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Tickers in this Article: NYSE:RDS-A, BP, TOT, X, DO, RIG
The Energy bull market collapsed last year in spectacular fashion, taking millions of investors down with it. One of the cornerstones of that bull market was the often-repeated claim that it was getting more and more expensive to find oil and natural gas, so therefore the price of oil and natural gas couldn't go below some magical floor price. (For more on the oil industry, refer to our Oil and Gas Industry Primer.)

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It's fairly obvious with hindsight that this wasn't true, and now there is increasing evidence from official sources on the fall in oil service and drilling costs.

Cambridge Energy Research Associates (Nasdaq:CERA) reported its Upstream Capital Costs Index last week, and reported that, over the last six months, upstream costs to construct oil and gas facilities fell by 8.5%. CERA also reported that the Upstream Operating Cost Index fell by 8% over the same time frame. This measures the cost to operate these facilities.

These numbers were confirmed by BP Inc (NYSE:BP), which reported an 11% drop in costs of exploration in the first quarter of 2009, and Royal Dutch Shell (NYSE:RDS.A), which has renegotiated many contracts at lower prices according to Jeroen van der Veer, the company's CEO.

The biggest loser based on this report is U.S. Steel (NYSE:X), as the Steel Cost component of the CERA index fell by 25.2%. U.S. Steel reported in its first quarter that its business was hurt by "a severe downturn primarily as a result of reduced drilling activity due to lower oil and gas prices."

The winners are the deep offshore rig companies like Transocean (NYSE:RIG) and Diamond Offshore (NYSE:DO). These companies are protected by the long-term contract backlog that both companies have for its fleet.

Oil sands projects in Canada are also seeing costs fall as companies delay projects, and capacity falls idle. One analyst noted that, due to the sharp drop in costs of materials and labor, many delayed projects are economical at current oil prices, compared to a previous price range of $80-100.

It's not over yet, as French oil company Total SA (NYSE:TOT) indicated that it would push for 20-30% cuts in service costs for the balance of the year. Total also directly its planned cuts toward the deepwater rig companies, and said that it would have to get rig costs down to 2005-2006 levels if it wanted to see contracts rolled over.

The Bottom Line
Oil service and drilling costs continue to fall, and it's not over yet, as some of the largest spenders of capital in the energy business continue to look for ways to slash costs during the recession. (Find out which catalysts can turn struggling stocks around in our related article Turnaround Stocks: U-Turn To High Returns.)

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