No, it's not the Tale of Two Cities, it's the Tale of the US Oilpatch. During the last few years, I have been lamenting to my friends that this was a "bad boom" because the cost of services went up lock step with prices. While the politicos got all hot and bothered by "windfall profits", the oxygen in the room was being efficiently sucked out by the service companies that made the last four years of living in the US oilpatch look like living in Argentina in the late 1980's, when 100% inflation abounded. We were faced with the charge that we were "Not Reinvesting" enough back into our business when our dollars bought a lot more in industries other than our own.
"What?" you say? "We all know that oil and gas has been at historically high prices, how can you bitch?"
The graph above illustrates the Cost to Drill vs Commodity Price very well. Note the year long lag between price upturns and service cost increases AND decreases. Then note the huge acceleration in costs between 2005 and 2008 over the cost of hydrocarbons. This is where the hogs began to elbow out the pigs. In 2006 until 2008, the cost to add a barrel of oil or MCFG per gas began to increase much faster than the commodity price of the product. When this happens at low commodity prices, you don't have the worries that prices will be cut from under you by 75%. You are in a much less risky environment. When it gets out of whack in high price environments, you are double whammied by the increased risk of price floor collapse. Lots of wells drilled in 2007 and 2008 that will never pay out today.
The graph below shows the Drill Cost to Commodity Price Index. Historically, the E&P business has been healthy and sustainable at an index no higher than 400, while the service companies depend on high price environment to proliferate. In essence, this creates a band between 200 and 400 where things get done sustainably. Below that band, service companies cannot exist, and above it, the cost and risk of the oil business does not support investment from a non-feverish investment climate.
The green bars represent times of lowest commodity price (less risky), and the red bars of highest commodity price (more risky). The spikes generally correlate to the lag between services and commodity prices. Costs have a long way to go down before we meet 2009 projections. By my calculation, drilling and completion costs will need to drop 61% before we enter the grey sustainable zone for $50 BOE. Either the service companies need to meet that cost reduction, or we are in for a real collapse of US energy deliverability.