How Can the North Sea Oil and Gas Industry be Revived?

Prof Alex  Kemp, Univerity of Aberdeen, United Kingdom

Ms Linda Stephen, Univerity of Aberdeen, United Kingdom

The collapse in oil prices has resulted in a dramatic reduction in investment activity in the UK Continental Shelf (UKCS) with both new field developments and exploration falling substantially.  Many currently producing fields are now operating at a loss.  Fears have been expressed regarding the sector’s longer term viability.  This paper seeks to illuminate the present position and prospects for the industry in the light of recent world energy market developments.  The UKCS is a mature petroleum province personified by declining geological prospectivity, the presence of many old fields, and the prevalence of high unit costs.  Over the period 2009 – 2014 the investment boom relating to a few large projects concealed the underlying problems.  The extreme cost inflation experienced in this period has exacerbated the current difficulties.  The study employs financial simulation modelling, including use of the Monte Carlo technique to assess exploration risks, to estimate the prospective returns at the field development and exploration stages under a variety of oil prices, cost, and tax regime assumptions.  The authors have access to a large field database which enables them to calculate prospective returns to explorers and field developers separately in the 4 main regions of the UKCS.  Prospectivity, sizes of fields, and unit costs vary significantly across these 4 regions.  The modelling seeks to discover what combinations of oil prices, unit investment and operating costs, and tax structure can facilitate substantial ongoing exploration and development activities.  Full attention is given to the question of the appropriate level and structure of the tax system.  The current tax system is entirely profit-related and is generally progressive, but, in the new market situation with a combination of low oil prices and modest geological prospectivity, there are questions about whether the level is now appropriate.  Capital rationing is also endemic in the sector and the tax system has to acknowledge the extent of materiality in returns required by investors.  The modelling will elucidate these issues.  It will also clarify the circumstances where projects are likely to be non-viable before tax.  There may not be any economic rents to collect.  Full attention will be paid to any tax changes proposed in Budget 2016.  The study will also add illumination to the issues of the costs and benefits associated with the enhancement of production efficiency.  This fell from c. 80% in 2004 to c. 60% in 2012.  The study will measure the national benefits from procuring a substantial increase in production efficiency as foreseen by an industry Task Force.  The paper will discuss how more effective regulation by the new Oil and Gas Authority can enhance production efficiency and the maximisation of economic recovery more widely.  In sum, the paper will illuminate the prospects for the sector from the viewpoints of both investors and government.