North Sea oil and gas: reaping the benefits of discipline?

This article explores the positive transformations made in the UK Continental Shelf in recent years while noting the need for renewed exploration and investment.

20 November 2018

By Andrew Meaden

Oil & Gas UK recently published its 'Economic Report 2018' ("Report") which provides a comprehensive assessment of the state of the UK's offshore oil and gas industry. The Report finds that the industry, which is in its sixth decade of production, is in a period of reinvention and transformation made necessary by both the maturity of the UK Continental Shelf (UKCS) basin and the 2014 collapse in the oil price. The Report highlights areas where positive transformations have been made and also points to areas of ongoing concern.

Positive transformations

Cost cutting

According to the Report, the cost of operating assets in the UKCS fell by almost 30 per cent between 2014 and 2017 (43 per cent in US dollar terms) from £9.8 billion to £7 billion. Cost reduction has been a top priority for oil and gas companies operating in the UKCS in recent years. Such reductions have been achieved through a range of methods, including stricter decisions on cost control, reduced capital expenditure, reductions to staff headcount and requiring that the supply chain shares the 'pain'. This marks a contrast with the pre-2014 position of cost escalation and price inflation.

Increase in oil price

Increased cost discipline combined with an unexpected increase in oil prices in 2018, has resulted in many companies being in far more robust financial health than in previous years. Indeed, the Report states that this year the UKCS could generate free cash flow levels in excess of £10 billion for the first time since 2010. One must note however that the majority of the free cash flow is being generated by a small number of companies and that, in particular, supplier companies are still facing significant financial challenges.

Regulatory and fiscal changes

The Report welcomes the host of regulatory and fiscal changes introduced by government and regulators in recent years in furtherance of the Maximising Economic Recovering (MER) strategy. These changes are aimed at enhancing the competitiveness of the UKCS and include:

  • The introduction of the Innovate Licence to replace the Promote and Frontier Licences. Amongst other things, the Innovate Licence allows applicants to propose the duration of a licence’s terms, permits earlier exit than previously allowed and reduces the licence fees that are payable.
  • Reductions to both the Petroleum Revenue Tax and the Supplemental Charge under the 2016 budget.
  • Allowing, with effect from November 2018, the tax history of an oil and gas field to be transferred from seller to buyer when it is sold. This will enable buyers to claim greater tax relief when the field is eventually decommissioned. Under the outgoing rules, where such a tax transfer is not permitted, the decommissioning costs can be prohibitive to new investors in the UKCS, especially smaller companies.

The above changes have widened the pool of investment in the UKCS and opened up opportunities for smaller players and even new types of investor, including private equity. Such new entrants have widely been acknowledged to have brought a greater degree of urgency and pace than was previously evident.

Areas of concern

Decline in exploration and investment

While production has increased by 16 per cent between 2015 and 2017, the Report notes that over the last five years there has been a 50 per cent decline in the level of drilling activity. This is exemplified by the fact that only 4 exploration wells were spudded in the first half of 2018. As the discovery of new volumes is crucial to the replenishing of the pipeline of projects, this decline poses serious questions about the ability of the industry to maintain production levels over the medium term.

According the Report, unless there is a significant increase in the rate of exploration and an acceleration in new fields gaining development, it is likely that post-2020 the UKCS will experience a period of accelerated production decline. To avoid this, investors will need to change their current approach, which is primarily focussed on investment in brownfield projects at the expense of potential new projects.

Conclusion

In recent years, the industry, government and regulators have collectively made changes that have made the UKCS more competitive than it was only a few years ago. Indeed some companies are making more profits now with an oil price of around $70-80 dollars a barrel than they did prior to the price collapse in 2014. However, in order for the industry to achieve its 'Vision 2035' objective of recovering at least 10 billion boe by 2035, it is necessary that it moves out of retrenchment and commits to a period of renewed exploration and investment in the UKCS.

How can Burges Salmon help?

Burges Salmon’s Oil and Gas team offers a wide range of legal services for upstream, midstream and downstream oil and gas matters. Through our activity in the sector’s key industry groups we ensure we are well placed to assist our clients to meet the challenges posed by current market conditions and capitalise on opportunities.

Key contact

James Phillips

James Phillips Partner

  • Head of Oil and Gas
  • Energy, Power and Utilities
  • Environment

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