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Vol. 225 No. 9 |
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| ØYSTEIN NORENG, CONTRIBUTING EDITOR, NORTH SEA |
High oil prices, but how much North Sea action? Even if the oil price rise in the North Sea has been somewhat mitigated by the appreciation of the euro and other relevant currencies (Britain's pound and Norway's krone), industry's response to prices seems surprisingly modest. By historical standards, oil prices above $30/bbl should have triggered a surge in exploratory wells, plus extra development projects that might have been marginal at lower prices. Little of this has materialized, particularly in Norway.
According to World Oil, the number of active mobile rigs in Europe and the Mediterranean has declined over the past year. In UK waters, data indicate a slight increase in offshore exploration and appraisal work, but a significant decline in development drilling. Danish and Dutch drilling remains modest.
During 2003, 16 exploration and seven appraisal wells were drilled in Norwegian waters. The Norwegian Petroleum Directorate (NPD) expects at least 20 exploration wells to be drilled during 2004, but 12 of these spudded during the first six months. Officially, NPD is optimistic about finding more reserves, but depletion is a growing concern, as has been the case in UK waters for a long time.
In the BP Statistical Review of World Energy, estimated British proved oil reserves have been fairly stagnant from 1993 until the end of 2003 at around 4.5 billion bbl. Norwegian oil reserves, however, rose to 10.5 billion bbl at the end of 2002 from 9.5 billion bbl in 1993. Then they declined to 10.1 billion bbl at the end of 2003. Thus, reserve replacement is precarious. UK reserve additions barely keep up with output, reflecting a quality deterioration in fields, with smaller, more difficult prospects that are high-cost and generate less economic rent. In Norway, output exceeds reserve additions, indicating deterioration in quantity and quality.
Multiple reasons for this sorry state of affairs pertain to geology, economics and politics. In both nations, powerful authorities – the UK Treasury and Norway's Finance Ministry – evidently ensure that capturing revenue from prospects already operating has priority over sustaining exploration and development. British oil output should continue declining, especially after the UK slapped a surcharge on the corporate income tax in 2002, raising the rate to 40% from 30%. This move also retained the fiscal ring fence that prevents consolidation of costs and income across fields.
Consequently, on offshore petroleum matters, the UK Treasury seems to act with a different agenda than the Department of Trade and Industry (DTI), which seeks to attract new companies and maintain levels of exploration, development and production, including competitive terms for new investors. In 2000, DTI launched the PILOT program to attract investors and reactivate dormant acreage. So far, DTI has not convinced Treasury of the need for stronger tax incentives. Geological maturity is an important reason for decline, but lifting the fiscal ring fence would permit firms to offset the costs of developing smaller, more difficult prospects against revenues from larger, more profitable fields.
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Britain's Treasury, headed by Chancellor of the Exchequer Gordon Brown (left), and Norway's Ministry of Finance, led by Finance Minister Per-Kristian Foss, do not always pursue policies that expedite oil and gas exploration and development.
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There is a striking parallel in Norway, where the Finance Ministry last spring rejected, wholesale, an industry tax proposal. Although Norway's finding costs are low, exploration is limited, thus reserves dwindle. Since the Ekofisk discovery in 1969, more giant finds have been made in Norway than in any other oil province. One of every four giant fields found worldwide in the past 25 years is on the Norwegian continental shelf (NCS).
Nevertheless, exploration is not up to expectations. Oil company pessimism may be inspired by unsuccessful drilling during 2002 and 2003, but the matter seems more complex. The industry is also reluctant to develop any of the NCS prospects already found.
Generally, the prospect development threshold is three or four times higher in Norway than in the UK, for reasons of costs and taxes. Capital costs are somewhat lower in Norway than in Britain (as measured by development investment per boe), but operational expenses are much higher, due to labor costs and shift practices. Consequently, small- and medium-sized Norwegian prospects' total costs are much higher.
Tax is another problem. Norwegian petroleum taxation captures economic rent from large oil fields, based on a 78% net income rate, with a six-year depreciation schedule. The absence of a ring fence means that new development costs can be offset against current revenues. Thus, the system favors incumbent companies and capital-rich newcomers that can buy producing assets over smaller, capital-poor companies and marginal prospects. This tax system was conceived in the 1970s, when Norway was a geologically immature province in a strong bargaining position. It has remained unchanged, regardless of maturing resources and a weaker bargaining position.
In the 2003 KonKraft report, the Norwegian Oil Industry Association proposed a tax reduction on new prospects to 53% from 78%. The group argued that this would permit development of numerous prospects and provide new exploration incentives. In hindsight, the report was timed with bad luck, due to high oil prices. Moreover, the report could have been more sharply targeted on less controversial issues, such as depreciation and volume allowances before application of the 50% special tax.
Instead, the Finance Ministry announced generous tax incentives for exploration, especially for newcomers, assuming in practice almost all the risk, and taking most profits. The oil industry and the Finance Ministry do not seem to engage in constructive dialogue. They make sound arguments that are of limited relevance to the other side. 
Øystein Noreng is Professor, Norwegian School of Management, and he holds the Total chair in petroleum economics and management. He is a regular contributor to this column.
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