North Sea’s glory days have long gone

Oil extracted from North Sea once made UK the world’s six-biggest producer of oil and natural gas. However, the tide turned after 1999 when production peaked at 4.5 million barrels per day. Estimates suggest that production is down nearly 40% since then.

At end of 2006 and 2007, UK production had dropped to 2.9 million and 2.8 million barrels per day respectively, indicative of a terminal decline. Geologists are not yet suggesting the North Sea oil has nearly run out. Government and private sector research indicates there is still about 15 to 25 billion barrels beneath the UK Continental Shelf (UKCS). However, all the “easy oil”, to be read as easier to extract, has nearly dwindled.

Most new discoveries contain less than 50 million barrels; minuscule amount by global standards. Harder to extract oil requires additional investment as production becomes more and more capital intensive. Research by Oil and Gas UK (OGUK) suggests that there are already signs of a sharp slowdown in exploration and appraisal drilling activity. In its Economic Report (2009), it noted that the first quarter of 2009 saw a 78% drop in the number of exploration wells drilled.

OGUK expects investment to fall significantly and fears it could even drop below £3 billion in 2010. Historic data suggests investment stood at £4.9 billion in 2007. Furthermore, a fall in the value of the pound sterling against the US dollar and relatively smaller discoveries per exploratory project would imply that 2010 would result in investment of a comparable level yielding less than one third of the oil did in 2001.

OGUK is not shying away from admitting things are not what they used to be. To its credit, the lobby group meaningfully acknowledges UK’s internal “Peak Oil” argument. It believes the surge in oil price during 2007 and 2008 masked a steady decline in the competitiveness of UKCS extraction.

Pure economics also comes into the picture. Quite frankly, despite a decline in relative value of the pound sterling, it is clear that UK oil and gas exploration projects will lose out to other regions around the world which offer more substantial investment opportunities on better terms. For instance, Cairn Energy (LSE: CNE) made its mark in the North Sea, but is banking its future strategy on South Asia (India and Bangladesh), Tunisia and Greenland.

UKCS' decline is unlikely to be stemmed unless the government provides tax breaks to ensure some semblance of competitiveness, according to business lobby groups. Even at the time of the oil price touching dizzy heights of US$147 per barrel many were concerned. I recollect a conversation I had at a House of Commons event early in 2008 with Geoff Runcie, Chief Executive, Aberdeen & Grampian Chamber of Commerce (AGCC) and Howard Archer, chief UK economist, IHS Global Insight.

Runcie believed that despite repeated warnings of escalating oil extraction costs, the UK oil industry had to contend with two major tax increases in recent years. He said that investment in real terms had fallen by £1 billion between the first quarter of 2006 and the first quarter of 2008, despite rising commodity prices.

Archer noted that giving tax breaks to oil companies at a time when crude oil price was at $147 per barrel, household energy prices were rising and oil companies were booking record profits, was politically suicidal for any government. The financial tsunami that followed over 2008-09 and the current precarious state of the UK public purse currently makes allowance for such tax breaks unthinkable.

Furthermore, energy economists believe North Sea investment was hit both ways. High oil price masked under-investment and made tax breaks unpalatable for most of 2007-08. Subsequently, a greater decline in activity was an obvious consequence of a lower oil price which fell to $34 per barrel in December 2008 with no tax break in sight for entirely different reasons.

Despite evidence to the contrary, fall in oil production and two of Scotland’s largest banks being owned by the UK taxpayer, the Scottish National Party (SNP) still bases its case for Scottish Independence on North Sea oil deposits, majority of which lie in what could geographically be described as Scottish waters. The figures may add up today, but do not stand up to scrutiny for much longer. SNP does find common ground with oilmen and lobbyists who wish to see more exploratory activity west of Shetland Islands. Even before significant prospecting, geologists believe it could hold up to 4 billion barrels of oil.

However, commencing projects in the area is not easy. A sea bed with prospective hydrocarbons stored at high pressures, inhospitable climate and a lack of infrastructure temper enthusiasm as easier exploration options are available globally. Total has got one gas project going which was commenced in 2007. It believes the West of Shetland area represents about 17% of UK’s remaining oil and gas resource base and could contribute up to 6% of the country's gas requirements by 2015.

If even a new exploratory zone represents 17% of what is left, one wonders how much actually does remain. Shetland Islands Council EDU sees the inevitable but not immediate decline. West Shetland will not prevent the North Sea’s decline. Furthermore, several government papers between 2003 and 2007 recognise the problem. However, in my opinion none of the papers seem to provide any concrete contingency plans when and if, as expected, UKCS production falls to a third of its 1999 peak level sometime between 2020 and 2030.

Concurrently, Office for National Statistics (ONS) data after the second quarter of 2007 suggests the UK is fast becoming a net importer of crude for the first time in decades. Glory days have long, off-shore industry faces tough challenges, government finances are precarious and no one is in denial. In short, it’s a jolly rotten mess, albeit one which has been in the pipeline for some time.

© Gaurav Sharma 2010. Photo Courtesy © BP Plc, Andrew Rig, N. Sea