How does the price of oil affect the price of oil extraction?

It seems to me that as oil prices rise, the price of extracting oil should also rise, because all the machines that are used to get the stuff run on oil-based fuels. I can see how you could make a profit if you found an oil field where the oil was easy to extract, but I don’t see how more difficult oil sources could become profitable just because the price of oil goes up. But this is supposedly what is happening up in Alberta right now.

Can someone who knows more about this straighten me out?

I don’t have the answer to the OP but something that I saw truly amazed me and changed my perception on the oil extraction business. It was a program done by National Geographic, The Discovery Channel, The Histoy Channel or Nova (can’t remember which). It was about the worlds largest deep sea drilling platform that was built and hauled out to sea from Newfoundland. The magnitude of the project and the technical challenges were truly astounding. Off the top of my head, they were stationing this massive platform, going down to a depth of thousands of feet, drilling into the sea bottom and with unpredictable weather and harsh sea conditions the platform couldn’t move more than 10 feet in any direction. The platform was like a mini city in the middle of the ocean. It had to maintain a reasonably comfortable and safe life for a lot of highly skilled employees. There was a huge room in the platform that produced 3D computer images of the area being drilled so that the engineers could monitor and guide the drilling process to hit the spots where oil was concentrated.

Now, consider that from start to whatever the life of the platform is, it is being conceived, designed, built and manned by highly trained and highly paid people. This isn’t some slave labor factory. Yet, on some level, it was a project that was only undertaken because it was seen as being profitable. This wasn’t just punching a hole in the ground.

Again, I’m no expert on the economics of the oil or energy business but the magnitude of what is going on is extraordinary. I just throw this out as consideration in case anyone thinks that the oil extraction business is in any way simple or a source of easy and immediate profit.

Actually, that sort of plays into what I was thinking about. Doesn’t an operation like that become more and more expensive as the price of oil goes up?

Let’s say that when oil is $50 a barrel, the gasoline to run your drilling machinery costs $20 a barrel and other expenses are $10 a barrel. A net profit of $20/barrel.

A while later, oil is now $100 a barrel. Fuel prices are now $40 a barrel and other expenses are $10 a barrel. A net profit of $50/barrel.

This is how oil reserves that were formerly uneconomic to exploit have become economically feasible to exploit.

I’ve been privy to some of the info from a few oil company AFE (Authorization for Expenditure) documents for drilling projects, mainly for deepwater offshore exploration wells. Don’t have the data right in front of me, so I may be off by a few percentage points, but by far the largest expenditures are for hire of the drilling rig itself and for the drilling fluid circulated through the well to balance pressures and bring the cuttings to surface.

There is a somewhat of a correlation between oil prices and drilling costs, as seen in this paper (PDF, pages 5-7) but most of the variation appears to stem from the variability of rates charged for rental of drilling rigs. Rig rental costs tend to go up drastically in times of high oil prices, mainly because there is more money available for drilling, so more drilling takes place and a shortage of drilling rigs tends to result.

Deepwater offshore rig rates in particular have soared in recent years, with some rigs commanding well over $200K/day. Synthetic oil-based drilling fluid is often quoted at around $50/barrel (42 US gal), with several thousand barrels or more used during the course of the well. These two items together generally count for somewhere from 50%-70% of the total cost of the well. Other significant costs include the steel casing used to line the wellbore after the drilling of each hole section, the cement used to hold the casing in place, and rental of downhole formation evaluation tools run in the hole to assess the reservoir zones. The formation evaluation service the company I work for provides, known as mud logging, is a relative bargain at only about 1-3% of overall well costs. IIRC fuel costs are somewhere around the 3-5% range.

Land operations have much lower average costs, especially for rig rental, but not necessarily vastly less requirement for fuel, so the proportion of fuel costs to total cost may be be larger than for offshore, even if the total cost is not.

Hope this helps.

