Equipment and service costs are still falling for E&P companies in the U.S., providing some cushion as commodity prices continue to lag peak 2008 levels. But that trend may end later this year, says J. Boyd Heath, chairman and chief executive of Network International, the online equipment marketplace with customers in 60 countries.

“The clear message we get from operators, analysts, manufacturers and service companies is that we are at or near the bottom and things will be picking up. The debate is, does the recovery come in the first half of 2010 or the second half?”

In addition to oil and natural gas, other commodities such as iron ore and copper soared last year and then fell precipitously from year-end through first-quarter 2009. Now they are stabilizing or in some cases, inching back up, he said.

“There’s a lot of stuff in play. In our space, a key indicator is iron ore prices, which influence steel and equipment manufacturing, and in turn, oil country tubular goods (OCTG),” Heath told the Houston Energy Finance Group recently.

Global steel mill capacity utilization is about 45%, the lowest it’s ever been, as the mills are being very disciplined, he said. Casing and tubing prices spiked in first-half 2008, then fell hard and now there is 13 months of pipe inventory on hand. Spot market buying is down from 2008 levels.

“A pick up in U.S. gas drilling would have a much larger impact on pipe inventories because those wells tend to be deeper and use more pipe.”

However, Chinese imports of iron ore were up 30% in first-half 2009 and world spot prices are rising again, he said, thanks to the massive Chinese stimulus package taking hold.

“Some steel mills are putting through small price increases, not because demand is up, but to test the market,” Heath said.

Prices for nickel used in tubing, piping and valves also saw a clear bottom and are ticking upward, as are prices for precious metals.

“Scrap metals are hugely influential, and while they hit bottom last summer, we are seeing prices stabilize now.” In addition, prices for well stimulation materials—sands, acids and other chemicals—have stabilized and in some cases, risen since March 2009, he said.

Meanwhile, Morgan Stanley E&P analyst Stephen I. Richardson says operating costs continue to decline: “A common theme from the first week of second-quarter earnings season was lower operating costs, which have exceeded both our and consensus' estimates.

“Newfield Exploration Co., EnCana, Range Resources Corp. and Cabot Oil & Gas Corp. beat consensus estimates driven primarily by lower costs. For E&Ps that have reported, average lease-operating expense (LOE) declined 10% sequentially and now stands 17% below year-ago levels,” Richardson says in a recent research note.

“EnCana indicated upstream capital costs are down 10% to 15% year-over-year, and likely to fall further. This view was confirmed by Oxy and others who continue to renegotiate supply and service contracts. From the supply side, Halliburton confirmed a view that costs are likely to remain under pressure in 2H09 until activity rates pick up,” Richardson says.

Given these lower service costs, producers expect to maintain activity levels at flat to declining capex levels in 2010, Richardson says.  

—Leslie Haines