Buoyant North Sea Masks Concern Over Long Term Future of UK Oil & Gas

Total spend in the UK offshore oil and gas sector is expected to climb to around £11 billion this year, boosted by increased exploration and development in fields around the British Isles. However, rising costs, worldwide pressure on resources and skills, as well as concerns about the long-term impact of increased taxation on a sector in slow decline may yet cast a shadow over the ultimate recovery of the UK's oil and gas reserves.

Speaking at an Energy Breakfast event in Aberdeen today (February 21) Mike Tholen, economics and commercial director of the UK Offshore Operators Association (UKOOA), said: "Activity over the coming year is a reflection of the industry's continued commitment to invest in the North Sea and to the modernizing schemes successfully introduced by industry and government over the past five years through PILOT. However, there are several underlying factors that give rise to concern for the longer term future."

In 2005, he said, "UK oil and gas production declined at an overall rate of 8 percent to around 3.3 million barrels of oil equivalent per day (boepd). Oil production was lower than anticipated, in part reflecting the challenges of operating in a mature basin, while gas production was in line with previous expectations."

Nevertheless, domestic production supplied around 90% of all of the UK's gas requirements, providing the foundation for UK security of energy supply and, when combined with UK oil production, saving the UK from having to import £36 billion worth of hydrocarbons to meet its energy needs.

While total expenditure in the sector is expected to approach £11 billion this year, just under half of this will be spent on operating costs which are forecast to rise from £4.7 billion in 2005 to £5.3 billion in 2006.

Around 80 exploration and appraisal wells were drilled last year, at a total cost of some £0.6 billion, with a similar level of activity expected for 2006. Around 20 percent of all this years exploration wells are expected to be on Promote licenses, the new fast-track, lower-cost license introduced by the government in 2002. Almost 230 development wells were drilled on the UKCS in 2005, a 30% increase on 2004. New records were set with 152 licenses awarded to 99 companies in the 23rd Licensing Round with renewed interest in less explored regions and a fresh focus on heavy oil.

Rig utilization has risen rapidly over the last two years and the UK faces extreme competition for resources which, should they not be available, could constrain future activity. Rig rates have soared and are approaching levels which could make some wells uneconomic and deter drilling activity.

Today's buoyant activity is founded in investment decisions taken before the announcement of the tax increase on UK oil and gas companies, Mike Tholen said. While the oil price has increased significantly since the first negative tax change in 2002, the post all-tax rate of return on industry investment has declined from 19 percent to 14 percent, highlighting the challenge the sector will face at lower oil prices. The industry will contribute around £10 billion in taxation to the UK Exchequer in 2005/06, even before the increase in the supplementary tax rate announced last December, rising to £12 billion in 2006/07.

"Experience shows that across industry, and not just in the oil and gas sector, higher taxation today will ultimately lead to a decline in investment," said Mike Tholen. "This is something we simply cannot afford to let happen at this crucial stage of the North Seas life. The majority of investment opportunities in the UK are small, risky, marginal discoveries. If the oil price were to fall, the economic viability of the UK oil and gas basin would be severely challenged. We do not believe therefore that the current tax regime is sustainable and the Government should signal its readiness to reduce the tax burden in light of a downward adjustment of prices."

Mike Tholen was speaking at the UKOOA Energy Breakfast in Aberdeen. Also speaking at the event, which was titled The Pre-Budget Report, what does it mean? was Tom Smith, managing director of international telecommunications specialist Nessco Limited and co-chairman of the Industry Leadership Team. UKOOA Energy Breakfasts are well established as an information and networking opportunity for the oil and gas industry in Aberdeen. They are sponsored by the Royal Bank of Scotland plc.