Subsea tie-back leader facing inflation-driven cost increase of $6.5 billion

Norway, the global subsea tie-back leader, is set for an inflation-driven cost increase of $6.5 billion on upcoming contract awards for goods and services in the offshore oil and gas industry through 2026, according to Rystad Energy’s latest report.

During the five-year period, about 275 subsea trees are expected to be ordered in Norway and will be the main driver for the added bill that operators will have since such projects are sensitive to the increase of costs for materials and labor, the report writes.

According to 2021 pricing, the Norwegian oil and gas industry would have to pay circa $91 billion for all upcoming contract awards through 2026. Instead, inflation will drive the total five-year cost to $97.5 billion, which, as Rystad says, implies that some of the biggest oil and gas firms active in Norwegian waters, including Equinor, ConocoPhillips, Aker BP, Vår Energy and Shell, will need to reassess their budgets since old break-even calculations will no longer be accurate.

The report forecasts that Norway will be the global leader for awards related to subsea tie-backs during the next five years, as its collective value is projected to reach $55 billion for suppliers, based on 2021 pricing. The U.S. subsea market will be the second largest with the anticipated $44 billion of new contracts, followed by the UK with $29 billion, Russia with $25 billion and Brazil with $24 billion.

While added subsea costs will account for over $2.2 billion of the total extra $6.5 billion that Norway faces, other supply segments have also been hit by inflation. The maintenance sector is facing $1.6 billion in added costs, with drilling following at $1.4 billion and with EPCI completing the top-four segments with $0.8 billion.

“Norway’s oil and gas industry will really feel the inflation hit in coming years, due to the nature of its upcoming contract awards,” said Matthew Fitzsimmons, senior vice president at Rystad Energy and head of cost and price research. “Subsea equipment prices for Norwegian projects have already climbed by more than 10% since mid-2020 and are set to be challenged further as demand keeps rising and the global subsea supply chain remains saturated.”

Although subsea and maintenance contracts give operators the largest risk, other segments have their fair share of inflationary challenges, Rystad states, adding that subsegments like OCTG are expected to see some long-term relief after steel prices surged in 2021, while other subsegments like drilling services have not yet plateaued.

Norway’s drilling services segment saw a 5% increase during the pandemic in 2021. While increased equipment and labor costs have been universal culprits when it comes to climbing prices, prices have behaved differently in the drilling services subsectors.

Conventional drilling services in the Norwegian Continental Shelf (NCS) region plummeted in the first quarter of 2020 to a trough in April that year, before rebounding sharply and adding 20% through 2021. Conversely, directional drilling services took longer to rebound from a low in mid-2020, with no material increase until the third quarter of 2021 and with current costs still below 2019 levels.

NCS drilling services pricing is expected to continue climbing in 2022, driven by a continued ramp-up in activity, both locally in the North Sea and internationally.

A recent uptick in activity is expected to create a 4% growth year-on-year for active wells on the NCS in 2022. Oil prices are anticipated to decline into 2023, as well as regional drilling services activity levels, with regional drilling days set to drop by more than 12% in 2023 from 2022. This should create some pricing relief in the segment before additional activity picks up in 2024 and beyond, the report writes.

While short-term price increases might challenge new work, long-term cost challenges are rooted in labor shortages, Rystad Energy claims.

With more fields coming online, and legacy assets not getting any younger, maintenance labor is set to be in high demand in the coming years. As a result, many segments are likely to see greater imbalances between demand and supply. For example, by 2025, the demand relative to overall supply for instrument repairers in the oil and gas industry will rise by 18% compared with the demand versus supply balance in 2021.

According to the report, the traditional industry impulse to solve such a labor shortage results in higher wages, however, increasing labor rates will not solve the issues presented by the labor shortage. After years of down-cycles and negative public sentiment against the petroleum industry, experienced personnel has been leaving the sector and it has become more difficult to recruit new talent.

Suppliers and operators are likely to be challenged by the resulting decrease in labor productivity as much as by rising labor rates. This is said to give both sides a mutual interest to decrease project management redundancy to avoid situations where operators, suppliers and subcontractors are forced to compete against each other for the same limited human resources.

Players unable to act against these rising cost pressures will undoubtedly find themselves writing larger checks for energy services over the coming years, Rystad Energy concludes.