices alone do not always reward E&Ps with lower F&D costs. Teamwork is essential to putting future production on stream at the lowest possible cost. Continued global crude oversupply has proven E&Ps are prepared to produce and sell existing barrels at the market price to keep the lights on. But if they don’t eventually replace these reserves they are effectively going out of business. Just a matter of time. If OFS loses too many clients or investments because F&D costs are too high to replace reserves, the service sector will also fail. So E&P and OFS are in the same sinking boat. Either collaborate to develop effective cost-saving solutions or disappear.
Historically, E&Ps and OFS have had a master/slave relationship in which the clients say “jump” and the vendors say “how high?” It is common knowledge oil companies (just ask them) are staffed by engineering and logistical experts who know exactly what they need and when they need it. OFS merely quotes a price and delivers the goods. But independent studies and practical experience have repeatedly demonstrated vendors often have much more expertise in their specific product and service lines than their clients and, as importantly, know more about best operating practices than some of their customers because they work for everybody.
But OFS has learned over the years not to offer too much advice unless asked. Telling the client how to do his job has historically not been good for business. Related: Clinton A Continuation Of Obama On Energy
There are many examples of how paying more can yield more. Drilling is a perfect example. The day rates for modern, high performance “walking rigs” are much higher. But the total drilling time is greatly reduced, saving the client a bundle. A big frack in which logistics are expertly coordinated with no operational downtime costs significantly less. If the job goes well, the savings created by reduced total time on location can be much greater than the perceived lower price of all the vendors working at or near cost.
Service companies have shaken their heads for years as clients drill wellbores at the lowest possible cost, which end up difficult to complete and even more difficult to produce and service. Too many oil companies compartmentalize drilling, completion and production departments with no management oversight to ensure every wellbore delivers the most barrels at the lowest unit cost over the life of the asset. The lowest possible component cost does not always yield a higher full cycle return on capital.
Fortunately, the hunt for lower F&D costs is underway and E&Ps are, out of necessity, examining their own operations. Clients have realized OFS has been ground down to the breaking point and now it is up to project managers to examine their own processes to extract greater efficiencies.
The Daily Oil Bulletin reported September 16 Suncor Energy Inc.’s CEO told a Peters & Co. Limited investment conference in Toronto part of its strategy was to use the most localized workforce possible and reduce the number of fly-in/fly-out workers. This is really expensive. Besides wages, oil sands developers have paid to fly workers to and from home every two weeks from as far away as Atlantic Canada, the most expensive plane ticket in the country from Fort McMurray. Hiring workers who live closer cuts costs, as does watching overtime and lowering non-salary incentives (hiring bonuses, retention payments).
For its vendors, besides seeking lower prices Suncor is also looking at single-source procurement. This has been proven to be more cost-effective for producers than using multiple vendors by cutting paperwork and administration. It is also more profitable for vendors because they can secure revenue certainly and spend less time and money looking for more work. (The drawback for OFS is clients want to hire fewer, larger vendors which puts pressure on smaller operators).
Cenovus Energy Inc. told the same conference it was looking at redesigning its Steam Assisted Gravity Drainage (SAGD) well pad modules to use 30 to 40 percent less steel and accessories. These are all above-ground facility design and investment changes intended to achieve the same production at a lower capital cost. Husky Energy Inc. reported switching to “walking rigs” to drill its well pads resulted in wellheads being closer together which reduced the costs for the plumbing and equipment to tie them all together.
The design of SAGD and other surface components is one area receiving extensive attention. Today each company and project has its own specifications for equipment. Vendors are pointing out how offshore production platforms were made more economic by standardizing designs for certain components creating economies of scale by manufacturers. Isn’t there one design for these systems that would work for everybody? Other manufacturing industries have developed tremendous economies of scale out of economic necessity. Does every piece of equipment from a drilling rig to a frac pumper to a steam generator to a production separator have to be custom designed and custom built, regardless of the extra cost? Related: Africa Banking On Nuclear Power
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With OFS working almost at cost, E&Ps are looking at their own fixed costs to become more competitive. Canadian Natural Resources Limited recently announced it was cutting all head office salaries by 10 percent across the board to reduce expenses but preserve it management and administrative team. Cenovus Energy Inc. announced it would be eliminating another 540 jobs taking its total staff count to 3,900 at the end of 2015 from about 5,200 at the end of 2014. Other E&Ps announcing more staff reductions are ConocoPhillips Canada, PennWest Petroleum, Baytex Energy and Pengrowth Energy.
Retooling the Canadian oil industry to be competitive at lower prices is much more complicated than sifting through stacks of quotes to save a few bucks on each and every input cost from lease construction to a rental wellsite trailer.
E&P managers must reclaim the future of the company from the purchasing department and start sitting down with major vendors to find common ground and search for total project operational efficiencies. Doing business the same way as in the past with a growing number of struggling or insolvent suppliers will not unlock lower reserve replacement costs.
OFS must educate itself as to what its clients are trying to accomplish and start bringing forward solutions to save their customers money. Owners and managers must understand it is imperative they help their customers stay in business by figuring out how to help clients replace reserves economically at market commodity prices. It’s not war but survival.
The adversarial love/hate relationship between oil companies and their suppliers is broken. Success will follow if we fix it.
By David Yager for Oilprice.com
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