Industry News - Offshore Engineer Reports - Blood, sweat and fearsBlood, sweat and fears
from: Offshore Engineer
by: Darius Snieckus
Saturday, May 01, 2004
The arrival of a new wave of independent operators
promising to reinvigorate life on the UK continental shelf
looked a vindication for those in industry and government
who had laboured since 1999 to find a winning formula for
the next phase in the development of the North Sea. This
new dawn has dimmed lately, as Darius Snieckus reports.
Misperception and slow
reaction time continue
to pose the greatest
threats to the future of
hydrocarbon production in the
UK North Sea, to judge by the
two latest studies attempting to
give an insight into the oil and
gas province's inability to
shake off its long-running
malaise. For at the heart of the
region's nascent decline, as
both University of Aberdeen
professor Alexander Kemp's
recent report A reassessment of
potential production from and
expenditures in the UK
continental shelf, and venture
capitalist 3i's 6000-word
Prospects for North Sea oil and
gas - challenges and
opportunities in a mature
province, is a psychology stuck
in a negative view of the
region's economic viability.
Seemingly destined to be
known as a 'high risk, high
cost' province to the end, the
UK North Sea, according to the
study carried out by Kemp with
Linda Stephen, should not be
tarred so liberally with this
brush. Even with 'no major
step changes' in technology
coming out of a province for
which technology has been a
brother-in-arms, the UKCS
could produce 133 new oil and
gas finds - averaging, based on
going-forward calculations
started in the late-1990s, a per
barrel development cost of
$4.33 boe - between now and
2028.
True, the UKCS could equally
see as few as 77 discoveries over
the next 25 years as the
international oil and gas
industry repositions its global
asset portfolio to the province's
detriment, turning a blind eye
to the fact that, as Kemp notes,
decline rates from 1997-2003
were 'quite modest' and the size
of the average find in 2004 is
expected to be a commercially
serviceable 34 million boe.
Which of these contrasting
scenarios lies ahead for the UK
North Sea remains a moot
point. Should oil companies
break with the strategic
thriftiness they have generally
demonstrated in their last
three E&P budgets, the
industry as a whole stands the
chance of putting the
exploration horse back in front
of the production cart - one of
few long-term options for a
group trying to keep its global
reserves increase targets on
track after a period
characterised by growth
through acquisition.
Straightforward enough on
first glance, perhaps, for a
province such as the UKCS, but
for the spoiler that behind the
sea-change in operating
practices demanded by the
situation lies something like
E&P's Gordian knot.
'Success rates depend
substantially on a combination
of recent experience and size of
effort,' underlines Kemp.
'Higher effort is associated
with more discoveries but with
lower success rates compared
to reduced levels of effort. This
reflects the view that low levels
of effort will be concentrated
on the lowest risk prospects
and thus that higher efforts
involve the acceptance of
higher risk.'
Risk and reward, then, are
moving targets. What remains
in the crosshairs however is the
total oil and gas resource still
represented by the UKCS.
Working from an operatorvalidated
database covering 270
sanctioned fields, 135
incremental projects related to
these developments, 43
probable and 40 possible fields,
as well as 199 prospects
categorised as 'technical
reserves', in the North Sea,
West of Shetland and Irish Sea
regions, Kemp's study echoes
the majority of approximations
of remaining production
potential from the UK North
Sea - somewhere between 23
billion boe and 32 billion boe -
and even gives a nod to the UK
Department of Trade &
Industry's latest 'maximum
eventual recoverable reserves'
figure of 47 billion boe.
And nonetheless, with
numbers crunched courtesy of
Monte Carlo modelling, he at
the same time confirms that
with oil/gas prices of $20/18p
(in constant real terms)
hydrocarbon output will fall
from last year's 4.15 million
boe/d to 3 million boe/d in 2010
and further to 1.9 million boe/d
in 2020. Likewise, given the UK
North Sea's 'considerable' price
sensitivity, new capital
spending in the province could
swing from a $25/24p high price
scenario of £3.25 billion in 2010
down to as low as £2 billion if
the oil/gas price case used is
$15/14p.
