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Low Oil Prices, Credit Woes Could Spell Trouble for UK North Sea

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LONDON (Dow Jones Newswires), November 14, 2008

The combination of falling oil prices and the credit crunch spells trouble for oil and gas production in the U.K. North Sea, said senior industry figures.

The U.K. has been counting on steadily rising oil prices to make new projects in the heavily depleted basin profitable and is depending on a legion of small independent oil and gas companies to develop many of the remaining fields as major companies focus their efforts elsewhere.

However, the price of North Sea benchmark Brent crude has fallen by more than half since July to $56.24 a barrel Thursday and the profitability of many new fields is looking doubtful. At the same time, many of the smaller companies that could have developed them are struggling to keep their heads above water.

"At $60-65 oil, a lot of projects are on the edge of being commercial," said Bill Transier, chief executive of Endeavour International Corp., a Houston-based independent oil company focused on the North Sea. "It's very difficult for small-cap companies to be able to survive in this environment."

Oil and gas fields in the U.K. North Sea first began producing in the 1960s. Since then the equivalent of 38 billion barrels of oil and gas have been extracted and most of the biggest fields are in rapid decline. Production peaked at 4.7 million barrels of oil equivalent per day in 1999 and was 2.9 million boe per day last year. The region has the fastest production decline rate in the world, at 11.5% a year, according to data from the International Energy Agency published this week.

The Norwegian sector of the North Sea is far less depleted than the U.K. side because it was developed much later and has not been as thoroughly explored.

The U.K. government says at least another 20 billion boe of oil and gas can be recovered from its stretch of the North Sea. "We can't overlook its contribution to our security of energy supply as well as to our economy," said the U.K. Department of Energy, Commerce and Climate Change in a statement. "The U.K.'s oil and gas sector currently provides 70% of the country's energy and benefits the U.K. balance of payments to the tune of GBP45 billion a year. It is by far the largest single industrial U.K. investor and supports over 450,000 jobs throughout the economy."

Expensive Proposition

But most of the remaining oil and gas is in small, technically challenging reservoirs that aren't cheap to produce from.

"In the North Sea there are two inescapable facts. The size of the opportunities is relatively small and unit costs aren't the cheapest in the world," said Mike Wagstaff, chief executive of Venture Production PLC, which specializes in squeezing the last drops of oil and gas out of small or depleted North Sea fields. "We are looking at a $100-a-barrel cost world and a $50- to $60-a-barrel revenue world."

Two-thirds of Venture's output is natural gas, the price of which has held up much better than oil in the U.K. "Projects on our books all make sense...at the expected commodity prices," he said, but companies will probably slow down North Sea projects and cut budgets in the current environment. "We will take our foot off the pedal in the short term, to see how the market goes."

Venture has produced an average of 43,500 boe per day this year, generating enough cash to see it through a rough patch. But not every company has that luxury.

"It's an impossible task for small companies who have no cash flow. A lot of them are living out of their bank facilities... Their business model is very difficult," said Endeavour's Transier.

"The situation for many oil and gas juniors is nearing critical. The doors to equity and capital are fast closing. A number of companies are already beginning to warn of uncertainty as to their ability to continue as a going concern," said Alec Carstairs, oil and gas partner at consultancy Ernst and Young.

For example, Canada's Oilexco Inc., which has been very active in the U.K. North Sea in recent years, last month lowered its 2008 production estimates and said it was having difficulty raising its credit lines. Transier said Endeavour has enough cash to get through two or three tough years, but he worries about how quickly he will be able to move his projects forward.

Small and medium-sized companies like them are important to the North Sea because most of the remaining oil and gas reserves are in pockets too small to be of much interest to the major international oil companies. "Of more than 28 projects planned in the North Sea, only a handful hold more than 100 million barrels," said the IEA.

Companies such as Royal Dutch Shell PLC, one of the pioneers of production in the region, are still investing in mega-projects like the Ormen Lange gas field in the Norwegian sector of the North Sea, but are selling some of their mature fields on the U.K. side.

If smaller companies fail, "you are going to see (production) decline rates get steeper than they have been. I think we are going to lose reserves that might have been there," said Transier.

Output Could Plummet

If the oil price stays above $80 a barrel and natural gas above 70 pence a therm, and North Sea investment continues to flow, by 2010 total output will still be a respectable 2.6 million boe per day, said a report from Alexander Kemp and Linda Stephen of the University of Aberdeen.

However, if the average price remains at current levels of around $60 a barrel for oil and 50p/therm for gas, the report said there would be a considerable reduction in field investment and by 2010 production would fall to 2.5 million boe per day.

If prices were to fall to $40 a barrel, "development activity collapses from its present level reflecting the non-viability of the great majority of most new projects," and by 2010 production would fall to 2.3 million boe per day, the report said.

Extend the timeframe out to 2020 and production in the low-price scenario would be just 800,000 boe per day, 1.3 million boe per day lower than if the average price stays above $80 per barrel, said the report.

In the current volatile market, it is hard to say where the oil price will be next week, let alone in 2020. Many industry experts say prices will rebound once the current economic turmoil subsides.

"We see a fairly short, sharp downturn and then a return," said Rhodri Thomas, Europe and Sub-Saharan Africa upstream research manager at consultancy Wood Mackenzie.

The IEA, despite warning this week that world oil demand is on the cusp of falling for the first time in 25 years, still expects the oil price to average $100 per barrel between 2008 and 2015. Analysts at Citigroup expect the price to be $65 a barrel in 2009.

But one danger specific to the U.K. North Sea is that a prolonged trough in the oil price could lead to aging pipelines and platforms needed to tap new fields being dismantled early. "Existing infrastructure is very important for companies to sweep up the remaining reserves," said Wood Mackenzie's Thomas. "There is a danger that as companies review capital expenditure and budgets and look to control their costs, they reduce investment. If that's sustained over a long period of time it could cause long-term damage to infrastructure."

Venture's Wagstaff agreed this is a concern, but said oil would have to stay at $50 a barrel for three years for it to become a serious issue.

The government says it is doing all it can to keep the North Sea alive through innovations in licensing arrangements and incentives to prolong field life. Transier said he would like to see it do even more, pushing people to speed up developments and encouraging cash-strapped companies to merge with larger partners that can fund development.

"It is a really tough environment," but the cost of developing new fields will probably fall in 2009 and 2010, which will make investment more attractive, said Thomas. "It's not a doomsday scenario... There are still a lot of good investment opportunities in the North Sea." 

Copyright (c) 2008 Dow Jones & Company, Inc.

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