Short answer, the cost of fuel oil has some impact. The largest impact on the cost of oil extraction is due to limited capacity in the service provider market, the cost of steel, the cost of general industrial heavy plant and a lack of trained people. These costs have risen, but not as fast as the sale price of crude oil. Tus a reservoir that would be uneconomic at $15/bbl oil would still not be economic at $40/bbl given todays cost environment, however with the price at $100 it is best to get drilling.
Second off I would say that the oil sands extraction, (which is a chunk of the new activity in Alberta right now) is largly a strip mining operation, or using steam assisted gravity drainage (SAGD) rather than an more conventional oil drilling operation. The economics of the heavy oil do not quite so closely match the economics of regular oil extraction, most significantly in the use of lots of hot water or steam, which as you correctly state has a huge dependence on the cost of fuel.

Long tedious answer below.

The process of oil extraction has several stages, exploration, drilling and production, we will leave off the transportation and refining ends as it is post extraction. We could get picky and talk about remoteness of souce and transportation cost , or oil quality and its worth for production and include them into the equation, but let´s leave that out for now.

Each of the 3 stages (exploration, drilling and production) has its own costs (ok there is a fair bit of interlinking of the costs, but unless you desire death by excessive parenthesis please allow me some simplifications). The key thing to consider in all these stages is that by and large, they are handled by 3rd party contractors, such as Schlumberger, Baker, Haliburton , Transocean, Nabors, H&P, Pride, KBR,GE, CGG Veritas etc etc. These guys, called service providers, have specialised knowledge and equipment suitable for each stage. The oil companies speciality is in geology, geophysics, reservoir engineering, having gobs of cash, and managing and pulling everything togeather. Most of the actual doing work of getting a hole in the ground is handled by the service providers under supervision of the oil co.

Exploration. In this we are looking at the sesimic, electromagnetic and airiel surveys and good old fashioned rock spoting field trips trying to link surface geology to subsurface geology. The exploration phase certainly includes drilling exploration and delineation wells, but the cost of those matches the drilling section cost , which we will get to. Bet you can´t wait. So exploration cost, as defined, are driven by the cost of the 3rd party service providers doing the sesimic work etc, and also some internal cost for the geological, geophysical, petrophysical and reservoir engineering, i.e the guys who will analyse the data and decide what to do.
Right now people costs are certainly rising but the big crunch comes in the cost of the 3rd party services, which is driven by good old supply and demand and teh need for new technology. The new technology is required because smaller harder to find reserviors are being sought, the move form 1D through 2D and onto 3D seismic and trying to image through salt has required new technology and processing power. Multiple seismic streemers, solid streemers, cleaner better sound sources, more acurate hydrophone positioning, wacking great ammounts of processing power for time/depth migration etc etc . Basically bigger bucks. There is also a limited seismic capacity in the market and so with people chasing exploration prospects left right and center, the cost of seismic services has risen.
Now the reason for the lack of capacity in the seismic market has something to do with the cyclical price of oil and the relationship between service providers and the oil companies. These factors have impacted the price of services for the drilling and to some extent the production phase, so may be worth expanding on.
The R&D, equipment purchasing and people training cycles for service providers can be quite lengthy, in the orders of a year to 5 or 6 years. The price of oil and activity has been somewhat cyclic, big crash in the mid 80s. In the early 90s, in the late 90s.During these price lows the oil companies slashed activity in exploration and drilling and the service companies had to slash prices and cut R&D and people. This has led to a serious lack of people and lack of equipment to service the oil companies needs when prices rose. Now during the activity peaks when demand was high and supply tight, the service companies have to make the money to tide them through the bad times and basically reward the investors who supported them through the bad and so the prices ramp up. The price drops during the low activity have led the service providers to be very very cautious with new investment and ramping up activity, because based on history, the slightest drop in activity wil lead to the servic eproviders being left with a bunch of hardware and people and the oil operaters shredding contracts as if a ticker tape parade was due, and renegotiating at lower prices. In short service providers and oil cos do not trust each other much leading to a conservative investment regime.

