Mixed fortunes in prospect for UKCS
The year 2017 has been one of mixed fortunes for the UK Continental Shelf (UKCS), and this promises to be the main feature in 2018. On the positive side, production has sustained growth throughout 2017, continuing the reversal of the downward trend from 1999 to 2014.
Reasons for improvement. The increase has emanated from two distinct sources. The first is from new developments coming onstream. An example is the large Schiehallion redevelopment project in the West of Shetlands, which is expected to continue to produce until the late 2030s. The second source of production growth has been the increase in output efficiency. This is measured by the ratio of actual production to the maximum efficient rate. This fell from 80% in 2004 to 60% in 2012, reflecting technical problems in fields that often required unplanned shutdowns. Reflecting much effort by the industry and the Oil and Gas Authority (OGA), there has been a substantial improvement. Production efficiency at present is around 73% and still rising. The industry target is 80%.
With the above background, oil production is likely to increase again in 2018 by a worthwhile amount. Gas production may fall, however, which shows a trend in the UKCS, as it becomes more oil-prone. Nonetheless, there should still be a net increase in total hydrocarbon production.
The revival of production has, in part, been due to remarkable reductions in operating and capital costs. The trade association, Oil and Gas UK (OGUK), has estimated that development costs fell from $30.60/boe in 2013 to $12.70 in 2016, with an estimate for 2017 of $8-10/boe. Operating costs have similarly fallen from a high of $29.70/boe in 2013 to $15.30 in 2016, and an estimated range of $14.10-$14.60 in 2017. These reductions have, of course, been extremely painful for individuals who have lost their jobs, and for companies throughout the supply chain that have encountered financial difficulties.
While the upstream industry may now be moving out of a negative cash flow position and into a positive one, problems still remain. Thus, new field investment has been falling substantially, and this fall is likely to continue in 2018. Many potential new projects have been put on hold, with a view to attaining substantial cost reductions from the original estimates. The remaining long-term potential is still substantial. The OGA estimates ultimate recovery to be in the range 10-20 Bboe. But for 2018, the outlook is for a further reduction in development expenditure, compared to 2017.
Exploration remains at a low level, with an annual average of only 14 wells being drilled over the last few years. By comparison, in the years after the collapse in oil prices to $10 in July 1986, the number of exploration wells drilled was in the 75-80 range. There may be a small increase in 2018 over 2017. The OGA has been very active in promoting exploration. To encourage it, the government has funded a substantial amount of seismic data, providing it freely to licensees.
Taxation considerations. Taxation arrangements continue to be important. A current issue concerns the tax treatment of late-field life asset transactions. In recent years, the mega-majors have been selling mature assets, which are deemed to be non-core. There is interest in buying these assets, often by new or nearly-new entrants who may have interesting ideas on extending field life. But a transaction can be stalled, because the buyer cannot obtain decommissioning tax relief to the extent that the seller can achieve. Relief is procured by the licensee, carrying back decommissioning losses against previous profits, corporation tax (30%) and supplementary charge (10%) previously paid.
To the buyer, this procedure is only available at the time of the asset transaction, and this may not be enough to procure relief at the (combined) tax rate of 40%. On the other hand, the seller with a large tax history can achieve full tax relief by carrying back losses to 2002. The net result is that, at the time of the proposed asset transaction, the seller’s post-tax prospective returns can exceed that of the buyer. This can stop the transaction.
After a long consultation, the UK government recently has announced that it will permit the tax history of the seller to be transferred to the buyer as part of the asset transaction. This should facilitate more late field life transactions and, hopefully, further incremental investments by the buyers. It is noteworthy that the concept of transfer of tax history is innovative and indeed unique in the design of taxation arrangements. The year 2018 should see a worthwhile number of late-field life transactions, particularly newer players as the buyers.
The Treasury estimates that over the next five years, the effect should be to increase tax revenues from the extra investment and production.
