Marginal oil production costs are heading towards $100/barrel

Bernstein’s energy analysts have looked at the upstream costs for the 50 biggest listed oil producers and found that — surprise, surprise — “the era of cheap oil is over”:

Tracking data from the 50 largest listed oil and gas producing companies globally (ex FSU) indicates that cash, production and unit costs in 2011 grew at a rate significantly faster than the 10 year average. Last year production costs increased 26% y-o-y, while the unit cost of production increased by 21% y-o-y to US$35.88/bbl. This is significantly higher than the longer term cost growth rates, highlighting continued cost pressures faced by the E&P industry as the incremental barrel continues to become more expensive to produce. The marginal cost of the 50 largest oil and gas producers globally increased to US$92/bbl in 2011, an increase of 11% y-o-y and in-line with historical average CAGR growth. Assuming another double digit increase this year, marginal costs for the 50 largest oil and gas producers could reach close to US$100/bbl.

While we see near term downside to oil prices on weaker demand growth, the longer term outlook for higher oil prices continues to be supported by the rising costs of production.

This is important because, as Bernstein analyst Neil Beveridge and colleagues note, the cost of producing marginal barrels of oil plays a big role in determining oil prices.

We’d add that the expectations of said costs also play a big role, but that’s another story… and anyway, the Bernstein team argue their point pretty strongly with this chart:

(DD&A is depletion, depreciation, and amortisation;  F&D is finding and development.)

Also, this research obviously only covers non-Opec producers, and it mostly excludes Russia too. Given Saudi Arabia’s role as the “swing producer”, how are the ex-Opec, ex-Former Soviet Union marginal oil production costs so correlated to Brent prices?

Bernstein argues that it’s because they are, basically, more costly:

While OPEC plays a key role in influencing price through production quotas, in the long run we believe that it is the marginal cost of non-OPEC production which sets the oil price. As global demand has surged over the past decade the marginal cost of production and oil prices have increased, as the industry has venture to increasingly higher cost (smaller, deeper fields) and more marginal regions (deep water, high arctic) to produce the incremental barrel of oil.

And if Saudi Arabia is already comfortable with oil priced at $100/barrel (or higher, judging from the state of the market), then presumably they’re not about to use their much cheaper production rates to save the big listed oil companies from the higher costs they face. Demand destruction might be another matter, but again, we digress…

Here’s a comparison of the median costs and the 90th percentile costs per barrel for this cohort:

(Click to expand.) The cost of producing the marginal barrel corresponds fairly closely to the overall barrel, especially in terms of cash costs. Beveridge et al write (emphasis ours):

We found that the marginal cost increased dramatically between 2002 and 2005, and then rose slightly in 2006 and 2007, peaked in 2008, dropped in 2009 and rose again in 2010 and 2011. The 90th percentile for marginal costs increased with 14% compound annual growth rate while the median marginal costs increased with 9% compound annual growth rate (Exhibit 10).

In addition to calculating the marginal cost required to replace production with new reserves, we also calculated the variable cash costs based on production costs (operating expenses and production taxes). This indicates at what point it becomes uneconomic to produce oil, which would lead to production shut-ins. Given the variability within each company’s portfolio, there presumably is some production that would be shut in even at higher levels than the overall cash costs, but the cash cost gives an indication of the range.

And here’s how that range looks:

Oh, Pemex…

We all remember what happens next, right?

Related links:
How will the world live with $100 crude? FT Alphaville
Saudi Arabia targets $100 crude – FT
Iranian oil embargo – Econbrowser