Welcome to our April edition of the Supply Chain Insights

High inflation levels look set to continue as industries and countries grapple with soaring energy prices, the fallout from Russia’s war with Ukraine, and continued Covid-19-related lockdowns in some key economies. 

In the past month and a half there have been large movements in the price of many materials that are essential for the oil and gas industry. Prices of key materials and commodities such as steel, nickel and aluminum now appear to have stabilized at higher levels than before the invasion of Ukraine. It is becoming evident that these prices will remain elevated throughout the year as the future of the relationship between Russia and the West is looking increasingly bleak. 

Additionally, the increase in Covid-19 cases in China means lockdowns could become more frequent, which may exacerbate the current shipping crisis. Based on these factors we expect inflation to remain high for the rest of the year, though we also see some elements that can provide some deflationary pressure through the supply chain. 

Below, we take a closer look at how the current situation will affect the offshore and onshore oil and gas industry and what it signifies for operators and service companies in different regions.

Thank you for reading.

Sumit

Sumit Yadav

Analyst 
Energy Service Research

What are your expectations for service price inflation across the energy supply chain?

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Inflation to stay resilient over the course of 2022; expect pressure to ease starting 2023

Labor costs shot up last year as a response to labor shortages caused by the Covid-19 pandemic, and this should materialize in the yearly average service price. Some of this labor cost pressure is likely to ease slightly this year, however, as fewer pandemic-related restrictions allow more workers to travel across borders and quarantine measures for employees going on site or offshore are drastically reduced. Highly skilled workers will be able to secure large wage increases if they are willing to sign on for shorter-term contracts as activity and hiring picks up. Looking at yearly average service prices this year, we expect the engineering, procurement, construction and installation (EPCI) sector to be one of the hardest hit segments in terms of inflation, as higher commodity prices wreak havoc with input manufacturing costs – to better understand the peak prices month-on-month, consult our Procurement Cost Calculator. For the offshore industry, we expect average global pricing to increase by 15% for EPCI in 2022 (Figure 1), potentially hitting over $7 billion in EPCI inflation for the contract awards expected this year.

We expect material prices to come down slightly in 2023 as the global supply chain adjusts to the disruption and high inflation eventually creates demand destruction. This applies across the board to materials and equipment impacted by high inflation this year. This is likely to push some prices down in 2023, before stabilizing towards 2025. For the global onshore industry (Figure 2), we expect well services and commodities to be the most impacted segment due to both rising demand and high manufacturing costs for equipment and materials this year. Demand will continue to rise and support relatively high prices through 2023, though easing off slightly from the 2022 peak.

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Inflation expected to impede industry players’ opportunities to take advantage of high oil prices

Crude oil prices are continuously testing $120/barrel levels, but inflation is likely to crimp industry players’ ability to take advantage of the higher prices. We have compared a $120/barrel oil price scenario with Rystad Energy’s base case oil price forecast, which currently calls for an average Brent oil price of the $90-110/barrel for 2022 and $70-80 per barrel in 2023. In a $120/barrel scenario, the impact of inflation will be particularly pronounced across North America, with the largest incremental gains in capital expenditure (capex) coming within well stimulation services, land rigs and onshore construction (Figure 3). 

North American well stimulation service capex could rise by $3.1 billion due to price inflation this year as prices could end up 10% higher than base case pricing. For land rigs, the additional cost would be 11% above base case resulting in $1.4 billion higher spending, while for onshore construction services, an 11% price hike would bring $1.1 billion in additional capex. 

Based on last year’s revenues, the service providers with the largest opportunity to benefit from high oil prices are Halliburton, Liberty and NexTier within well stimulation services, Helmerich and Payne, Patterson-UTI Energy, and Nabors within land rigs, and Fluor, Kiewit, and JGC in the onshore construction segment.

From an operator perspective in North America, well stimulation and land rigs are likely to see more price volatility than onshore construction services, due to the comparatively shorter-cycle nature of their contracts and services. Additionally, sustained higher oil prices will make it harder to recruit and retain direct-hire construction workers as they will be in higher demand and have more opportunities to choose from. Operators will therefore need to plan for this challenge if they want to keep up with their scheduled commitments.

US shale operators may face incremental inflationary pressure as early as this year, with an even stronger impact next year, if oil prices stay above Rystad Energy’s base case at $120 per barrel. Well stimulation is the largest expenditure item for horizontal unconventional well development and has the greatest impact on overall well cost. Depending on the well design and play, well stimulation (including frac sands) normally accounts for 20-40% of total drilling and completion costs. Figure 5 shows the increase beyond base capex due to inflation for well stimulation services in the Permian Basin. This indicates that if oil prices approach and stay at $120 per barrel, operators in the Permian will likely spend an additional $1.4 billion in 2022 and $2.8 billion in 2023. 

In other words, a $120 oil price environment would result in 10% to 20% incremental inflation in the Permian’s $14.5 billion well stimulation market. At the same time, the total stimulation market is set to expand by more than 20% in 2023 in a $120 per barrel scenario, as an additional increase above projected inflation will come from more aggressive well activity programs to lift production while oil price are high. 

Resurgent inflation likely to raise greenfield development costs across the Middle East

High inflation is also expected to adversely impact the Middle East, which is on track to record one of the highest greenfield spending levels by region this year. The Middle East EPCI segment will be among the worst hit in a $120/barrel scenario, with total cost overruns amounting to more than $500 million for the onshore construction and topsides construction categories alone in 2022. We also expect strong inflationary pressure across the well services and commodities segment, where the drilling services sub-category is expected to post a price spike of nearly 11%, resulting in potential cost overruns of $400 million for 2022 alone. Similarly, prices for wellbore completion and re-entry services are expected to climb nearly 8%, adding close to $350 million in spending for 2022. Cost overruns for land rigs may reach $385 million this year in a $120/barrel scenario, driven by the Ghawar fields in Saudi Arabia, while the Saudi Arabian Safaniya and Zuluf fields could help lift costs for jackup rigs by $233 million.

To conclude: High service price inflation is here to stay for 2022. Operators’ ability to successfully navigate this price surge will determine how much benefit they are able to leverage from the current high oil prices.