North Sea Energy Upstarts Teach an Old Dog New Tricks

Young upstarts seldom have respect for conventional wisdom, and small independent oil and gas companies in the U.K.'s North Sea are proving that you can teach an old dog new tricks.

Despite being one of the most heavily explored and exploited hydrocarbon basins in the world, leading figures in the offshore oil and gas industry say there are still riches to be extracted from beneath the North Sea. In many cases it is small independent oil companies that are proving them right.

Taking advantage of high oil and gas prices and improved exploration and drilling technology, an influx of small and dynamic independent oil companies have caused a "sea change" in the industry, and could dramatically improve prospects for future production of the U.K. continental shelf.

But industry observers say the thorny issue of who is responsible for decommissioning costs of aging offshore pipelines and platforms could stop the independents in their tracks and lead to valuable resources being abandoned forever beneath the sea.

"The dynamic of the North Sea has changed dramatically over the last few years. Lots of smaller companies are in the North Sea taking license positions and bringing new ideas to the basin," said Mark Carne, Executive Vice President and Managing Director for Europe and Central Asia of gas producer BG Group (BRG).

Carne said there are several reasons why smaller companies are better at extracting value from the mature U.K. North Sea fields than incumbent oil majors.

"Field size today is a fraction of what it was years ago," Carne said. These fields have, "higher pressures, higher temperatures and are more difficult to manage.

"These small opportunities are no longer attractive to the bigger players. The [North Sea] basin is the preserve of more and more smaller companies. These companies should be welcomed because of the investment they bring and the opportunities they create," Carne said.

U.K.-based oil and gas company Venture Production PLC (VPC.LN) focuses on extending oil output from aging fields.

Since entering the U.K. North Sea, Venture has made 30 acquisitions from larger companies including Shell, Exxon Mobil, Total, ConocoPhillips, Eni, ChevronTexaco, BG and Centrica.

Venture's chief executive Mike Wagstaff said independent companies are able to extract more value from older fields because, "we're able to move a bit faster and have a quicker response to changes. We're more willing to adopt technology rather than innovate. We're able to take on more risk."

Several major oil companies have recently divested stakes in North Sea oil projects. ConocoPhillips (COP) sold off its equity interests in the Armada and Everest fields to BG earlier this week.

Royal Dutch Shell PLC (RDSA) and BP PLC (BP) have also sold off some of their holdings in the North Sea this year, while Exxon Mobil (XOM) is looking to offload 3% of its U.K. and Norwegian North Sea assets.

Bob Ruddiman, partner and head of energy at McGrigors law firm, said the majors are not walking away from the U.K. North Sea. "If you stand back and look at the statistics, in particular who holds production, it is still a relatively small club in critical areas," he said.

"The majors aren't so much moving away [from the North Sea] as sharpening their focus" by holding on to fields where they are in a strong position, and selling off lesser assets, Ruddiman said.

But while there are clear financial incentives for the majors to focus on their core assets, the unresolved question of who is held responsible for hefty decommissioning costs could get in the way. "We are getting close to the point where some of the future production might be put at risk because of the requirement to decommission," Ruddiman said.

"In the U.K. shelf, (the government) operates a perpetual liability on the original partners. If the asset is sold, the original partners remain liable for the abandonment costs of the facilities. In other countries, such as Norway, there is a 'clean break' model," said Malcolm Ricketts, European Upstream Analyst at Wood Mackenzie energy consultancy.

"If you're selling an asset, you want to know there won't be a liability coming back to you," Ruddiman said. Under the current legislation, the seller could find themselves faced with huge future liabilities if their buyer defaults on decommissioning costs.

To mitigate that exposure, the seller can ask for a letter of credit, bond or some other kind of guarantee from the buyer to cover decommissioning, Ruddiman said, but not all independent companies can provide that.

"There may well be deals which simply haven't progressed because the vendor hasn't been able to get comfortable regarding a purchaser's ability to carry out the decommissioning," he said.

In the most recent decommissioning guidelines, the U.K. Department of Trade and Industry, or DTI, said it, "has a responsibility to ensure that the taxpayer is not exposed to the risk of default in meeting costs associated with decommissioning."

The DTI acknowledged that current rules could be burdensome and has set up the PILOT Brownfields Initiative, a joint government and industry body, to improve guidelines and maximize the potential of remaining North Sea resources. A spokesman for the DTI said there is no firm date for the release of the new guidelines.

Wood Mackenzie forecasts decommissioning costs in the U.K. North Sea will total around $16.8 billion. "Ultimately, (the government) must balance the risk of the shelf not being developed to its potential against the potential for decommissioning liability defaulting to the government," said Ricketts.

Some people think the government should be doing a lot more. David Odling, Gas & Commercial Issues Manager for the U.K. Offshore Operators Association said: "In the DTI's current consultation, you almost wouldn't think [the U.K. continental shelf] exists. There are no measures in there as to how we might exploit it to its full, which is extraordinary given the importance that it holds."

Current estimates show the U.K. North Sea will contribute 10% to Britain's gas supplies in 2010, Odling said.

"If we get the right policies into place and exploit the basin to the full, that its more likely to be nearer 25%. That's an awful lot of gas and it's an awful lot of investment and jobs that we will have," Odling said.

Copyright (c) 2006 Dow Jones & Company, Inc.