High Drilling Cost: Efficiency’s Main Challenge

High Drilling Cost: Efficiency’s Main Challenge

By Mahinaz El Baz

The fall of international oil prices has forced industry players to consider controlling, optimizing, or cutting drilling cost to increase efficiency and maintain positive profitability ratios. Drilling a well is a costly process with a high element of risk that requires strict monitoring. Exploration and production (E&P) companies may spend 50% or more of their capital budgets on drilling and completion costs.

Some companies—those with large unconventional resource components—may spend much more, according to RISC’s analysis on well-cost reduction. It is essential for most international oil companies (IOCs) to develop drilling techniques and implement new technologies that reduce drilling costs.

High Drilling Cost: Causes and Solutions

The high cost of drilling and completion (D&C) is considered one of the biggest challenges facing E&P companies. For an average offshore oil and gas operator, D&C accounts for about 40-50% of total capital expenditure; for many onshore operators, these costs can be as high as 65%, according to a study conducted by McKinsey & Company. “Drilling is a very expensive operation, especially offshore drilling,” Ahmad Shehata, Directional Drilling Services Coordinator at Schlumberger, noted. For offshore wells, about 70-80% of these costs are time related, suggesting that any compression in delivery time will have a direct benefit to the bottom line, noted the study.

Different factors impact the drilling cost during different stages. Major aspects impacting drilling cost include drilling footage, drilling cycle, formation, well type, drilling accidents and failures, surface casing, production casing, drilling bits, the components of drilling fluids, and different well sketches, according to a research paper by Qu et al. On average, half of this cost is in leasing rigs and the remaining half is in equipment, engineering services, consumables, and project management. Although there are many factors that affect drilling costs, drilling footage and the drilling cycle are the main components of the total drilling cost, according to a study on drilling cost optimization in hydrocarbon fields by Bahari and Seyed. Moreover, the drilling cost can be divided according to impacting factors into fixed and variable costs. The fees that are not affected by the drilling footage and drilling cycle are called fixed costs. The expenses that are influenced by the drilling footage and drilling cycle are called variable costs, according to Qu et al.

In many locations D&C costs are much higher than they need to be. Many of the factors that influence coast are within the control of the E&P company—such as ageing equipment, superseded technology, a non-aligned contracting and procurement process, inefficient specification, design and operating practices, sub-optimal continuous improvement processes, lack of organizational empowerment, and limited competition for service. On the other hand, there are factors out of the company’s control, such as low activity levels, high labor costs, remote operations, weather conditions, and lack of infrastructure, according to RISC.

High drilling costs directly affect profitability by increasing the breakeven reserve volume and/or prices. RISC’s analysis shows that a D&C cost reduction of 50% or more is necessary to monetize the substantial potential that exists in many portfolios in some cases. In addition, drilling returns depend on the cost to drill and complete a well, plus ongoing production costs versus the cash inflow from the sale of the oil and natural gas produced from the well. Cash inflows depend on commodity prices and the volume of production, a study by CBRE Clarion Securities notes. The two key variables, aside from oil and natural gas prices, are costs and production volume. Efficiency gains arise from either a reduction in costs or an increase in production. Maximizing cost reductions can be achieved through optimizing five levers, according to McKinsey & Company.

The first lever is to drive learning curves rigorous portfolio and planning optimization at all levels, in order to prevent overwork and thus reduce the steepness of the learning curve. Optimizing this lever can achieve up to a 20-25% reduction in the average cost per well. The second lever is about standardizing and simplifying wells to reduce unit costs, a proven cost-reduction method that enables improvements in several other related areas. The potential cost reduction of up to 10-15% arises through several related mechanisms. Furthermore, the third lever includes initiatives to reduce non-productive time (NPT) and improve efficiency. This lever is a collection of many smaller efforts that have been proven to provide at least a 5-10% reduction in total well delivery costs. Applying a normal toolkit to prevent rework, reduce waiting time, eliminate contingencies, and enable processes to be executed at the same time—instead of in sequence–can cut NPT in half.

