Higher oilfield development costs and a weakening dollar pose an upside risk to energy majors' upstream investment plans for next year, analysts say. BP noted risks to its capital spending plans in third quarter results last week, pointing to capital goods inflation it said was running at 10 percent per year, and the declining value of the dollar.
Chief Executive John Browne said BP's 2005 upstream spending could have to rise by about $1.1 billion from last year's forecasts just to accommodate these factors.
"What's new over the last 18 months is that stuff is actually costing more. Materials costs and rig rentals are starting to run away," said Deutsche Bank's JJ Traynor.
"There is no reason why this should be restricted to BP."
Oil market analysts have been watching upstream spending for clues on how quickly oil supply will react to fast growing demand and record prices.
"What we will see is exploration and production budgets having to go up probably in the order of 10 to 20 percent simply to maintain the same level of activity," said Robert Plummer of Wood Mackenzie in Edinburgh.
TIGHTER UPSTREAM MARKET: Wood Mackenzie, an upstream consultancy, said last month that development spending by the 10 largest quoted western oil firms reached record highs in 2003, up 40 percent from 1998, and predicted similar high levels to be maintained to at least 2006.
BP's Browne said investment by the largest 30 publicly quoted firms had risen by 15 percent per year since 2000.
This upturn in development activity has tightened up the market for subcontractor services like drilling and pipeline laying.
Oilfield services firms have reported improved pricing environments this year in many key markets, like the Gulf of Mexico.
On top of increased subcontractor costs, BP said it had been forced to adapt to faster inflation in capital goods.
"In the spring of this year, we began to see that the market prices for our capital goods were increasing quite strongly," Browne said.
"The increased investment within the global E&P sector...led to a tightening in all our supply markets."
Annual capital goods inflation had increased to 10 percent from a previous level around two percent, Browne said, although he added that supply chain management had offset much of this.
In addition, a weaker dollar has raised the cost of goods and services denominated in other currencies. The dollar/euro average so far this year has weakened about eight percent in dollar terms against its 2003 level.
On top of this, the upturn in oilfield activity could bring even faster inflation, while analysts say the ballooning US current account deficit poses a serious risk to the strength of the dollar in the near to medium term.
AFFECTS ACROSS THE SECTOR: Analysts say these factors inflating upstream expenditure are likely to affect all major oil companies, and that higher spending year on year will have to offset this influence before making any real difference to the supply outlook.
In Q3 results last week, ExxonMobil, the world's largest oil firm, said it expected 2004 capital expenditure in the region of $15 to $16 billion, and that it planned to maintain that level in 2005.
ChevronTexaco said its 2005 capex would likely increase, pointing to the midpoint of its spending over the past five years, which has varied between $7 and $12 billion.
Shell said its capex would probably reach about $15 billion in 2005, unchanged from plans for 2004, although actual 2004 spending had been hampered by Hurricane Ivan.