Low oil prices and activity on the UK Continental Shelf

Alex Kemp

March 1, 2015

It is widely accepted that the UK Continental Shelf (UKCS) is a high cost petroleum province by world standards. The collapse in oil prices from over US$100/bbl to less than $50 can thus be expected to have a substantial effect on activity levels.

It should be recognized that even before the price fall investment in new fields and projects was set to fall sig­nificantly from 2015 onwards. This is a reflection of the near completion of a few very large investments with rampant cost inflation.

At current oil prices, many new projects which would have been accept­able at $100 are no longer viable. The upstream industry in the UKCS ended 2013 in a negative net cash flow position. This will have become worse in 2014. Given this, and the increased capital rationing, investment budgets have been significantly cut. Studies undertaken by the present writer indicate that if a real oil price of $70 for investment screen­ing were to prevail rather than one of $90 in real terms (i.e. with both increas­ing at 2.5%/yr) over the period to 2050, cumulative production would be around 12 billion boe, rather than 15 billion boe, and field investment would be £81 billion at 2014 prices, rather than £122 billion.

But this somber prospect need not become a reality, even if oil prices remain relatively low. The outlook can be transformed through a combination of changes in government policy and self-help within the industry. The Wood Review and studies undertaken as a consequence of the current environment both point the way to the achievement of substantial new activity.

Research undertaken by the pres­ent writer indicates that, if production efficiency could be increased from the present 60% to 70% through a combina­tion of more effective regulation by the new Oil and Gas Authority and enhanced implementation of the relevant measures by the industry, the resulting increase in production and revenues over the next few years could be very substantial.

It had become clear well before the price collapse that the present tax system in the UKCS was no longer appropriate for the attainment of maximum economic recovery. This has now been recognized by the UK government, and the current debate is concerned with the extent of the reforms which are necessary.

Currently, the UK government is giving priority to the introduction of a basin-wide investment allowance against the Supplementary Charge. Research by the present author indicates that, if this allowance were implemented at a rate of 50% or 62.5% the result would be a sub­stantial increase in investment totalling many £ billions in the period to 2050. There would be a win-win situation for both the industry and government as the allowance would only be given for new investment. There would be a significant net increase in longer-term tax revenues as well as capital expenditure and production.

The industry is pressing for a reduc­tion in the rate of Supplementary Charge from its present level of 30%. The case for this has become stronger recently as a result of the price collapse and the consequent negative cash flow position of the industry. A combination of a substan­tial investment allowance and reduction in the headline rate of the Supplementary Charge could significantly improve the investment environment for new field developments, incremental projects and exploration.

With respect to self-help, the most obvious response to the price fall is through cost savings. Many companies have already announced redundancies and reductions in contractor rates. But little attention has been given to the further consequences of achieved cost savings. Research by the present author indicates that, if the industry effected cost savings of 15% applicable to both investment and operating activities the result could be that over time significant numbers of new fields and projects could become viable when they were uncom­mercial before the cost savings. In fact, over time the investment expenditures relating to new projects could exceed the value of the cost reductions effected in projects which were in any case viable at the relatively low price.

It follows from the above that a combination of targeted tax reliefs, more effective regulation, and carefully designed and implemented cost savings could produce a substantial increase in activity relating to investment expendi­ture, operating expenditure, production, and tax revenues. A challenge will be to effect the necessary cost savings in such a manner that production efficiency is still enhanced, and the expertise within the sector (oil companies and supply chain) continues to be deployed to best effect.

Alex Kemp is currently Professor of Petroleum Economics and Director of Aberdeen Centre for Research in Energy Economics and Finance at the University of Aberdeen. He has published more than 200 papers on petroleum econom­ics. He was a specialist adviser to the UK House of Commons Select Committee on Energy in 1980-1992, and in 2004, and 2009. From 1993-2003, he was a member of the UK Government Energy Advisory Panel. He was awarded the OBE in 2006, for services to the oil and gas industries. He wrote The Official History of North Sea Oil and Gas, published in 2011, in two volumes.