Still, all is far from lost, in
Kemp's opinion. Governmentindustry
task force Pilot's
target of ensuring the UKCS is
producing 3 million boe/d
beyond into the next decade
remains attainable, albeit
'heavily dependent on
significant contributions' from
future incremental projects,
development of fields currently
in the technical reserves
category, and development of
'some' new discoveries.
'These collectively represent
substantial challenges to the
industry,' states Kemp. 'They
are plausible in relation to
historic behaviour but, given
the timescale and the size of
the collective requirement from
the three sources [oil, gas and
condensate], significant and
speedy investment in these
areas is required.'
A Third Age renaissance, he
underlines, will depend on
investment in the 'range of
initiatives' that will generate
brownfield activity; ready
access to infrastructure 'on
transparent and competitive
terms'; and further
government 'encouragement'
aimed at bringing fallow fields
onstream and increasing
exploration of fallow blocks.
'The potential reward is
substantial,' he offers. 'Not only
would output be higher in the
medium-term but the use of
the infrastructure could be
extended to produce further
benefits to activity in the
longer-term.'
This 'maintenance spending'
in the UK North Sea will also
be crucial to whatever new
exploration the oil industry can
muster, something that today
necessarily hangs on the future
commerciality of existing
pipelines and offshore
installations.
'The full cycle rate of return
to exploration can be
significantly affected by the
availability and cost of
infrastructure,' notes Kemp.
'From this perspective alone
there are advantages in more
exploration being undertaken
"earlier" rather than "later".
The consequential moderation
to the overall production
decline rate clearly produces
further benefits to the industry
and the national economy
generally. The implication is
that a range of policies which
can stimulate exploration is
clearly desirable.'
The latest government push
to prolong production on the
UKCS, it merits mentioning,
came last month in the form of
a DTI report entitled
Implementing a demonstration
of enhanced oil recovery using
CO2, its final contribution to
the government's 2002 energy
white paper.
Central to the report's main
conclusions is a paradox. On the
one hand, as there was
perceived to be 'little interest' in
CO2-based EOR amongst North
Sea oil producers, a 'full
implementation plan' is not on
the cards. However, based on the
belief that CO2-based EOR
'remains a potential option for
demonstrating carbon dioxide
capture and storage' central to
the development of 'near to zero
emissions' fossil fuel
combustion plant, the DTI paper
also specified a set of 'interim
actions to take the concept
forward for possible inclusion
in the overall strategy'.
The VC view
Lifeblood of any industry,
investment takes on added
significance in an oil and gas
province such as the UK North
Sea where the majority of new
operators have come into being
underwritten by venture
capital - a source of backing
previously more often
associated with SME
contractors targeting the UKCS
market. 3i's Prospects for North
Sea oil and gas report provides
a view of the future of the
region through a different lens
from that of the University of
Aberdeen study, while finding
many of the same reasons for
hope - and sounding many of
the same alarm bells - as those
cited by Kemp.
The self-proclaimed 'white
paper', commissioned in
cooperation with the
Economist Intelligence Unit,
sets itself apart from the
growing library of UK North
Sea Third Age consultation
documents on the grounds that
it is 'the first produced by a
private equity investor,
approaching the questions of
the UKCS' future from that
private investment mindset',
according to 3i head of oil and
gas Graeme Sword.
'This study was an attempt to
condense a number of the
issues that we were seeing on a
daily basis from all parts of the
sector from major corporates,
private companies,
entrepreneurs, and
government bodies - all of
which want to stimulate
activity in the North Sea,' he
states. 'Capital, in the big
picture, is often perceived to be
the constraint for both growth
and change.'
