UKCS investment boom continues

ALEXANDER G. KEMP, Professor of Petroleum Economics, University of Aberdeen

The year 2012 has been one of contrasts on the UKCS. Field investment could end up at a record level of £11.5 billion (US$18.4 billion), compared to £8.5 billion (US$13.6 billion) in 2011. The increase is due principally to the coincident development of a group of large, expensive projects, such as Clair Ridge, Laggan and Tormore fields, and the redevelopment of Schiehallion field. These fields are located West of Shetlands and contain substantial reserves. It should be noted that the current record level investment also reflects decisions made before the various tax reliefs announced in Budget 2012 and more recently. Field operating expenditures are also at record levels and could be around £7.5 billion (US$12.0 billion) for 2012. The result is that, currently, the supply chain is fully stretched, with widespread shortages of skills and consequential cost inflation.

Mixed statistics. But other activity indicators are disappointing. Thus, oil and gas production, which, together, fell 19% in 2011, have continued their sharp declines in 2012. To a substantial extent, this has reflected increases in downtime on the production platforms. The ever-increasing interconnected-ness of platforms and pipeline infrastructure has resulted in knock-on effects of production shutdowns. There are many platforms producing well beyond their design lives. Thus, 15% are more than 40 years old, and 33% are more than 30 years old. Increased attention to asset integrity is needed for production purposes, as well as for safety reasons.

Exploration activity has also been at low levels. In 2011, only 14 exploration wells were drilled, compared to 28 in 2010. For the first nine months of 2012, 14 wells have been drilled, and only a modest increase over 2011 can be expected for the whole year.

But there are encouraging signs for 2013. The field investment boom will certainly continue, with around £11 billion (US$17.6 billion) likely to be spent. Operating expenditures should be around £7.5 billion (US$12.0 billion). There should also be a modest increase in total hydrocarbon production, from around 1.8 MMboed to around 2.0 MMboed. There is good reason to expect that oil production, in particular, should continue to increase over the next few years. But this is dependent on the amount of unplanned downtime being significantly lower than in the last two years.

Regulatory changes. In Budget 2012, the UK government introduced significant increases in tax allowances for new field investments against the Supplementary Charge (SC). This action was followed up by the announcement of further allowances in the summer and autumn. The latter was for brownfield investments. The net effect of these allowances should be to substantially increase investment over the medium and longer term.

These allowances should also have a favorable effect on exploration. In particular, the doubling of the allowance for small fields against SC significantly increases the full-cycle returns from new exploration efforts. Evidence that the tax incentive is likely to increase exploration comes from the results of the 27th Round of licensing, which were announced at the end of October. Thus, 330 blocks were offered to applicants, with a suggestion that several more could be offered. So, 61 other blocks are still being subjected to environmental assessment. Out of these awarded, there are 18 obligation wells committed by applicants, with another 17 contingent wells. All the above compares favorably with the experience of other recent licence rounds.

Various other initiatives are in progress to enhance activity. One relates to third-party access to infrastructure. Basically, this is obtained by negotiation between asset owners and potential users. These negotiations have often been prolonged and fraught. The UK government has played a watchful role but, until recently, has only intervened when one of the parties requests it. Under new legislation, it can now intervene proactively, if it feels that the time taken to reach an agreement has been unreasonably long. But a streamlined solution to the problem remains elusive.

In Budget 2013, details are expected of the contractual guarantee scheme between the government and licensees over the availability of tax relief for decommissioning expenditures. This will facilitate asset transactions in mature fields, because the letters of credit/bank guarantees in relation to the decommissioning obligation (which may well be needed) can be executed on a post-tax basis, rather than pre-tax. Given that tax relief for decommissioning costs will be at 50% (more in old fields), the reduction in net cost of the guarantee is very substantial. The result should be an increase in investment incremental projects, including EOR schemes.

In sum, the industry can look forward to a year of enhanced activity on the UKCS. The oil and gas cluster centered on Aberdeen is now very active internationally, especially in the subsea sector. Nearly 45% of the turnover of the whole Scottish oil and gas cluster now comes from exports. This business should see further growth in 2013.