Norway can learn from UKCS maturity and costs

Advancing maturity represents a challenge to Norway’s government to improve oil industry conditions and to take less of a diminishing economic rent. It is industry’s challenge to find new solutions and reduce costs. Compared to the UK, Norway may still experience decades of E&P, provided regulatory conditions give the right incentives to industry.

Development trends. In the North Sea, the number of prospects under development rose consistently from the mid-1960s to 1998. The rise was strongest in Norway, where only one field was developed between 1965 and 1973, vs. 10 UK fields. During the 1965 – 1998 period, close to 200 UK prospects were committed to development vs. almost 50 in Norway. In the 1990s, Norway had yet to catch up to the UK’s activity level of the late 1970s.

Over the whole period, the UK committed about 37 billion boe to development, vs. Norway’s roughly 34 billion boe. The UK committed more than half its amount between 1965 and 1979. Norway has, since 1980, committed markedly more resources for development than the UK. Hence, Norway has been developing much larger oil fields than the UK, about three to four times as large. Indeed, Norway seems in the 1990s to be where the UK was in the late 1970s.

With larger fields, Norway has committed much less capital to develop nearly the same amount of resources as the UK. Still, annual oil investment is below UK levels. Hence, average investment per barrel has been consistently higher in the UK. In the 1990s, average investment per barrel rose significantly in the UK, whereas it actually fell in Norway. In constant dollars, Norway’s investment per barrel in the 1990s again is at the UK’s stage of the late 1970s.

A comparison of costs shows that smaller oil companies seem to have an advantage in smaller UK fields in shallow waters, and that large oil companies have their advantage in large fields in deep waters. The general tendency is for large oil companies to consolidate their dominance with deeper waters, and that the importance of the smaller ones diminishes. Another trend during the 1964 – 1998 period is for capital costs per barrel to decline with company size.

When the whole period is considered, large oil companies have the lowest capital costs per barrel in shallow and medium-deep waters. This does not take into account, however, that large oil companies generally have had larger fields than smaller and medium-sized firms. The impact of time and technical development seems to have been greater on smaller and medium-sized oil companies than on the larger ones.

On prospects developed through 1979, large and medium-sized oil companies had a cost advantage over small firms. On prospects developed between 1980 and 1989, large companies were the least cost-effective, while medium firms were the most cost-effective. On prospects developed since 1990, small oil companies are the most cost-effective, while medium-sized ones are now the least cost-effective.

Capital costs on small prospects developed during the 1990s, by water depth, give a clearer picture. On small prospects in shallow waters, small firms have a cost advantage. In shallow and medium-depth waters (to 200 m), capital costs increase with company size. By contrast, large firms’ capital costs decline as waters deepen. Other field characteristics may alter the result. So, during the 1990s, small oil companies were particularly cost-effective in mature UKCS areas.

Large oil companies, on average, have the lowest capital costs, because they have the largest fields. The less-productive acreage represents an additional incentive for smaller and medium-sized firms to be more cost-effective, as a matter of survival. They have to invest more selectively than do large companies. The small oil companies each operate only one or a few small fields, but with a large equity share. By contrast, large multi-national companies usually operate a number of large fields, but with a comparatively low equity share in each. Medium-sized companies are in an intermediary position. Hence, equity also is an important incentive to cost-effectiveness.

Government’s task. With advancing maturity, Norway will face some of the issues that prompted the UK changes in licensing and taxation. Norwegian policies will imitate those of the UK, but with declining field sizes, cost control will be increasingly urgent in Norway. This is an urgent task for the new government. In a mature oil province, competition and flexibility may be more important than economies of scale. A mature oil province also needs specialization – this requires easier sales and acquisition of shares in fields. Norway will face an increasing need for new concepts and new partnerships. With maturity, there also is a need for a more active second-hand market and operator changes. Efficiency requires flexibility in the division of shares and tasks. Development requires more emphasis on specialists and a transfer of tasks. A mature oil province means more differentiated tasks. All oil companies are not equally good at all tasks.

Hence, there is a need for more open competition. This could translate into simpler allocation methods in mature areas. The petroleum tax system must be reviewed. The present system consolidates historical positions for some companies. There are barriers to entry, especially for small explorers and developers. A high marginal tax rate gives undesirable incentives. Moreover, the CO₂ tax functions as a gross excise levy, with negative effects for smaller fields and mature areas. With the required changes, Norway should still be able to experience decades of offshore petroleum activity.

Øystein Noreng is Professor, Norwegian School of Management, and holds the TOTAL FINA chair in petroleum economics and management. He is a regular contributor to this column.