The Nelson-Farrar Cost Indexes
The Nelson-Farrar Cost Indexes were started by Dr. W. L. Nelson and Dr. Gerald L. Farrar. The indexes were calculated and published in every issue each month by the Oil & Gas Journal and with quarterly summaries in the January, April, July, and October issues. The indexes were originally named the Nelson Cost Index.
Dr. Gerald Farrar was employed by PennWell Corporation. His field of study was in chemical engineering. Dr. Nelson was head of the petroleum engineering department at University of Tulsa, Tulsa, OK. Dr. Farrar’s son, Gary Farrar, personally worked with his father on the indexes, starting while he was attending the Oklahoma State University. It continued as a joint effort until Dr. Farrar’s death in 1995. Since then, Gary has continued the two gentlemen’s efforts. The Nelson-Farrar Cost Indexes were carried by the Oil & Gas Journal until December, 2017.
These indexes are calculated and published in the first issue each month of the Oil & Gas Journal with quarterly summaries in January, April, July, and October. The original indexes were established in 1946 with a value of 100 and are heavily weighted towards the petroleum and petrochemical industries. The Nelson-Farrar Cost Indexes are based upon the following:
-Pumps, compressors, etc. -Electrical machinery
-Internal combustion engines -Instruments
-Heat exchangers -Miscellaneous equipment, average
A more detailed breakdown of each of the above components may be found in annual index summaries and how the index was determined may be found in the November 29, 1978 issue of the Oil & Gas Journal. This index does account for changes in labor productivity.
The Cost of Constructing an Oil Shale Facility
A reliable cost estimate for producing oil shale has proved challenging, if not controversial. The cost of resources extraction had depended on whether conventional underground or strip-mining methods were employed. Because there was a considerable experience in mining, reliable cost estimates could be developed. A second variable – the cost of constructing and operating an oil shale facility – had to be accounted for separately. The former OTA estimated in 1979 that a 50,000 bpd oil shale facility (based on above-ground retorting technology) would have required an investment of $1.5 billion and operating costs of $8 to $13/bbl. Using the Nelson-Farrar Cost Indexes to adjust refinery construction and operation costs of $13 to $21/bbl. This excludes the cost of shale extraction.
In comparison, the cost of building a new conventional refinery has been estimated to range between $2 and $4 billion as recently as 2001. The cost of operating a refinery (marketing. energy. and other costs) averaged nearly $6/bbl during 2003-2004, as reflected by the difference between gross and net margins (where the gross margin reflects the refiner’s revenue minus the cost of crude oil).
Chemical plant cost indexes are dimensionless numbers employed to updating capital cost required to erect a chemical plant from a past date to a later time, following changes in the value of money due to inflation and deflation. Since, at any given time, the number of chemical plants is insufficient to use in a preliminary or predesign estimate, cost indexes are handy for a series of management purposes, like long-range planning, budgeting and escalating or de-escalating contract costs.
A cost index is the ratio of the actual price in a time period compared to that in a selected base period (a defined point in time or the average price in a certain year), multiplied by 100. Raw materials, products and energy prices, labor and construction costs change at different rates, and plant construction cost indexes are actually a composite, able to compare generic chemical plants capital costs.
Using a Cost Index
To update an item cost (equipment, projects) from period A to period B, is necessary to multiply period A’s cost by the ratio of period B’s index over period A’s index, according to the following equation:
As a rule-of-thumb, cost indexes permit fairly accurate estimates for cost escalation if the difference between period A and period B is less than 10 years. Differences between the actual equipment and labor prices and those predicted by the index tend to grow over the years, surpassing the typical error verified in budget-level estimates.
A cost index is merely for a given year showing the cost at that time relative to a certain base year. If the cost at some time in the past is unknown, the equivalent cost at the present time can be determined by multiplying the original cost by the ratio of the present index value to the index value applicable when the original cost was obtained.
Below is an example of the Nelson-Farrar Cost Indexes formally published from the Oil & Gas Journal: