December 2015 /// Vol 236 No. 12

Industry leaders outlook 2016

Another challenging year is in prospect for UK Continental Shelf

The year 2015 has been challenging for stakeholders on the UK Continental Shelf (UKCS). The continuation of low oil prices has ensured that the industry will end up with a substantial, negative cash flow. Cash flow-negative situations also occurred in 2014 and 2013, when oil prices were, on average, much higher.

Alexander G. Kemp, University of Aberdeen

The year 2015 has been challenging for stakeholders on the UK Continental Shelf (UKCS). The continuation of low oil prices has ensured that the industry will end up with a substantial, negative cash flow. Cash flow-negative situations also occurred in 2014 and 2013, when oil prices were, on average, much higher.

To a considerable extent, these outcomes reflect very high investment, which is usually regarded as a positive feature in the industry. For 2014, field investment totalled £14.8 billion ($22.4 billion), a remarkably high figure. For 2015, Oil and Gas UK (OGUK), the industry trade association, estimates that the total will be in the £10-£11-billion ($15.1-$16.6-billion) range, which is still a very substantial amount. However, the unit investment cost has been very high for some years, averaging around £32/boe ($48.4/boe) for 2014. This average conceals considerably higher figures for some fields.

Unit operating costs also have escalated in recent years, reflecting not only inflation but the decline in production. For 2014, OGUK estimates average lifting costs at £17.80/bbl ($26.90/bbl), but there is a very wide range. Some old fields have operating costs in the range £40-£60/boe ($60.50-$90.80/boe).

A problem that has exacerbated operational issues on the UKCS has been the decline in production efficiency over the last decade. Production efficiency is the ratio of actual production to the maximum potential rate. This was estimated by the Department of Energy and Climate Change (DECC) at 80% in 2004, falling substantially to 61% in 2012.

A major cause of this decrease has been unplanned shutdowns, due to corrosion, leaks and other technical problems. The industry has devoted much effort to reducing downtime, and, recently, production efficiency has increased to around 65%. The industry target is to obtain an 80% average over the next few years.

Recently, aggregate production has increased a little. There are hopes that output for 2015 will exceed that achieved in 2014. This would be the first aggregate increase since production peaked in 1999, due to new fields going onstream and enhanced production efficiency in existing fields.

The year 2015 also saw major tax changes applicable to the UKCS. Thus the rate of Supplementary Charge (SC) was reduced from 32% to 20%. A new investment allowance of 62.5% was introduced for SC, to replace the existing complex plethora of field allowances. The rate of Petroleum Revenue Tax (PRT), which applies to old fields only, is being reduced from 50% to 35%. The consequence of all this is that the overall headline rate of tax on new fields is 50%, but the average or effective rate can be as low as 30%. On old fields, the headline rate is still high at 67.5%.

But, despite these changes, collapsed oil prices are still holding back new investments. Modeling by the author and Linda Stephen at the University of Aberdeen indicates that, without cost reductions, many new field developments in the North Sea are non-viable, even before tax. Exploration is similarly disincentivized. However, if cost reductions of 20%-30% can be achieved, many projects on hold can become viable at $55–$70 oil prices.

Cost reductions have been pursued through 2015, and more can be expected in 2016, as contracts with the supply chain expire and terms are renegotiated. As an example, drilling rig day rates for semisubmersibles, a major cost item in the UKCS, have fallen by some 40% in the first half of 2015.

Modeling by the present author and Linda Stephen suggests that field investment will decrease significantly in 2016. However, by 2017, the decline could be moderated, due to projects becoming viable with 20% cost reductions.

Exploration has been at very low levels, with only 14 wells spudded in both 2013 and 2014. For 2015, the eventual number may be no higher. The industry has asked for further tax reliefs to incentivize further exploration activity, which is clearly necessary to exploit the remaining physical potential. Again, modeling by the present author and Linda Stephen suggests that, while tax relief can help, cost reductions are necessary.

The Oil and Gas Authority, the new independent regulator, is now very active. It has recruited much expertise from the industry, and initiatives relating to exploration, infrastructure (including third-party access), production efficiency, cost reductions, and collaboration among licensees and with the supply chain, are being pursued with vigor. There is a determination to achieve maximum economic recovery. In 2016, there will, hopefully, be tangible evidence of positive effects on activity from these initiatives. The first indication of this could be an increase in total production. wo-box_blue.gif

The Authors ///

Alexander G. Kemp is professor of Petroleum Economics at the University of Aberdeen, and director of its Aberdeen Centre for Research in Energy Economics and Finance (ACREEF). For many years, he has specialized in petroleum economics research, particularly licensing and taxation issues, and has published over 200 papers and books. Professor Kemp was a specialist adviser to the UK House of Commons Select Committee on Energy from 1980 to 1992, and again in 2004 and 2009. From 1993 to 2003, he was a member of the UK government’s Energy Advisory Panel. In May 1999, he was awarded the Alick Buchanan-Smith Memorial Award for personal achievement and contribution to the offshore oil and gas industry. He is a fellow of the Royal Society of Edinburgh, and was awarded the OBE in 2006. Professor Kemp was a member of the Council of Economic Advisers to the First Minister of the Scottish government from 2007–2011. In June 2011, he was appointed a member of the Scottish Energy Advisory Board. In March 2012, he received SPE’s Lifetime Achievement Award. In September 2013, he was appointed a member of the Independent Oil and Gas Expert Commission by the Scottish government.

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