Alexander Kemp, Professor, University of Aberdeen
In 2008, the major oil and gas price fluctuations have dominated the fortunes of the industry in the North Sea. Activity has generally been high, though production has continued to fall. More than 20 new fields came onstream in 2007, but it is highly unlikely that this figure will be achieved in 2008. The numbers of exploration and appraisal wells being drilled have been running at levels considerably in excess of those achieved in 2006 and 2007. This is perhaps the most encouraging feature of the year’s activities. On the other hand, the number of development wells drilled is running considerably below the levels of the past few years. Reflecting this, field development expenditure in 2008 will be less than achieved in 2007.
Cost inflation continued to be a problem for much of 2008, though toward the end of the year there were some signs that the pressures were easing. This is to be welcomed as the dramatic fall in oil prices threatens to jeopardize the viability of some new development projects. The UK Continental Shelf (UKCS) is a mature petroleum province, with the average size of new fields being around 20 million barrels of oil equivalent (boe) and the most likely size being less than that given the log-normal distribution of field sizes.
The Central North Sea has seen most of the drilling activity this year. Some worthwhile discoveries have come out of the significant exploration effort there. Development drilling has also been strong in this sector. In the Northern North Sea, drilling has been noticeably less strong, but this may change next year when the new owners of several mature fields embark on substantial investment programs.
In the West of Shetland region, slow progress has been made toward the development of a group of gas fields. To facilitate their development, new and expensive infrastructure is required. Determining the optimal location of the processing hub and the size and route of the pipeline network is proving very difficult. Third parties have been invited to share in the pipeline and processing hub infrastructure. While the cost sharing has advantages, there are extra complications that arise from the involvement of more parties where interests are not always fully aligned.
If oil prices continue at their present levels, there is a considerable chance that investment will be trimmed next year. Because many of the new fields are quite small, their costs per boe are relatively high. Given that oil companies now generally screen their prospective investments on a worldwide basis and employ criteria that emphasize the productivity of the capital invested, some projects in the UKCS may be screened out in the capital budget collection process, in light of the oil price drop.
The other possible effect on investment in 2009 results from the problems in the financial sector. Companies that need to obtain substantial debt or equity capital may find that their weighted average cost of capital is increasing. When small projects in the UKCS are assessed, it is found that the returns expressed in terms of capital productivity are very sensitive to upward movements in the hurdle rates employed.
The UK government is, of course, anxious to maintain high levels of activity, as production is falling and the UK is a substantial gas importer and now also a (small) net oil importer. Hydrocarbon production remains important to the balance of trade and the public finances. Initiatives relating to the activation of idle blocks and discoveries have already borne fruit, and these will continue. Similarly, under the stewardship initiative, licensees holding mature fields are being encouraged to ensure that every effort is made to maximize economic recovery. Otherwise they must trade their assets.
The issue of tax relief for new investments continues to be debated between the industry and the government. Discussions are in progress on the subject of removing the Petroleum Revenue Tax (PRT) from incremental projects. The investor has to demonstrate that the project in question is not viable with PRT (levied at 50%), but becomes viable when PRT is removed. The effect is to reduce the overall tax charge to 50% from 75%.
The licensee has to prove his case to the satisfaction of the government, and the case-by-case approach - coupled with the likelihood that different investors will employ different assumptions regarding prospective reserves, oil prices and investment hurdles - may make agreement difficult to achieve. Economic modeling by this author suggests that worthwhile extra investment and production could be achieved if relief were given.
All things considered, 2009 should see a healthy volume of activity in the UKCS, but the level may be below that achieved in 2008.
For the longer term, an encouraging sign is the newly announced results of the 25th Licensing Round, which highlight the award of 257 blocks in the UKCS, involving 34 obligation wells. Many medium-sized and small players clearly see worthwhile remaining exploration potential. 
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THE AUTHOR
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Alexander G. Kemp is the Schlumberger Professor of Petroleum Economics at the University of Aberdeen. He previously worked for Shell, the University of Strathclyde and the University of Nairobi. For many years, Professor Kemp has specialized in petroleum economics research, with emphasis on licensing and taxation. He has published more than 100 books and papers in this field. Professor Kemp is Director of Aberdeen University Petroleum and Economic Consultants, providing consultancy in petroleum economics.
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