• Text size      
  • Send this article to a friend
  • Print this article

Over a barrel

ENERGY Secretary Ed Davey received a report last week that offers a tantalising £200 billion boost for the UK economy - or the Scottish economy, predominantly, if this country votes yes in the referendum.

Sir Ian Wood spoke to Norwegian regulators
Sir Ian Wood spoke to Norwegian regulators

The report proposes strategy and policy changes that aim to maximise the recovery of oil and gas from the North Sea as resources there continue to dwindle.

But to realise this goal, the UK Government will have to break with central tenets of industrial policy followed by governments of left and right for 30 years, namely ending light-touch regulation and along-term economic strategies.

The report, which will not be made public for a few weeks, was put together by Aberdeen oil veteran Sir Ian Wood at the request of the Government. Wood interviewed 40 companies representing more than 95% of UK continental shelf (UKCS) production, along with Government officials, and regulators from neighbouring territories such as Norway.

An interim version was released in November and was widely welcomed by the UK Government, the Scottish Government and the industry. This industry approval came despite the fact that the implications are radical to say the least and could seriously impact profit margins for the majors, although Wood avoided joining up most of these awkward dots. This didn't stop the Prime Minister saying on the record that the report needs implemented.

"The Wood Report is an excellent report and we are looking to put that in place," he told the House of Commons on December 18.

To date, the UKCS has produced the equivalent of 41 billion barrels of oil and there is an estimated 12 billion to 24 billion barrels still left. But despite a record £13.5 billion investment in 2013 thanks to Coalition tax sweeteners for the sector, extraction continues to fall.

Figures from industry body Oil & Gas UK estimate 1.4 million barrels of oil equivalent (BOE) per day were produced in 2013, down from the 1.55 million in 2012.

Over the past three years, production has fallen in the North Sea by 38%, resulting in £6bn less in tax receipts for the Treasury. Exploration has also declined to the point that less than 50 million barrels was discovered in 2012 - a small fraction of that found in the 1970s heyday.

This remorseless decline has prompted most major oil firms to cut exposure to the North Sea. Shell's intentions were being scrutinised late last week after speculation over whether it would be forced to sell off assets to shore up flagging profits.

Wood believes if his recommendations are fully implemented it will mean an extra three to four billion BOE recovered, worth an estimated £200bn to the economy.

The report's key ­recommendations include setting up an arms-length industry regulator and adopting a new strategy for maximising recovery.

Wood pointed out the UKCS has over 300 fields in production but the regulator has fewer than 50 personnel. In contrast, the Norwegian Petroleum Directorate has 220 staff.

"We definitely need tougher regulation," says Bob Ruddiman, global head of energy and natural resources at Pinsent Masons. "There are some very good people at DECC [the Department of Energy & Climate Change] at the moment but there just aren't enough of them."

For Andrew McCallum, director of corporate affairs at Dana Petroleum, a middle-sized exploration and production company now owned by by Korean interests, head-count is not the only issue.

"If there's a lack of incentive to work together then individual operators are going to be interested in their individual commercial goals.

"Like any industry there are lots of codes of practice but if the fundamentals of the business and the way the industry works are not aligned to them they are going to fail."

He added: "Ian Wood is proposing the ­separation of the regulatory function from DECC. He is pointing towards a regulator with more power and a clearer mandate to effect change around the way the companies work together and collaborate."

Central to the issue of how companies work together is infrastructure such as pipelines and access to electrical power. UK pipelines are pretty much exclusively owned by the large oil firms. A smaller company looking to piggy-back a major's piece of infrastructure will face delays and high tariffs.

The reason why this is important is that maximising extraction depends heavily on smaller players buying acreage from the majors once the easiest, highest-margin petroleum has already been taken out of the seabed.

AT this stage, the majors want to sell on the acreage or at least reduce their stake so that they can re-invest their money in easier plays elsewhere. It becomes easier for the smaller players to make the numbers work if infrastructure costs are lower - though this would involve the majors giving up income.

"The difficulties of trying to access infrastructure is a huge issue in the North Sea," says Graham Stewart, chief executive of niche explore-producer Faroe Petroleum.

"In Norway, they have tackled this in a completely different way. They introduced laws to ensure infrastructure is available and at sensible rates."

The Norwegian sector also has non-oil companies owning and operate the pipelines - which would be another radical change for the UK. The Norwegian firms are more like our National Grid.

