WHAT'S AHEAD IN 2000

Mixed year ahead for UK continental shelf

Alexander G. Kemp, Professor of Economics, University of Aberdeen, Aberdeen, Scotland

he year 1999 has generally been broadly defined as difficult for the UK oil and gas industry. Exploration and development activities have fallen substantially compared to 1998. For the first nine months of the year, the number of exploration and appraisal wells drilled is down 58%. This trend is continuing for the rest of 1999. New field development expenditures are likely to end the year down by well over $1.6 billion, compared to 1998, although the number of development wells drilled has held up relatively well.

Construction and drilling companies, along with design and other engineering sectors linked to new field developments, have endured the brunt of difficulties experienced. The oil price rise during 1999 has not led to a significant improvement in the fortunes of these sectors. This is only partly due to the fact that capital budgets had been set in anticipation of much lower prices than those realized in the latter two-thirds of the year. Many investors also are not convinced that higher oil prices will prevail in 2000.

A more fundamental change has taken place in the UKCS over the past few years, and this is now recognized in the forward planning of investors on exploration and development. Prospectivity has been falling over the last few years. Using official data, the significant exploration success rate averaged only 12.8% in the 1995–1998 period, compared to 16.7% for 1988–1996 and over 22% for 1984–1994. It was only 11.4% in 1998.

Average new-discovery size has been falling for a considerable amount of time – average size of new developments follows – e.g., by 1998, to less than 40 million boe. In the Southern North Sea, average discovery size is now very small.

Against this background, one can readily understand why there has been no immediate response in activity levels to recent oil price rises. Further, gas prices have not risen noticeably at all in 1999, and present levels do not encourage many investments.

There are, of course, some positive features regarding the UK sector’s performance in 1999. Production of both oil and gas is at record levels and significantly ahead of rates achieved in 1998. This reflects the fruits of large investments made over the last few years.

In 2000, these production increases should continue. Combined crude and condensate output could increase and peak at around 3 million bpd. Gas production could grow at an even faster pace. Peak gas output will not be reached for a few years. The UKCS is becoming more gas-prone, especially in the Central North Sea.

These record production figures will co-exist with a subdued level of new investment. Investors are likely to adopt a cautious attitude, remaining skeptical about whether the recent price rises will be sustained. This is not the only problem, however. The falling exploration prospectivity over recent years has meant that new fields available for development are both fewer in number and smaller in size. Some are close to existing infrastructure, so the development costs are moderate. But others are located some distance from existing platforms and pipelines, and development costs on a stand-alone basis are very high.

These problems of maturity in a relatively high-cost operating area have been recognized. The joint government / industry Oil and Gas Task Force reported in September, offering many innovative proposals to deal with the problems. The UK government already has announced changes to the licensing and regulatory system that should help reduce project development time scales, and possibly attract new players into the UKCS. The provision of rollover relief for capital gains tax purposes should also help facilitate more asset transactions. These are likely to increase substantially following consummation of the recent spate of mergers.

The Task Force recognized the need for large cost savings and productivity gains, if activity is going to be enhanced to a worthwhile extent. It also recognized that the development of new technologies and their widespread adoption were key elements of a successful strategy. Total research and development expenditures have stagnated in recent years, and steps are being taken to enhance the effort.

In addition, the Task Force often found that new technologies offering higher productivity and / or lower unit costs did exist but were not being widely adopted. Changes to contractual arrangements between oil companies and their suppliers may be necessary to encourage the latter to adopt what are perceived to be higher-risk techniques.

Gas prices available to UK producers are very low. The gas bubble has been in existence for a number of years. There is, of course, an export outlet to Europe available through the Interconnector line from Bacton to Zeebrugge. There are problems facing exporters, however, in the form of constraints on access to infrastructure and markets. The EU Gas Directive does provide for liberalization of the market, but the projected pace in some countries is very gradual. The UK government is keen to promote faster progress in this area.

In sum, the UKCS faces another challenging year. If the issues noted above can be tackled successfully, the sector will continue to play a key role on the world petroleum stage.

Alexander G. Kemp is professor of economics at the University of Aberdeen. He was formerly lecturer, senior lecturer and reader. He also 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 special reference to licensing and taxation issues. He has published more than 100 books and papers in this field, including Petroleum Rent Collection Around the World, Institute for Research on Public Policy (Canada), 1988. He is European editor of the Energy Journal and editorial advisor to other academic / professional journals. Professor Kemp is director of Aberdeen University Petroleum and Economic Consultants (AUPEC), which provides consultancy services in petroleum economics.

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