AUSTERITY SET TO CONTINUE ON UKCS IN 2017

In 2016, activity on the UK Continental Shelf (UKCS) has remained subdued, reflecting the province’s growing maturity, the relatively low oil prices, and high unit costs.

In 2016, activity on the UK Continental Shelf (UKCS) has remained subdued, reflecting the province’s growing maturity, the relatively low oil prices, and high unit costs. Thus, the number of exploration wells drilled this year may end up below the record-low 13 achieved in 2015.

Miniscule exploration. To put this in historic perspective, after the oil price crashed to $10 in 1986 (about $30 in today’s money), 74 exploration wells were drilled in 1987, and 93 in 1988. The exploration decline is a long-term phenomenon that became pronounced well before the oil price collapse in the latter months of 2014. Similarly, appraisal drilling has declined substantially since 2008, and is far below the levels attained after the 1986 crash. While development drilling has declined substantially since 2000, it has held up well since 2008.

Reduced exploration has led to fewer reserves discovered in recent years, though the success rate has held up well by international standards. Average discovery size is now around 20 MMboe, but, given that the distribution is log-normal, the most likely discovery size is less than this.

Cost reductions. The industry has responded robustly to recent difficulties. Costs have been reduced very substantially. This has involved major reductions in both contract prices (such as drilling rig rates) and employment. These have been very painful. Oil and Gas UK, (OGUK), the industry trade association, estimates that average operating costs have been reduced to $16/boe, compared to $29.30 in 2014. Nevertheless, the industry remains substantially cash flow-negative. This is despite a major decrease in field investment expenditure, from £14.8 billion in 2014 to around £9 billion in 2016, according to OGUK.

In the midst of these gloomy trends, some encouraging signs prevail. Thus, production, which has fallen from a peak of 4.55 MMboed in 2014, has increased to over 1.64 MMboed recently. This is due to a combination of new fields coming onstream, plus an increase in production efficiency. This is defined as the ratio of actual production to the maximum efficient rate. It fell from 80% in 2004 to 60% in 2012. But it now has increased to 71%, reflecting a major effort by the industry to reduce downtime on the producing facilities and to increase the effective use of manpower.

Investment outlook. Looking ahead to 2017, it is difficult to foresee an exploration increase from the current low levels. Industry cash flows remain under stress, and this will continue to be a prime determinant of the exploration effort, despite the current, low, drilling rig contract rates.

It is also likely that field investment will be lower in 2017 than in 2016. Many development projects have been put on hold since the oil price collapse, with efforts being made to reduce costs. There are over 280 undeveloped discoveries on the UKCS, but most are relatively small.

There are over 130 discoveries, each, with less than 10 MMboe of potentially recoverable reserves. There are over 200 fields, each, with less than 20 MMboe of potentially recoverable reserves. But the total of these is 1.9 Bboe. This is a substantial prize, but at a current oil price of less than $50, the great majority are uneconomic, even before tax. This finding also applies to larger fields, which often have further cost problems.

If an oil price in the $60-$70 range were attained, and was believed by investors to be sustainable, a significant number of these undeveloped discoveries could become viable following recent cost reductions. Further tax incentives could also make marginal fields viable.

Technological progress could help. A new Oil and Gas Technology Centre (OGTC) has recently been established, with significant funds available to support R&D activities that include those to facilitate the development of the many small pools in the province. The prize for successful R&D in this area is substantial.

The Oil and Gas Authority (OGA), the new regulator, is now well-staffed with relevant expertise, and has been very actively promoting exploration, asset integrity, and collaboration to facilitate field developments and third-party use of infrastructure. Government-funded seismic data have been made available to encourage exploration in the current 29th Licensing Round. A new flexible licensing system has been introduced to better reflect the decision-making processes of investors. The know-how and enthusiasm of the new body should affect activity positively.

Capital rationing is very apparent on the UKCS. Some licensees are keen to sell mature assets, while others, sometimes new entrants, are keen to acquire them. There are several problems in valuing these assets. From the buyer’s viewpoint, future, large, decommissioning costs are an issue, particularly obtaining tax relief for these costs. Currently, a field’s tax history rests with the seller. If this could be transferred to the buyer with the asset transaction, it could greatly increase a deal’s attractiveness from the buyer’s viewpoint. It would help to enhance oil recovery. But this requires UK government legislation. This is one area where the Treasury could help to stimulate activity.

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