UK Continental Shelf at a crossroads

The UK Continental Shelf (UKCS) is at a crossroads in its long-term evolution, as recent measures of activity present a mixed picture. Production has been falling at a brisk pace, reaching 1.45 MMboed in 2013. This is far below the peak of 4.5 MMboed in 1999. This is due to several factors, particularly the natural and inevitable decline in output from mature fields, the falling, average size of new field discoveries and development, and the fall in production efficiency. Production efficiency is the ratio of output to the maximum attainable rate, taking into account the need for regular maintenance. This ratio has fallen from 81% in 2004 to 61% in 2012, and reflects the substantial increase in downtime from technical problems in producing facilities. This problem is present in very old, and not-so-old, platforms.

Exploration activity also has fallen in recent years, with only 15 wells being drilled in 2013. At the time of writing, the indications are that for 2014, the number will not be very different. While the exploration success rate remains high by international standards at well over 20%, the prospectivity in terms of expected size of discovery is modest.

But all is not gloom on the exploration front. There continues to be keen interest in the acquisition of exploration acreage in new licence rounds. In the 27th Round, which was completed in late 2013, over 400 blocks were offered to investors. In the 28th Round, with results announced in November 2014, 252 blocks were offered to investors. But, care is required in interpreting these results. Thus in the 28th Round, only six commitment wells have been offered. Most of the work programs offered relate to seismic work and drill-or-drop commitments, or the drilling of contingent wells.

Field investment has been at record levels in recent years, reaching an all-time high, in real terms, of £14.4 billion in 2013. For 2014, the level should be less, but still extremely high by historical standards. While this generates very substantial business for the supply chain, it also reflects very high investment costs per boe. The same comment applies to unit operating costs. Both have exhibited rapid inflation over the past few years.

In recognition of the current problems in the UKCS, the UK government appointed Sir Ian Wood to conduct a review, which was published in early 2014. It recognized the problems noted above, plus the lack of cooperation among licensees with respect to sharing of infrastructure facilities, and development of fields in clusters to procure economies-of-scale. He recommended that a new strategy be devised to maximize economic recovery. A new arm’s-length regulator should be established, and made responsible for effective stewardship of the UKCS, and for maximizing E&P collaboration.

The new regulator has been appointed and takes up his formal duties on Jan. 1, 2015. The diagnosis of the problems of the maturing UKCS in the Wood Review is very perceptive, but the implementation of its recommendations is by no means straightforward. For example, the regulator will be encouraging the enhancement of production efficiency. The short- and medium-terms gains to the industry and the nation from this are enormous. The issue is now widely recognized within the industry, but whether the practical problems involved in significantly increasing efficiency from 60% to 70% or 80% can be resolved remains an open question.

The Wood Review recognized that the tax system was important in the pursuit of maximum economic recovery. The chancellor accepted this and instigated a full-scale tax review. At the time of writing, the government’s proposals are not yet known. Research conducted by the present author and Linda Stephen at the University of Aberdeen indicate that reliefs are necessary to procure maximum long term economic recovery. There is a case for reducing the rate of PRT on old fields from its present 50% (giving a total tax rate of 81% on these fields). A significant reduction should encourage incremental investment.

There are many field allowances for the Supplementary Charge. These relate to physical characteristics, such as field size, water depth, distance from infrastructure, heavy oil, and HPHT. There is a case for the introduction of an investment uplift allowance, which is based directly on the economic characteristics of the fields to replace the current allowances. This would apply to unsanctioned fields.

The industry is keen to see a reduction in the rate of Supplementary Charge from its current level of 32%. On new fields, the overall rate is 62% and a reduction to 50% has been sought. The substantial fall in oil prices in recent months has increased the case for a reduction in the rate so that investment hurdles can be passed. But the treasury will also be concerned about the loss of tax revenues.

In sum, the outlook for 2015 is quite uncertain, due to a combination of the fall in the oil price (which will affect new investment), the extent to which the new regulator can positively influence production efficiency and collaboration, and the effects of any new tax changes.