The high oil prices have encouraged a surge in exploration that has put the market for upstream oil and gas services under intense pressure. In particular, the cost to hire or purchase a drilling rig is rocketing. Between 2002 and 2006, the cost of purchasing a new deepwater, semi-submersible rig almost doubled to $500m, and the daily rate to hire an offshore rig increased by 135-430 per cent, depending on location and drilling depth.

Day rates for the technologically advanced fifth and sixth-generation rigs, built in the past 10 years, increased to more than $450,000 a day in 2006 from less than $120,000 a day at the start of 2002. The global cost of a semi-submersible rig, which drills in water depths of 2,001-5,000 feet, increased by 250 per cent over the same period.

Although the variety of rigs used to drill in a range of environments across the world makes it impossible to have a single measure of the increase in rig prices, the sharp upward trend over the past five years is indisputable. According to UK-based energy consultant Douglas Westwood, global offshore drilling expenditure increased by 80 per cent between 2002 and 2006, from $32.6bn to $58.5bn.

This upward trend has continued in the past 12 months. “In 2007, the daily cost of high-spec semi-submersible rigs increased to $500,000, and in some cases $600,000, from $250,000 in 2002-03,” says Steve Robertson, an oil and gas expert at Douglas Westwood.

“Day rates for the heavier, 2,000-3,000-horsepower onshore rigs have increased from about $20,000 to $30,000-40,000 over the same period.”

The increase in rig prices closely mirrors the rising oil price. The anticipation of higher returns on hydrocarbon finds has given producers an incentive to intensify exploration activity, while high oil revenues have provided them with the capital to do so.

“There is a general trend that when oil prices increase, so do oil services, and especially drilling rigs,” says Toufik Nassif, commercial director of BP Libya, which signed a $2bn agreement to explore offshore Libya in 2007.

The challenge for the industry is to address the dearth of investment in rigs in the late 1980s and 1990s, when oil prices were relatively low. Reversing the trend is a costly business.

Increasing exploration

“When oil prices go up, rig costs go up,” says James Williams, president and chief economist at US-based consultant WTRG Economics. But there is a lag between the two. After a period of relatively low exploration, a lot of rigs are in disrepair and some are junked, so when there is suddenly an increased demand for exploration, you have to build rigs and hire people.”

Opec, which has all of the Middle East’s major producers as members, is playing an increasingly important role in meeting energy demand, as reserves elsewhere in the world dwindle. But in recent years, the rate of drilling activity in this part of the world has been slow. “In the US, there are about 350 rigs drilling for oil,” says Williams. “That is more than the whole of Opec, excluding Iran and Iraq. Until recently, Saudi Arabia was managing to maintain production of 9-10 million barrels a day (b/d) of oil with only 20-30 rigs drilling.”

More recently, this has begun to change. “Saudi Arabia has seen a real step change in activity,” says Robertson. “It has increased its rig count to about 120.”

North Africa is also increasing its drilling activity and the intensification of upstream activity globally and in the Middle East has created a highly competitive environment for rig services. “Rigs to drill in water depths of 1,800-2,000 metres and greater are difficult to find,” says Nassef. “A one-well programme is one thing, but we will have a 12-well programme [for offshore Libya]. Planning is the key to ensuring the availability of rigs when you need them. We will co-ordinate with our global drilling community to ensure that we have the right rig when we need it.”

Smaller companies are most affected by the tightness of the market because their financial resources and operational flexibility are more limited. But even the majors have been suffering. The exploration work by the UK/Dutch Shell Group in Libya’s Sirte basin, for example, was held up because of delays over the delivery of a second rig, which were a direct result of market competition.

“There is a big demand for rigs in Libya,” says Mohamed Attawil, drilling services manager at the local Arab Drilling & Workover Company (Adwoc). “We have 17 rigs at the moment and are planning to contract a further four from China and two from the US, which will be delivered in September.”

Rising costs

The rapid rise in rig costs reflects not only a growth in exploration activity, but also rising production costs. The extraction of metal, one of the most important raw materials in the manufacture of drill rig equipment, is highly energy intensive.

Finding staff is also a problem. According to figures from Geneva-based energy consultant IHS, project management rates in the oil and gas industry increased by almost 90 per cent between 2002 and 2006, while construction labour rates increased by about 25 per cent. “Manpower is a very difficult issue,” says Attawil. “We have to pay double what we paid just a few years ago.”

There are signs that the increase in rig manufacturing is beginning to bridge the gap between supply and demand. The number of rigs operating worldwide increased to about 3,000 in 2006 from about 1,800 in 2002, and more than 100 rigs will be introduced worldwide between 2007 and 2010, according to Douglas Westwood.

As supply catches up with demand, the growth in rig prices is levelling off. A joint research team of IHS and Cambridge Energy Research Associates of the US reports a 4 per cent decrease in day rates for offshore rigs in the six months to November 2007. Figures from the US Bureau of Labor Statistics also suggest that rig costs are levelling off.

But while the rig market is cooling in North America, in the Middle East it is still strong. Saudi Aramco is set to procure 20 more land rigs in 2008, and a recent exploration licensing round in Libya and Egypt, in addition to the forthcoming Algerian round, will ensure that the North African rig market remains tight.

“[National Oil Corporation (NOC) chairman] Shokri Ghanem said in September that Libya needs 40 more rigs by 2010,” says Attawil. “Bids have been opened for the new gas exploration round and NOC is increasing its drilling activities, so even that might not be enough.”

According to Douglas Westwood, the global rig shortfall will continue until 2011 at least. “Although supply is coming, it will take time,” says Robertson. “It is difficult to paint a picture of a major decrease in prices over the next five to six years.”