This point first surfaced a few months ago when Shell muttered darkly about the high cost of building its Sakhalin Island LNG project off the coast of Russia – and then admitted that the budget had doubled to around $US20 billion.

For a while everyone assumed that Shell had botched its original costings, perhaps a comment on the Anglo-Dutch oil giant’s freshly-acquired reputation for being accident prone – while leaving a question hanging: how could anyone mis-cost a project by $US10 billion?

But it now seems that Shell’s horrific cost blow-out at Sakhalin was not an isolated incident. Just witness what’s happening at a liquefied natural gas project closer to home.

Chevron’s Gorgon project is widely reported to have risen in cost from $US11 billion to $US15 billion, but the final budget might actually be a lot higher, if it ever gets environmental approval, or is not first forced to abandon its preferred Barrow Island location.

Everyone in the petroleum industry is being hit by spectacular increases in costs. And the long-term implications are only just sinking in because a cost explosion cuts very deep indeed, especially when the oil price itself has tumbled from its giddy mid-year heights, creating a classic pincer move of rising costs and falling revenue.

To those wondering where The Slug is going with this latest ramble, there is a one-word answer: inflation.

Understand that the oil patch, and much of the rest of the resources world is trapped in a spectacular inflationary bubble, and you will start to grasp that there is a game-changing event underway.

Inflation, for engineers who spent too much time designing structures and worrying about flow rates, is the worst enemy of business. It is as corrosive as sour crude, and can destroy a business overnight.

In fact, unchecked inflation can destroy entire countries – and do a thorough job on making a god-awful mess of the world because of the way it changes values and inhibits investment.

The most striking example was how inflation crippled the German economy in the 1920s. Rather than collecting a fistful of marks for a week’s work, people collected their cash by the wheelbarrow load, jobs disappeared and a chap with a funny moustache, answering to the name of Adolf, hijacked the country.

The Slug is getting a little over-excited, but the great German hyper-inflation of 80 years ago is an extreme example of what can happen when costs skyrocket, values are destroyed, budgeting become impossible, and businesses call “time out”.

For the petroleum industry today, inflation is doing just that. So it should hardly a surprise that some companies are shelving “mega” investment decisions until normality (whatever that is) returns.

Sakhalin is a severe example of what’s afoot. Gorgon is another, although perhaps not as severe.

But, measuring degrees of severity is not the game. The game is all about whether soaring capital costs, and their closely-related cousins called operating costs, can destroy the financial viability of a project in a climate of falling oil prices.

Imagine that you’re a director of a supermajor. Take a close look at what the engineers and cost accountant are putting forward as (a) future investments, and (b) the profitability of those investments.

In the investments category you will find a blank space where someone ought to have listed the “final cost” number. Why? Because the poor darling preparing the board papers simply doesn’t know.

It’s the same in the future profitability category, where best guesses are replacing rock solid numbers.

The problem is that no one really knows the future price of stainless steel, or cement, or copper. The cost accountants hope it will be lower, but hope is not an acceptable budget item.

This is the start of the problem. Inflation, caused partly by the oil price itself, and partly by China’s demand for raw materials, has driven the cost of every commodity sharply higher.

Worse still, costs are continuing to rise as two other events occur in the global economy. Interest rates are also rising as central banks launch their attacks on the inflationary demon, and the price of oil is falling.

It is at this point that you, in your new position as a director of a petroleum supermajor start to realise a couple of pertinent facts of life.

First, that the costs side of your business is spiralling out of control. Second, that the revenue side of your business is falling.

What do you do?

There are three possibilities. You could charge ahead as an act of blind faith and hope that costs – and the oil price – stabilises. You could go on a long holiday to Tahiti. Or, you could tell everyone to stop what they’re doing, unless it is essential to the company’s day-to-day working.

Some people known to The Slug would take the holiday. The engineers he knows would charge ahead because they just love building things and budgets are for sissies.

Sensible people would push the stop button. And that’s just what appears to be happening at Gorgon. Until the boards of the three companies being asked to make a massive investment commitment to Gorgon are satisfied that the costs side of the project have been nailed down, and that the revenue side has stopped sliding, the do-nothing option becomes the wisest choice.

What does this mean for the petroleum patch?

Expect a classic inflation-fighting reaction. The weakest projects, and those without rock-solid budgets, are mothballed. Only the best proceed, and slowly, inflation is squeezed out of the system.

So, if you’re planning an investment, or a career move, think very carefully about who’s got their budget under control. Because if they haven’t got a firm grip on costs, you’d better get ready for someone to press the big red stop button.

First published in the November issue of Petroleum magazine