Procurement and supply chain management (SCM) is a key driver of cost reduction. 90% of the industry’s capital spending and 70% of its operational expenses are for contracted services and products. Hence, the fourth lever refers to basic procurement best practices. Implementing better practices can reduce costs by 10-15%—a significant step toward the 50% target. However, this requires a fundamental rethinking of commercial models and an aggressive approach to take advantage of the current market downturn. Many experts believe the downturn may offer even greater potential savings. Finally, rigorous performance management is required to revitalize the performance drive, and that alone has been proven to reduce well costs by up to 5-10%. As wells are hard to compare, operators tend to view each drilling job as different and resist ambitious targets for time improvements. With the standardization of drilling plans, it becomes easier to set bold targets.

Discussing the current and potential methods to reduce the cost of drilling a well in Egypt, Shehata thinks that cost reduction can be achieved through planning and experience sharing between the operators and the service providers under the supervision of the Ministry of Petroleum and Mineral Resources. Moreover, he believes that investments in training and human capital will also reduce the cost.

Drilling Techniques: From Vertical to Horizontal

IOCs are developing drilling techniques to reduce the high costs of D&C. Horizontal and vertical drilling are two different techniques that are used to explore and develop oil and natural gas. Horizontal drillingsometimes referred to as directional drilling“involves drilling a well to a predetermined depth based on seismic and other geological data and then turning the well horizontally to a set lateral length. The well is then completed and the production of oil and natural gas begins,” according to bizfluent. On the other hand, “vertical drilling involves drilling a well straight down into the earth until the drill bit reaches the formation being developed. The well is then completed and starts producing oil or natural gas.”

Horizontal drilling has become more common recently, according to bizfluent. “Wells drilled horizontally are much more productive than vertical wells, due to extended contact with the formation,” the website states. “The achievement of desired technical objectives via horizontal drilling comes at a price,” according to Lynn Helms. The average horizontal well is more expensive and is more technically difficult to drill than the average vertical well. “A horizontal well can cost up to 300% more to drill and complete for production than a vertical well directed to the same target horizon,” Helms continues. Despite their higher cost, an increasing number of horizontal wells are being drill around the world, according to Roy Nurmi writing the Middle East Well Evaluation Review. “Although drilling a horizontal well is more difficult than a vertical well […] the benefits greatly outweigh the challenges,” explained Marek Bartlomowicz, Technology and Performance Manager at Husky Drilling.

Deciding to go for horizontal or vertical drilling is associated with some technical and financial factors. In an oil reservoir which has good matrix permeability in all directions, no gas cap, and no water drive, the drilling of horizontal wells would likely prove to be a financial folly as a vertical well could achieve a similar recovery of oil at lower cost. However, when low matrix permeability exists, the greater exposure to the wellbore provided by horizontal drilling could produce greater dividends, according to the Office of Oil and Gas at the Energy Information Administration.

Horizontal drilling becomes financially viable, even the preferred option, when the reservoir rock is on a horizontal plane or when gas or water coning could be expected to interfere with full recovery. In these circumstances, horizontal drilling can produce 2.5 to 7 times what a vertical well can produce.  The higher production rate results in a higher rate of return on investment for the horizontal project than would be achieved by a vertical project, Helms noted.

Drilling a horizontal well includes many benefits. In addition to the higher production rates, the developing cost for many horizontal-well projects—defined as well cost divided by well reserves—is about 25-50% lower than the cost of buying proved reserves. Fewer horizontal wells are needed as compared to vertical wells to produce the same amount of oil. This results in a reduced need for surface pipelines and locations, according to S. D. Joshi.  “Horizontal drilling is better for the environment, because multiple horizontal wells extending in different directions can be drilled from a single pad site, effectively reducing the surface environmental footprint,” said Bartlomowicz.

On the other hand, horizontal drilling has distinct disadvantages in addition to the higher drilling costs. Notably only one zone can be tapped by a horizontal well. If the reservoir has multiple pay-zones—especially with large differences in vertical depth—or large differences in permeabilities, it is not easy to drain all the layers using a single horizontal well.

In Egypt, the government is making efforts to cooperate with energy firms. IOCs tend to avoid horizontal wells due to their high costs; however, the government should encourage firms to drill them, Ahmed Shohdy, Development and Operation Geologist at Saudi Aramco, argues.

New Trends and Technologies

As low oil prices negatively affect both industry profits and cost estimations, industry “operators are turning, in part, to technological solutions and innovative techniques to reduce drilling cost and increase capital efficiency in the short-term,” according to an analysis from IHS Markit.

“Rapid changes in price, such as the halving of the oil benchmark between 2014 and 2015, naturally bring into focus the need for oil companies and their suppliers to reduce costs to maintain viable returns. Technology helps on two fronts. The first is in raising short-term production, the key denominator in the cost-per-barrel equation. The other involves attacking capital costs and operating expenses head on. Both place an emphasis on efficiency,” said Paul Markwell, Vice President of Upstream Oil and Gas Consulting and Research at IHS Energy, according to IHS Markit’s press release.

Experts argue that investing in drilling technology should be viewed as a long-time strategy. “Producers must commit to unwavering innovation through the oil and gas price cycles if they are to meet demand safely and at competitive costs,” Markwell said, according to IHS Markit. In the course of technological innovation, increased investments will stand in contrast with the aim of cost-saving and profit-taking. If investments in technological innovation are reasonably planned, short-term costs could rise but higher long-term production should offset it, according to Qu et al.

Creating a balance between petroleum supply and demand represents a real challenge for IOCs. In 2014, the increase in the global supply of petroleum and other liquid fuels was almost twice the increase in consumption, according to estimates by the US Energy Information Administration. As a result, companies are aiming to apply drilling technologies to help in improving their operations in a few fundamental areas.

Scientists argue that companies should focus on decreasing rising well costs, lowering operating costs, or streamlining business functions in the well life cycle. “Organizations operating in this sector know firsthand that continued success means being able to constantly improve efficiency for capital deployments. As a result, finding new avenues for efficiency is an ongoing concern,” according to Capgemini Insights & Data.  “To meet demand and remain competitive…operators are pursuing a range of cost-cutting and efficiency initiatives including automation, hiring robots, and mechanization of high-cost, repetitive oil and gas activities, such as drilling,” Manufacturing Engineering writes. Furthermore, some IOCs are willing “to apply data-driven analytics to draw key insights from high-volume data streams, such as detecting when a piece of drilling equipment is going to fail or identifying ‘sweet spots’ in unconventional oil and gas plays. In still other instances, operators are increasing their use of mobility technologies to improve the efficiency and effectiveness of their field workforces,” according to James D. Sawyer, writing for Advanced Manufacturing.

Application in Egypt

Applying new drilling technologies is expected to benefit the petroleum industry in Egypt, providing decision makers with accurate information and more advanced analysis to help forecast production. Furthermore, collaboration between IOCs and national oil companies could transfer new drilling technologies to Egypt if managed efficiently by the Ministry of Petroleum and Mineral Resources, according to Shehata.

Maintaining profitability in an era of relatively low the oil prices has become more challenging. The combination of falling fuel prices and the rising costs associated with drilling and hydraulic fracturing have squeezed profit margins, making greater efficiency vital for producers’ success. As a result, IOCs have adopted a number of measures to cut drilling costs and increase efficiency. Quantitative analysis in many case studies shows that lower drilling costs could carry significant benefits in the low-price environment.


Dr. Mahinaz El-Baz 318 Posts

Mahinaz El Baz received her PhD degree in International Economics from Helwan University in 2022. She has +10 years of experience in journalism and economic analysis. She received the "Best Economic Article Award" in 2016 from CFA Society Egypt.


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