Paradoxes to remain in prospect for UK Continental Shelf

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

The year 2013 on the UK Continental Shelf (UKCS) has been personified by major paradoxes. On the positive side, field development expenditures have been at a record high with Oil and Gas UK, the industry trade association, estimating that the amount could be £13.5 billion. This reflects, in particular, the coincident development of several very large and expensive new projects, such as Clair Ridge, Schiehallion’s redevelopment, Laggan/Tormore and the Mariner heavy oil field. For 2014, it is quite possible that even higher levels of development expenditures will take place. Thereafter, there is likely to be a modest fall from these record levels.

Higher costs. But the record levels of investment have been accompanied by large increases in unit costs. Thus, for 2013, Oil and Gas UK has estimated that average development costs could be over $21/boe. In some fields, the figure is much, much higher, particularly in the small fields (i.e. with reserves of less than 20 MMboe), which reflects current conditions in the UKCS. Cost inflation and project completion delays are very common in the sector.

Operating costs per boe have also been increasing sharply. For 2013, Oil and Gas UK estimates that the average is now around $23/boe. This reflects not only inflation, but the sharp decrease in production, which has been a worrying feature for some years. For 2013, total hydrocarbon production could be 1.39 MMboed, compared to 1.55 MMboed in 2012. This is a far cry from the peak of 4.55 MMboed, achieved in 1999.

Concern over output levels. The recent, unexpectedly sharp, output decline has been due to a combination of the modest additions from new fields coming onstream and the sharp decline in production efficiency. This refers to the ratio of actual production to maximum potential production. The Department of Energy and Climate Change (DECC) has estimated that this has fallen from around 80% in 2004 to around 60% in 2012. It is unlikely that there has been any improvement during 2013. Unplanned shutdowns have occurred in several fields, due to leaks and other technical problems. The growing interconnectedness of hub platforms and infrastructure with other fields has sometimes exacerbated the unplanned shutdown problem. More than a third of UKCS platforms are over 30 years old and prone to age-related problems.

The industry and the UK government are well aware of the problem, and a joint working party is examining the issue. The extent to which production efficiency can be enhanced will have a major bearing on total production over the next few years. With the coming onstream of fields under development, there is potential to reverse the downturn. But, if production efficiency does not improve, the result may be a flat overall output profile, in line with the 2013 figure. This is the view of DECC. Success of the production efficiency initiative could have a major positive effect.

In 2012, some new tax allowances were introduced to encourage investment in both new and mature fields. These are having a significant effect. Thus, DECC approval has already been given to 23 incremental projects that promise to significantly enhance production from mature fields. In these, the tax rate can be as high as 81%, but the Brownfield Allowance can substantially reduce the effective rate and enhance post-tax returns.

Low exploration activity. In recent years, a cause for concern has been the relatively low level of exploration. Thus, in 2011, only 14 exploration wells were started, and 22 in 2012. Thirteen exploration wells were started in the first nine months of 2013. To put these figures in perspective, during the 2005-2008 period, inclusive, the annual average effort was 40 wells. This year, the effort has been held back by a shortage of drilling rigs, so some increase can be expected in 2014. The recent increase in the value of the small field tax allowance, and in the interest rate allowed on unused tax allowances carried forward, should also have a positive effect on exploration activity. Cost inflation and difficulties of access to capital remain problems for smaller companies.

The problems outlined above, and several others, such as lack of ready third-party access to infrastructure and low levels of R&D, have been recognized in the Interim Report of the review being undertaken by Sir Ian Wood at the request of the Secretary of State for Energy. The report recommends the establishment of an independent regulator, (broadly, such as exists in Norway) with greatly augmented resources and some additional powers, compared to the current situation. The final report is expected in the early part of 2014.

Given the magnitude of the problems outlined here, a significant change in the regulatory arrangements can be expected. The need for additional resources to regulate an increasingly complex industry is clear. The potential gains, in terms of accelerating and enhancing activity, could be substantial.