WHAT'S AHEAD IN 2001

North Sea prospects depend on price and technology

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

The year 2000 has seen a marked improvement to the operating environment on the UK Continental Shelf (UKCS). The oil price increase has been followed in the second half of the year by a major increase in natural gas prices. In turn, this was due primarily to increased demand for UK gas from the continent, where prices are linked to oil values. The result has been a substantial increase in total North Sea production income despite a small fall in oil production (though gas output continues to grow).

Exploration and appraisal wells drilled are up significantly from the very low levels attained in 1999, but expenditures on these activities are still down vs. 1999 values, reflecting continued cost reductions. The number of development wells drilled and total capital invested in field developments have been running at levels below those for corresponding periods in 1999, although there may be little difference by the end of the year.

"Field development expenditures should increase substantially in 2001."    – Alexander Kemp

All of this means that 2000 has generally been a fairly tough year for contractors and suppliers in terms of volume of business. Major operators’ budgets have been set in relation to oil and gas price levels that are well below those actually realized in the second half of this year. Field development expenditures should increase substantially in 2001, to around £4 billion ($5.78 billion), compared to just over £3 billion ($4.34 billion) expected in 2000.

While the oil price increase has played a part in producing this increase, it is not the sole factor. The industry and its associated stakeholders have given much attention to cost reductions and productivity increases. These are beginning to bear fruit. LOGIC (Leading Oil and Gas Industry Competitiveness) has been very active in promoting effective supply chain management and coordinating pan-industry initiatives. Examples are in the area of logistics (supply vessels and offshore flights), and in the provision of innovative solutions for the development of currently uneconomic fields.

PILOT, the government / industry successor body to the task force, has also produced some initiatives. The concept of a group of fields being developed as a cluster has received much attention. Several promising clusters have been identified for further, detailed examination. Cluster developments offer the possibility of improved economies-of-scale through the use of common infrastructure facilities. There are also risk-sharing benefits from cluster developments. Thus, if one field experiences difficulties (such as poor reservoir performance or development cost escalation), there may be compensation by way of above-expected performance from other fields in the cluster.

Maximizing the opportunities from cluster developments requires substantial collaboration among licensees. Inevitably, license interests will vary across the fields in a potential cluster. This can cause conflicts of interest among licensees and delays in reaching agreement on how the common infrastructure will be shared among participants. There is then much merit in procuring unitization of license interests across the fields in question. In turn, this requires a willingness and ability among licensees to trade assets. The establishment of LIFT (License Information for Trading) and rollover relief for capital gains tax has helped to facilitate trading.

Further development of new, small fields will require the utilization of new technologies. The new Industry Technology Facilitator (ITF) has been operational for some months now. Essentially, this body acts as a broker for new technologies. It is expected that, in 2001, tangible benefits will emerge from its activities.

Next year, development of associated gas from Schiehallion and Foinaven fields west of Shetland will commence. A pipeline will be constructed to Sullom Voe and subsequently to Magnus field, where it will be injected to enhance oil recovery. Hopefully, this scheme will, in due course, encourage further gas developments from the Atlantic margin.

In recent years, this part of the UKCS has been somewhat disappointing in terms of discoveries. Next year may herald a positive development decision for Clair field (discovered in 1977). It also will see further appraisal of the Solan / Strathmore discoveries that form part of a LOGIC initiative. These – along with the new, frontier, 19th Licensing Round (and the likely start of exploration drilling in the Faroe Islands’ sector) – will ensure that the Atlantic margin is the focus of much interest.

Higher activity levels will bring their own problems. One could be a skills shortage in certain areas if development expenditures of around £4 billion are undertaken. In new developments, drilling will, on average, account for nearly 50% of expenditures, and increases in drilling costs seem inevitable. They have, of course, been generally low over the last couple of years, so it is hoped that productivity-increasing innovations will ensure that costs per barrel do not increase.

North Sea operations remain relatively high-cost by international standards, reflecting in particular the maturity of the province. The newest generation of fields is, on average, much smaller than fields in other parts of the world, such as West Africa and the Gulf of Mexico. These regions, by the way, are competing for investment funds.

This gives additional force to the argument that technological innovations are essential to the maintenance of substantial activity levels. High oil prices by themselves are not enough. In any case, investors are taking a cautious view of the likelihood that current price levels will be maintained. They continue to assess their new projects at oil and gas values well below present levels. The expected, sharp increase in activity next year thus provides confidence for the medium term.

Next year should see levels of activity significantly above those achieved this year. Two of the largest operators already have announced substantial new investments.

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.