Significant progress in cost reduction in the oil and gas sector is likely to bottom out this year. The latest Supermajors Cost Index – Has cost efficiency peaked?, available from Apex Consulting, determines the oil and gas industry’s efficiency in developing its reserves by analysing the performance of the seven supermajors: BP, Chevron, ConocoPhillips, Eni, ExxonMobil, Total and Shell, setting an important cost benchmark for the industry as a whole.
Changes in this Index provide crucial information about the underlying cost pressure that these firms, and by extension the industry as a whole, face. A rising Index in this case typically signals increasing cost pressure across the industry and can be used to prompt industry-wide actions to prevent a recurrence of runaway cost escalations seen in the past. On the other hand, a falling Index indicates an easing of cost pressure and is a measure of how successful the industry has been in bringing costs down to a more sustainable level.
This first of a three-part series outlines the historical context for the latest Supermajors Cost Index.
The oil and gas industry has experienced some dramatic changes over the last couple of years. Prices collapsed to around $26/bbl in early 2016 as the market became increasingly gloomy about persistent excess supply in the global oil markets and OPEC’s ability to reach an agreement among its members to address this worldwide glut.
But bearish sentiments gave way to optimism as robust global economic growth led to higher-than-initially-anticipated demand for oil. This, together with the historic OPEC and Non-OPEC alliance to address the oil inventory overhang, resulted in a strong price recovery. As a result, prices more than doubled from their nadir in the first quarter to over $52/bbl by the end of the fourth quarter of 2016.
Other than occasional fluctuations, prices continued to move upwards throughout 2017 and 2018 as inventories fell sharply. By the end of April 2018, OECD commercial stocks dropped from 292 million barrels  above the 5-year average a year ago to 27 million barrels  below the 5-year average.
Strong, synchronised growth across the major economies, and record-high compliance with the production cuts agreed by OPEC and Non-OPEC members, were mainly responsible for this reduction in stocks of approximately 319 million barrels.
Higher oil prices also helped oil and gas operators to rebuild their financial health. The combination of rising oil prices, stronger balance sheets and an industry still experiencing significant cost deflation created a “sweet spot” in which oil executives felt confident enough to start investing in new projects.
As optimism gradually returned to the market and capital spending picked up after years of deep cuts, many industry players and observers became concerned about the sustainability of the cost reductions achieved during the downturn. Citing recent cost inflation in the US shale region as an example, some argued that the industry was moving back to a high cost environment as a wave of new projects reached Final Investment Decision (FID) in 2017.
Given that the number of new projects, including large-scale LNG projects, reaching FID in the coming years is expected to remain high by recent historical standards it is instructive to analyse the industry’s latest performance in developing its reserves. We have therefore updated our proprietary Supermajors Cost Index to determine how the industry has performed over recent years, and also investigated the performance of the industry’s “trendsetters”, the seven supermajors, in this context.
Industry trend since 2014
Global growth remained sluggish between 2014 and 2016 due to subdued economic activity in the advanced economies as well as in the EMDE (emerging markets and developing economies) regions. This period of weak global growth took place against the backdrop of weakening long-term demand for fossil fuel brought on by a continued increase in energy efficiency and energy productivity, a growth in renewables, and the rise of electric vehicles.
While oil demand prospects remained weak, supply continued to increase throughout this period, led by US shale production. In 2014, growth in US shale oil production alone outstripped the rise in global oil demand . The resulting oversupply triggered an almost 18-month long decline in oil prices.
Prior to its collapse in mid-2014, price growth had slowed significantly in response to weak projections of long-term oil demand . This, together with the staggering rise in the cost of developing assets, brought cost reduction back into the spotlight. As a result, by the end of 2013, several projects were delayed or cancelled, and many companies had cut their capital investment budget for 2014.
The combination of project cancellations and a slowdown in upstream investment eased the pressure on the supply chain which had previously caused service and supply costs to escalate. As a result, service sector cost started to soften as early as 2014.
This trend of project cancellation and cuts in investment accelerated sharply as prices more than halved over the next couple of years . As the industry’s attention shifted back firmly to value instead of volume, companies decided to high-grade their portfolios and focus investment activities on their most productive low-cost basins. In addition, operators took a number of steps to reduce the costs of developing assets, as many projects were not commercially viable in this “lower-for-longer” oil price environment.
The service sector also played its part in reducing the cost of new projects. The collapse in upstream investment which began in 2014 resulted in a significant oversupply of equipment, labour and materials across the board. In response to this supply overhang, oil services companies offered deep rate cuts in order to survive and maintain the utilisation of their rigs and equipment. Furthermore, greater collaboration between the operators and service companies improved the industry’s ability to manage complex technical challenges and its overall project execution capability.
At the same time, industry-wide job losses decreased the cost of labour, while lower input costs, such as for steel, reduced the cost of equipment and building appropriate facilities.
The mixture of smaller project footprints, improved efficiency, and lower input and service sector costs raised cost efficiency and capital productivity of the sector significantly. As a result, by 2017, our Supermajors Cost Index had declined by more than 41% compared with the level seen in 2014, when the Index reached its peak.
We estimate that about 35% of this cost reduction took place between 2014 and 2015, which largely reflects the reduction in service sector costs during this period. The remaining 65% took place between 2015 and 2017, reflecting various cost saving measures adopted by the industry, as well as a continued fall in service sector costs.
Despite this impressive reduction, cost was about 16% higher in 2017 than in 2011, when the industry was in the midst of significant cost escalation.
Read part two: Supermajors Cost Index – Leaders and laggards
Read part three: Supermajors Cost Index – Has cost efficiency peaked?
 International Energy Agency (IEA), “Oil Market Report”, 14 June 2017, page 31.
 International Energy Agency (IEA), “Oil Market Report”, 13 June 2018, page 30.
 World Bank; “Global Economic Prospects: Broad-based upturn but for how long?”; January 2018.
 Between 2000 and 2007, average Brent price grew at a compounded annual growth rate of (CAGR) 14.2% whereas it grew at a compounded annual growth rate of 7.0% between 2007 and 2013. [Source: Apex estimates based on U.S. Energy Information Administration (EIA) data.]
 Apex estimates based on U.S. Energy Information Administration (EIA) WTI and Brent price data.
A highly experienced consultant with considerable expertise in project economics, modelling of upstream projects and portfolios, capital raising activities, commercial/contract negotiation strategy, and regulatory compliance, Muktadir Ur Rahman has worked extensively with major oil and gas companies worldwide on a variety of projects, from undertaking independent reviews of economic models and modelling various fiscal regimes to leading investment appraisal, risk and sensitivity exercises to identify commercial value drivers for clients’ commercial teams.