The Most Expensive Place in the World for Oil Companies

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Over the past few years, rapidly rising production costs among energy exploration and production companies have been an unmistakable trend. According to Bernstein Research, marginal production costs among the world's 50 largest public oil companies rose 229% between 2001 and 2010. 

While production and operational costs can vary widely from country to country, one nation stands out as the most expensive place for oil companies to do business -- Australia. Let's take a closer look.

Why Australia is so expensive
A handful of studies suggest that Australia is the single most costly offshore exploration and production location in the world. Operating costs in the land down under are roughly three times what they are in the U.S. Gulf Coast and even slightly higher than Norway -- another uber-expensive drilling location -- mainly because of soaring labor costs.  

Australian oil and gas workers are the highest paid in the world, earning about 25% more on average than their counterparts in the United States. According to a survey by recruitment firm Hays, Australian workers make an average of $163,600 a year to work on projects such as deepwater and onshore oil and gas drilling. 

By comparison, U.S. oil and gas workers pull in about $121,400 a year on average, making them the fifth best-paid workers anywhere in the world. The second and thirst most expensive locations for oil and gas employers are Norway and New Zealand, where workers can expect to earn average annual salaries of $152,600 and $127,600, respectively. Meanwhile, at the other end of the spectrum is Sudan, where the average salary is just $31,100.  

In addition to high labor costs, a strong local currency has also contributed to making Australia the most expensive offshore exploration and production location in the world. The Aussie dollar soared to a nearly three-decade high earlier this year, though it has since retreated. If it reverses its downward slide and starts rising again, further investment in oil and gas projects may not be forthcoming.

Australian LNG projects under threat
Energy companies operating in Australia are currently developing seven liquefied natural gas export projects -- worth nearly A$200 billion -- at the same time. But budget overruns and project delays are casting major doubts on the profitability and viability of these projects.  

For instance, Chevron (NYSE: CVX  ) said in December that its budget for the Gorgon LNG project in Western Australia had spiraled to A$52 billion, representing a 21% increase from the oil major's previous estimates. Cost blowouts such as these are already leading many companies to reconsider their operations in the country.

For instance, Woodside Petroleum, Australia's biggest oil and gas producer, shelved its Browse LNG project because of the project's deteriorating economics, while Royal Dutch Shell (NYSE: RDS-A  ) and its partner PetroChina may hold back on the $20 billion they were planning to spend on the Arrow LNG project in Queensland. 

Why Australia is vulnerable
Australia was one of the lucky few developed countries to emerge from the global financial crisis relatively unscathed. Strong demand for commodities attracted a flood of foreign capital seeking outsized returns from the resource-rich nation's mining boom, propping up the Australian dollar and housing prices in major cities.

Unfortunately, however, Australia's economy is highly leveraged to China's economy and its demand for commodities; about a quarter of Australian exports end up in China. Therefore, when demand from China slows, the impact can be felt in Australia, as operators may be forced to curtail capital spending to rein in costs.

For instance, Rio Tinto (NYSE: RIO  ) sounded a warning as early as 2011 that spiraling labor costs and a strong Australian dollar were hurting the company's profits and would put pressure on the mining giant's expansion plans in the country. Not long after, BHP Billiton (NYSE: BHP  ) announced that it would scrap or shelve new projects in an effort to slash operating costs.

Final thoughts
As you can see, Australia's sky-high operating costs and exceptional vulnerability to a slowdown in China's economy are threats that shouldn't be taken lightly. Many are also growing concerned that Australia could have a property bubble of epic proportions on its hands, which -- if it crashes -- could have devastating consequences for the nation's banking sector, which some have characterized as inadequately capitalized. 

If Chinese economic growth deteriorates over the next few years -- as I argued last year it probably will -- Australia's decades-long resource boom could come to a screeching halt. As the Asian financial crisis of the late 1990s illustrated, foreign capital inflows can temporarily prop up an economy, disguising its weak underlying fundamentals. But when that money decides to chase returns elsewhere, the reversal of capital flows can wreak havoc.

Exploring for and producing oil and gas in Australia may have gotten extremely expensive over the years. But in North Dakota's Bakken shale, it's getting cheaper. Companies such as Kodiak Oil & Gas continue to report major progress in slashing costs and boosting both production and reserves. Though the company is a dynamic growth story that offers tremendous opportunity, it also comes with great risks. Before you hitch your horse to this carriage, let us help you with your due diligence. To find out whether Kodiak is currently a buy or a sell, you're invited to check out The Motley Fool's premium research report on the company, which comes with a full year of updates and analysis as key news breaks. To get started simply click here now.

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Arjun Sreekumar

Arjun is a value-oriented investor focusing primarily on the oil and gas sector, with an emphasis on E&Ps and integrated majors. He also occasionally writes about the US housing market and China’s economy.

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