Analysis: Incentives Key to Unlock North Sea Potential

A tax regime more favorable to investment in oil and gas exploration and infrastructure is needed to encourage development of remaining oil and gas reserves on the UK Continental Shelf (UKCS). While significant untapped reserves remain in marginal fields and the West Shetland area, high taxes, rising costs and last year's credit crunch negatively impacted exploration and development activity in the UK North Sea.

Exploration Outlook Improves, But Concerns Remain

Industry trade association Oil & Gas UK in February reported in its annual forecast of offshore oil and gas exploration and development that 73 offshore UK oil and gas projects were being considered for development compared to 56 the previous year.

Oil & Gas UK estimates that up to 25 billion barrels remain untapped in the UKCS, with business plans developed over the latter half of 2009 have identified up to 11 billion barrels of oil gas in new and existing projects. If 60 billion pounds (US $87.9 billion) in capital expenditure can be secured, the UK oil and gas industry could still be delivering 1.5 million barrels of oil and gas per day in 2020, enough to satisfy half of total UK demand.

UK continental shelf production

However, the 17 fields new to Oil & Gas UK's survey are on average 20 percent more expensive on a coast per barrel basis, reflecting the technically and commercially challenging nature of these opportunities. Additionally, an estimated 25 billion pounds (US $36.6 billion) capital must be spent to install needed infrastructure over the next five years.

The survey of spending plans for 70 oil and gas companies also showed that the number of reserves being developed or in production have declined as possible new projects fail to meet companies' economic criteria. UK oil and gas production totaled 2.48 million b/d in 2009, down six percent from 2008 and reflecting the 20 percent slowdown in capital expenditure since 2006.

These new fields are in all areas of the UKCS, with the majority located in the central North Sea and west of Shetland. "Securing all the investments identified by our survey will demand action from industry to reduce costs and improve efficiency and from Government to lower production taxes and lighten UK and EU regulatory burden."

Earlier this year, Deloitte reported that first quarter 2010 drilling activity on the UKCS declined 33 percent from the same quarter a year ago and eight percent from the fourth quarter of 2009. UKCS drilling activity for this year's first quarter was a six-year low, with eight exploration wells and four appraisal wells spud during that time.

UKCS Exploration / Appraisal Wells January to June 2010

Oil and gas production from the UK North Sea sector peaked in 1999, but industry sources see significant untapped potential. In 2008, the UK North Sea was the 14th largest oil and gas producer in the world.

New Tax Incentives Help Production

The fiscal regime of the UK, where no incentives for exploration exist, is quite different from other North Sea countries such as Norway, where companies are provided incentive for drilling through a 78 percent tax rebate on all dry exploration wells. UKCS production profits are some of the most heavily taxed worldwide, with a 50 percent special tax for oil and gas profits plus 28 percent corporate tax levied on production.

Last year, an incentive was added to aid production to small fields, ultra heavy fields, and ultra high temperature/pressure fields.

This year, this allowance was restructured to allow for deep water gas fields, aiming to encourage activity in the last major area in the UKCS to be developed. The new field allowance applies to new fields whose characteristics significantly increase costs, particularly small fields, remote gas fields to the west of Shetland and technically complex high press high temperature fields. New fields normally pay 30 percent corporation tax plus 20 percent supplementary charge on corporation tax. The allowance means that when investment in made in a new field fitting the correct description, the operator can produce oil and gas to a certain value before incurring the supplementary corporation tax of 20 percent.

Other positive signs are appearing for exploration and production in the UK North Sea. Last month, the UK government unveiled its Energy Bill 2010, which includes provisions to ensure that all North Sea oil and gas operators will have access to North Sea infrastructure to ease the exploitation of smaller and more difficult oil and gas fields.

The Department of Energy and Climate Change at the end of March closed the 26th offshore licensing round, which offered for the first time blocks in all regions of the UK. Acreage will be available in the West of Shetland, Northern North Sea, Central North Sea, Southern North Sea, Irish Sea, Morecambe Bay, West of Hebrides, South West Approaches and the English Channel. Announcements of license awards will be made in due course.

As part of the round, the UK government introduced a new Frontier license, with an extended nine-year exploration term for the West of Shetland region. It is hoped that the new license will encourage development of some of the new discoveries made in the region, with a potential GBP160 million (US 233.9 million) of tax relief for each qualifying field.

"Given that the UK will continue to rely on oil and gas to provide the vast majority of its energy needs until 2020 and beyond, any measures that again hamper investment will jeopardize future energy security," said Oil & Gas UK. "If the status quo remains, investment in new and mature assets will be encouraged and we will be more likely to maximize the economic recovery of this vital natural resource. In the longer-term, we do need to see a lowering of the overall tax rate to reflect the maturity of the UK's oil and gas province."

North Sea Rig Utilization Sags, Discoveries Continue

Last year's global credit crunch, which dried up credit lines for many North Sea players, coupled with high costs associated with the North Sea, resulted in delays in drilling activity and spending, job losses and some consolidation among companies. A number of rigs in the region were stacked due to the lack of demand, resulting in a near stand-off between the oil and gas companies and the rig operators in terms of day rates being demanded and day rates companies were willing to pay. Fewer rigs are now stacked in the region at present.

According to RigLogix, one drillship, 32 jackups and 33 semis currently are drilling in the North Sea region, and the current North Sea fleet is comprised of one drillship, 37 jackups and 37 semis. Last year at this time, two drillships, 31 jackups and 32 semis were drilling in the North Sea out of the two drillships, 34 jackups and 38 semis available.

Jackup utilization for the region has decreased by 22.8 percent from 91.2 percent a year ago to 86.5 percent this month; meanwhile, the average day rate has also weakened from US $198k this time a year ago to US $153k at present.

Utilization of the region's semisubmersible fleet stands at 89.2 percent, up from utilization in June 2009 of 84.2 percent ; however, the average semi day rate has declined from US $379k this time last year to US $375k. The number of drillships in the region has declined from two this time last year to one at present, with utilization remaining at 100 percent. Since 2005, overall rig utilization and the average day rate for the region have declined.

North Sea Rig Utilization Since 200

Some drilling activity has continued in the region as the credit crunch eases and operators forge ahead with exploration plans. According to SubseaIQ, 12 oil and gas discoveries have been made in the past six months, including the recently announced Catcher discovery in the central North Sea.