Drilling, this is probably the biggest cost item.
At the drilling stage the cost are largly driven by the availability of drilling rigs, the cost of steel for casing and completions, the cost of service providers for directional drilling, drilling fluids, logging, cementing, bits wellheads and completion running.

All of these components have a cost element associated with increasing technical difficulty, such as deeper water capability for drill ships/rigs, funky metalurgy for completions and casing in hostile environments, electronics required to operate at temperatures of 150C+ and pressure of 30,000 psi. These all have cost rises due to materials, development, people costs and for sure, the rise in the price of fuel is factored in there, but it is diluted. The cost of diesel is certainly more of a dirct issue for th drilling rig operation, but based on oprationg rates for a land rig we are looking at 10% of the rig hire rate, which may be 50% of the well cost. Clearly for different rigs this will vary, but the cost of fuel is diluted. The rises in cost of steel for casing and completion equipment (the plumbing reequired for the well to flow to surface) has had a significant impact on the price of a well, worldwide (not just oil) demand for funky metalurgy steels is the big driver there.

The biggest impact on the cost of drilling is, as for exploration, in the availability of equipment. If you want a land rig in the US, you will need to wait 18 months before you can hire one as all the slots are full. If you want a deep water drill ship, you will need to enter into a 3-5 year contract at 400,000 USD a day. The rig contractor will recoup the operating and construction cost in that 3 year period even though the rig is good for working for another 20 year, but they have been left holding the can before during price dips. If the rig contractor wants to get the money from their investors to build said rig, they need a contract that covers the full purchase price and operating costs. The same goes for the other service providers, the times are good, make hay and raise prices.

On the production side we have to consider a range of facilities, from simple pump jacks and a seperator tank, to multi billion dollar floating primary proces plants. Increasing technical difficulty of the reservoirs has an impact on the cost, be it in hotter higher pressure fluids with CO2 or H2S, or physical location, eg in 10,000 feet of water in a hurricane prone environment 200 miles from land. Again fuel is a consideration, but it is pretty miniscule. The cost of steel for construction, construction yard space and capability (everyone and their dog are vyying for space to build) are big drivers along with the cost of generators, steel, compressors and control systems for hich teh oil companies are competing with every other industry.

Hope the above gave you some insight to some of the costs for oil extraction. To summarise, the costs increases have some impact from the cost increase of oil , but are mostly due to the cost of services due to limited availability and demand, increasing technical difficulty of developing reservoirs, the global cost rises of comodities (primarily steel) , and competion for resource and equipment from other industries. The cost rises have been out stripped by the rise in the cost of oil making prviously uneconomic reservoirs economic.

Cheers NBC (operator drilling enginer and ex service company chap for the last 15 years)

Just to give you an idea of numbers, I’m currently drilling a well that will cost in the order of $100,000,000 :eek:

Did you really read my whole post? Most peoples eyes glaze over after the first couple of lines.
Mud volcanos and seismic uncertainty in the Caspian will do that to a drilling budget.
Are you planning to blow it all by emulating Exxons multiple spud 120 million dollar dry hole, redoing a platform template lost to shallow water flow or is it to be spent on armour plating the rig against Iranian gunboats if you are on that more southerly prospect, or are you with the cult of the jaundiced clam further north. :slight_smile:
Good luck.

We can’t afford to do those things - we’re too busy running casing (one string - one month)

Oooch ya, that´ll do it to the AFE.
I wasn´t bing snarky earlier, just illustrating to readers of the thread some of the crazy nonsense that can happen and cause 100 mil to evaporate without much to show for it.
Good luck again.

Thanks to everyone that responded that works in the industry, it’s a fascinating topic and you all have offered a great deal of insight into the economics and risk that underlies fossil fuel extraction. You guys should consider opening an, “Ask the …” thread.