In this episode of Upstream in Perspective, Aje Singh Rihel from our upstream cost and technology team joins the podcast to discuss some of the cost and spending trends in the Middle East. Here's an excerpt from the podcast:

Jessica Nelson:

Aje, spending in the Middle East looks like it will continue to account for about 10% of upstream capex outlays for the next five years. I know IHS Markit is forecasting a significant year-over-year change in onshore facilities, which you expect to jump in 2019. Are there certain countries or projects driving this increase?

Aje Singh Rihel:

We expect the spending activity levels to be high in the Middle East, not only in the next 12 months, but over the next five years, as they have been over the past five years. I'd like to highlight Iraq as probably the most interesting and most promising country in the Middle East, both over the next 12 months, and also over the next five years.

We see quite a few initiatives in Iraq. On the upstream side, they are related to the rebuild of facilities in the north after the defeat of the Islamic State. I would say that the most important driver for future, both spending and activity, is related to the Iraqi government that states its target to increase their old production from 2 million barrels a day to 6.5 million barrels a day by 2022.

A tripling of the oil production is quite ambitious and not necessarily a realistic target. But even if they don't meet this stated target, we can expect quite high activity in the country over the next year.

Jessica Nelson:

This spending increase is coming as upstream costs are still significantly down since 2014, correct?

Aje Singh Rihel:

Yes, you're correct. If you're thinking cost in terms of oil- and gas-specific cost drivers. We think of equipment prices; they are still low, but they are on the rise. On the rig side, offshore rigs, day rates are depressed. We expect them to remain depressed over the next few years. The costs are down from 2014, but I think it's important to keep in mind that the Middle East oil and gas landscape is dominated by onshore projects. And some key cost components within this part of the oil & gas sector are raw materials and labor.

When it comes to raw materials, if you look at steel prices, they're almost half from 2011 to 2015, but have been recovering since then. Cement prices on a global level have escalated annually since 2012. But, if you look at the Middle East, there has been this region-wide construction boom going on there for five or six years. They are competing for the same type of resources or raw materials as the oil and gas sector. What we see is that while the prices on the global level have increased, cement prices, for instance, in the Middle East have far outpaced the global escalation level. The story is more or less the same on the labor side.

There's been high activity among industries that compete for the same type of labor as the oil and gas sector, which has kept the labor supply quite tight in large parts of the Middle East. The consequence has been that while engineering, construction and manufacturing salaries have dropped in Europe and North America, they continue to increase in the Middle East.

On a global basis, upstream costs are down since 2014, but in some regions, such as the Middle East, we see that the cost in terms of labor and raw materials have actually increased-especially for those items that are forged locally and on the global market.

Jessica Nelson:

You talked a little bit about how the Middle East has responded to those costs. How else have operators been responding to declining costs, and has it changed the timing of any projects going forward?

Aje Singh Rihel:

The oil and gas industry in the Middle East, and including its E&P companies, are of course, not immune to decline in oil prices or in other market changes on a global level. But there are a few items or elements that make them stand out.

First of all, it's the breakeven cost in the Middle East which are considerably lower than in other parts of the world. So for them, it's easier to, from a financial point of view, project economics point of view, it's easier for them to justify project development. We've seen historically that activity deriving from the Middle East has tended to increase in times of low oil prices.

To put this in perspective, the Middle East has historically accounted for about 10% of the global upstream oil and gas spending. This share was 9% in 2014 then increased to 12% in 2017. It's expected to remain around 11 to 13 percent over the next five years. These percentage points don't sound like much if they were up and down a couple of percentage points from one year to another.

But if we look at it in absolute terms, we're still talking tens of billions of dollars. If you look from 2014 to 2017, not only has the spending in the Middle East remained relatively stable, but also actually gained quite a large part of the global market share in the oil and gas sector.

Another aspect is that the E&P companies in the Middle East are largely NOCs, and the national economies in the region are very much financed by the oil and gas sector. The projects in the region tend to be as much driven by sociopolitical goals and targets as by commercial considerations and interests. Whether that's employment rate, investments and activities, or the longer-term revenue from the oil and gas sector.

All-in-all, operations in the region have seen the cost deflation as an opportunity to carry out projects at a reduced cost. But at the same time, they also have done so to keep high economic activity in their respective countries.

Hear additional details about activity in Iraq and upcoming projects in Saudi Arabia in the full episode of Upstream in Perspective.
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Posted 28 November 2018

This is an excerpt from Upstream in Perspective and has been professionally transcribed as accurately as possible. Please note, some words and phrases may have been unintentionally excluded.

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.