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BP, Shell Cost Cuts May Falter as Drilling Stirs Oil Inflation

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February 21, 2010, 07:10 PM EST

By Eduard Gismatullin and Marianne Stigset

Feb. 22 (Bloomberg) — BP Plc and Royal Dutch Shell Plc may falter in their campaigns to save billions in oil and gas project costs as a resurgence in drilling and demand for engineers threaten to revive inflation in the industry.

Crude prices doubled in the past year, prompting producers to resume projects put on hold during the recession. Oil and gas industry spending will rise 11 percent this year to $439 billion, according to Barclays Capital.

“Oil price inflation and cost inflation are highly correlated, albeit with some delay,” said Paul Wheeler, a London-based managing director in the oil and gas group at investment bank Jefferies International Ltd. “The oil industry is always people constrained. It’s one of the biggest challenges: a lack of young engineers and geologists.”

BP Chief Executive Officer Tony Hayward said Europe’s largest oil company will try to cut costs further this year after saving $4 billion in 2009. Shell’s Peter Voser aims to trim expenses by $1 billion. The respite the economic crisis brought on costs may prove temporary as producers are forced to spend more to recover oil from deepwater reserves, tar sands and gas-bearing rocks.

While the major oil companies may face difficulty holding costs down, the beneficiaries of increased drilling will be oil services companies like Schlumberger Ltd., Baker Hughes Inc. and Petrofac Ltd., hired to work on production projects.

Investor Outlook

Investors prefer the outlook for service companies to oil producers. Shares of Schlumberger, which yesterday agreed to buy drilling lubricants provider Smith International Inc. for about $11.3 billion, have gained 82 percent in the last year. Petrofac has more than doubled. In the same period BP has gained 28 percent and Shell is up 11 percent.

“All the service sector is going to be busy again,” Ayman Asfari, CEO of Petrofac, the U.K.’s biggest oil contractor by market value, said in an interview in London. “All the majors now are realizing they cannot stop investing and they are all coming back.”

Aside from salaries, prices for raw materials such as steel, are the biggest contributor to project costs. World steel prices have recovered 19 percent since reaching a three- year low in May as the global economy returns to growth, according to a tracker index from Steel Business Briefing. That will push up the prices of piping and sheet metal needed to build rigs and processing plants.

‘Log Jam’

“Cost pressures on oil services are bottoming out and the next move is up,” Keith Morris, an analyst at London-based Evolution Securities Ltd., said in a note earlier this month. A “log-jam of projects postponed from 2009 will lead to a scramble for oil services. Spare capacity will get booked up, quickly leading to return of cost inflation.”

London-based BP will invest $20 billion this year, little changed from 2009, as it works on projects in Alaska, Trinidad & Tobago and the Gulf of Mexico. Shell, based in The Hague, expects to spend $28 billion this year and Paris-based Total plans $18 billion.

“We are definitely seeing costs recover slightly,” Total CEO Christophe de Margerie told reporters in London this month.

The trend toward deepwater drilling, liquefied natural gas plants and other high-technology projects is adding to pressure on contractor capacity, de Margerie said.

“The costs of developing assets today are significantly higher than they were five years ago and there is no way we are going back to those levels,” Petrofac’s Asfari said in London. “There is nothing you can do about the underlying costs, like human resources.”

Skilled Workers

In Australia, where San Ramon, California-based Chevron Corp.’s $40 billion Gorgon project is among more than a dozen LNG ventures under development, cost pressures are already starting to show in salaries for skilled workers. Woodside Petroleum Ltd. said in November the cost of its $12 billion Pluto project may surge as much as $1 billion, partly because of labor expenses.

Pressure on skilled oil industry professionals may increase in other parts of the world as projects get up to speed, recruitment consultants said.

“We’re still far away from the pre-financial crisis levels, but there has been an increase in demand for engineers,” said Geir Doelvik, managing director of Manpower Professional Engineering AS, an Oslo-based recruiter for the oil industry. “We haven’t seen salaries increase yet, but we’re going into wage negotiations, so we’ll see what happens then.”

Charges for hiring drilling rigs may rebound after more units were pressed into service in recent months. The number of rigs in use worldwide has risen 40 percent from May’s six- year low, according to data from Baker Hughes.

Talks with producers to cut prices “are behind us,” Andrew Gould, CEO of Schlumberger, the world’s largest oilfield-services provider, said in an interview in Oslo this month. “The danger is that if oil prices accelerate then in the supply industry, certain shortages will appear quite quickly.”

–With additional reporting by Brian Swint in London. Editors: Will Kennedy, Amanda Jordan.

To contact the reporter on this story: Eduard Gismatullin in London at +44-20-7673-2268 or [email protected]; Marianne Stigset in Oslo at +47-22-99-6109 or [email protected].

To contact the editor responsible for this story: Will Kennedy at +44-20-7073-3603 or [email protected].

BLOOMBERG/BUSINESS WEEK ARTICLE

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