"They don't have to make as much money from those pipelines," says Stewart. "A utility infrastructure owner might look for 5% or 10% rate of return but an oil company might be looking for 20% or more.

"A UK pipeline owner is going to charge a lot more to access a pipeline. It's a fundamental difference. Ownership of the pipelines in Norway has been forced out of the hands of the oil companies and into the hands of separate companies."

The chance to replicate this infrastructure model has been on the table before. Five years ago, as the Laggan Tormore fields west of Shetland were developed, having pipelines owned by non-oil companies was discussed

"That discussion didn't go very well," says Stewart. "It was left to Total to build the pipeline from Laggan to Tormore to the Shetlands and then on to the UK. This meant you didn't have an open-access pipeline, which could have been a much bigger 30-inch pipeline rather than a 20-inch.

"That would have allowed much more volume through and at a lower price. Other fields could have been discovered and developed using that open infrastructure. That was a lost opportunity in my view but it doesn't mean it can't happen in the future."

Wood's report also stresses the need to boost the level of exploration in the UKCS. A report out last week from Deloitte's Petroleum Services Group (PSG) highlighted the scale of the problem.

Only 47 exploration and appraisal wells were drilled on the UKCS in 2013, compared with 65 in 2012 - a fall of 28%. In that period, the Norwegian continental shelf saw a 41% increase in drilling activity.

One reason for the poor UK rate, says Hamish Wilson of drilling specialist SLR Consulting, is the poor quality of data available to the newer entrants to the UKCS.

"Exploration in the North Sea has not been very successful over the last couple of years. What is concerning is that from 28 wells costing between $20m and $50m (£12m to £30m), we only got 20 to 30 million barrels of oil.

"That's not a good investment. The investment community is seeing a lot of dry wells being drilled. We need much better exploration. Over the last five years there has been a huge increase in seismic technology, including 3D broadband seismic.

"This provides good quality data but it's the majors who have that technology."

Many of the smaller companies still use old models, so it is understandable the exploration success rate is so low. This makes accessing finance harder for the companies involved, though again it is hard to imagine the likes of BP and Shell gifting their cutting-edge data to the also-rans.

"Access to finance is a chicken-and-egg situation," says Wilson. "Investors invest if they believe they will get their money back.

"Improved geoscience, together with new technology, can be presented to the investment community to help persuade them that you are doing things differently and in such a way that the chances of making a profit are increased."

A related issue is the UKCS tax regime. It was outside the scope of the Wood review but all parties interviewed stressed the role of HM Treasury in the industry's future.

"Norway has improved the attractiveness of Norway as a place to explore," explains Stewart. "In 2005, it introduced a new tax regime. The tax take in Norway is higher at 78% compared to 62% in the UK.

"But what they do is that even if you have no production and therefore no tax shelter, for every pound you spend on exploration they will give you back 78p the following year. In the UK you can only claim back investment on exploration if you are paying tax on profits."

For smaller companies that want to explore this is a catch-22: they often don't have enough production to get a tax shelter. "Prior to 2005, the UK's exploration activity was much much higher than in Norway," Stewart adds. "Now many more companies have arrived in Norway and it enjoys much more exploration and as a result they are making many more discoveries. If you stop exploring you'll never get more than you've already discovered."

The danger with Wood's report is it has raised expectations that longstanding difficulties such as the tax problem and relations between the majors and the rest will be tackled. But the industry is behind change.

"The bottom line is that the industry needs to change," says Dana's McCallum. "If it doesn't then the UK and Scotland won't enjoy the benefits of the 12 to 24 billion barrels that remain."

Quite apart from the boost to North Sea jobs and the increased revenue from a successful implementation of the Wood Report, the prospect of the UK Government opting to beef up regulation and introduce long-term thinking signals a sea-change in industrial policy. The wider economy should take note.

Contextual targeting label: 
Business

Commenting & Moderation

We moderate all comments on HeraldScotland on either a pre-moderated or post-moderated basis.
If you're a relatively new user then your comments will be reviewed before publication and if we know you well and trust you then your comments will be subject to moderation only if other users or the moderators believe you've broken the rules

Moderation is undertaken full-time 9am-6pm on weekdays, and on a part-time basis outwith those hours. Please be patient if your posts are not approved instantly.

209900