Ineluctably, 3i's report
touches upon all the hot-button
topics - the untapped oil and
gas potential of the North Sea,
the industry's regional
restructuring and divestments,
the need for new technology,
new business models, and
renewed national interest in
sustaining E&P in the province
- but, more usefully,
scrutinises the role emerging
independents such as Venture
Production, Highland Energy,
Tuscan Energy and ENS - all
private equity backed
businesses that have acquired
North Sea assets - will play
going forward.
'Private equity is certainly
beginning to make its mark on
the E&P sector,' Sword argues,
though he acknowledges that
pinning sector hopes on these
independents is not without its
potential pitfalls.
Many a new operator has
been floated on a productionled
business model to reduce
investment risk, meaning, on
balance, that oil and gas
revenues generated are
returned to the investor rather
than being ploughed into
developing the exploration side
of a company. As such, these
start-ups do little to stop the
North Sea's sliding exploration
levels. In a high oil price - and
therefore more competitive -
environment, moreover, the
majority of these
unapologetically small
companies are unlikely to have
the strength of balance sheet
needed to justify risks linked to
a business model that includes
exploration.
'Most of these production-led
companies and their investors,
if private equity is looking for
the upside, are going to have to
take on a bit more risk if they
are going to move away from
pure production toward a
combination of production and
development,' says Sword.
The long-standing argument
that what is most needed to
invigorate the E&P ecosystem
in the North Sea is a wider
spectrum of business models
has not yet taken hold. Instead,
high oil prices have led to a
rush of likeminded start-ups to
the UKCS birdtable - the 'me
too' phenomenon. Sword sees a
healthy future ahead for the
region once natural market
forces have shaken things out.
'There is bound to always be
plenty of capital for
differentiated, quality
investment opportunities,' he
stresses. 'For me the bottom
line for E&P start-ups is not
capital, it is quality strategies
put forward by management
teams that can deliver them.'
The burden of responsibility
does not rest strictly on the
commercial ingenuity of the
next wave of independents,
naturally, and Sword reckons
the UK government has still to
answer the charge that it could
do more. 'The government
needs to go further [than
schemes such as the fallow
fields initiative and promote
licences],' he offers. 'The issue
remains that even those
companies that manage to
attract funding still find it
difficult to consummate a
transaction because accessing
infrastructure, negotiating
tariffs and so on with the
majors is still difficult.'
Among the less often seen
figures in the great Third Age
debate are those indicating
divestments of some
$3-$4 billion in the UK sector
over the next five years.
Research carried out for 3i by
Deloitte Petroleum Services
further suggests that the pace
of this asset shedding will
accelerate from that point,
translating into 'more openings
for the independents'. Should
barriers of infrastructure,
tariffs and - a subject still paid
little heed - decommissioning
cost be left unaddressed much
of the upside in the UKCS
future will go begging.
There is no mistaking that a
'substantial and internationally
competitive'
independents sector remains
some way off, with the makeup
of the UK North Sea
operating community still
very much polarised between
so-called 'superindependents'
of the scale of Apache and
EnCana and the raft of UK
start-ups. That these
companies nonetheless
represent 'an excellent
business opportunity' for
private equity specialists is
plain: PE investment in
Europe's oil and gas sector as a
whole leapt 127% from 2002/03
- a year in which total PE
spending on business fell by
20%.
'We need more radical
thinking,' Sword states. 'If I'm
saying there is capital available
and there are entrepreneurs
saying they have the energy
and motivation to do it and
there are majors saying they
will eventually rationalise their
portfolios and sell off UKCS
assets, I am not quite sure what
is holding us back. The
overriding issue is that
government has to make it
easier for some of these
transactions to happen.'
For all the barrels of ink
spilled on analysis of the
ultimate prospectivity of the
UKCS' Third Age, the singlemost
dispiriting - and damning
- fact might well be found
within 3i's polling of 110 of the
industry's 'main players' at a
recent forum on the province's
future held in Prague.
Responding to a questionnaire
prepared by the venture
capitalist for the occasion, 44%
expressed the view that they
'did not believe that new "world
class" oil and gas assets would
ultimately be found in the UK
sector of the North Sea'. OE
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