E & P Operators Deal With Rising Costs

By Eric Fox | August 05, 2011 AAA

Exploration and production companies continued to experience rising costs for various oil services in the second quarter of 2011. This is a familiar story that is handled in different ways by those in the industry.

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Rising Costs
During the company's earnings conference call, Newfield Exploration Company (NYSE:NFX) said that the company faced "increasing cost pressures related to equipment, labor, and services" so far in 2011. Management cited water handling and hauling as one of the areas facing the highest inflation.

Newfield Exploration Company is trying to counter this inflation by drilling more efficiently in the various basins that the company is involved with. The company is developing the Marmaton formation in the Texas Panhandle area and recently reported that it has reduced its time to drill here to an average of 28 days. Newfield Exploration expects to drill thirty 30 extra wells here in 2011 using the same number of rigs.

EnCana (NYSE:ECA) also faced rising costs during the most recent quarter, with completion equipment experienced the highest inflation. The company is dealing with this by entering into longer- term contracts with providers, using the company's scale to negotiate higher prices and through sourcing steel, fuel and sand proppant through its own network.

EnCana expects that this strategy will limit the company's realized inflation in its United States operations in 2011 to between 5% and 7%, compared to an industry average of 10% to 12%.

Chesapeake Energy (NYSE:CHK) also acknowledged rising costs in oil services in 2011, and is managing the situation by essentially building its own oil services company internally. The company owns interests in companies involved in drilling rigs, pressure pumping and compression equipment, rental tools, and trucking.

These interests are aggregated into Chesapeake Oilfield Services, L.L.C., a subsidiary of the company that management estimates would have $600 million in operating cash flow in 2012. The company also owns a 30% interest in Frac Tech Services, LLC, a private pressure pumping company active in the United States.

This is a dynamic strategy for Chesapeake Energy, as the company disclosed during its most recent earnings conference call that it was increasing its oil trucking fleet by 150 units to help transport oil to market. Even with this strategy, Chesapeake Energy increased capital expenditures by $1 billion over 2011 and 2012, partly due to rising costs.

Chesapeake Energy is looking to monetize part of this oil service subsidiary to unlock value, a strategy that the company uses extensively in its exploration and production segment.

Another company that owns and operates its own fleet of drilling rigs is Unit Corporation (NYSE:UNT), which has 121 rigs located in the United States.

The Bottom Line
Rising costs for oil services seems to an ongoing situation every quarter, and companies must adapt to this environment until enough capacity enters the market to shift supply and demand more towards the consumers of these services. (For additional reading, also check out Accounting For Differences In Oil And Gas Accounting.)

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