Activity in the North Sea oil and gas sector is fast approaching a cliff.
Radical action is needed to maintain the level of production and to prevent a sharp downturn which would destroy jobs and leave billions of barrels of oil and gas undeveloped.
For the moment production from the UKCS is being maintained from investments which began before the fall in prices started in the summer of 2014. Beyond that, however, the cliff looms. Very few new significant investments have been made over the past year and exploration activity is minimal. 8,000 jobs have already been shed.
Attempts by operators to cut costs are hurting the service sector and the impact is beginning to spread back along the whole supply chain and across the region, which has come to rely on oil and gas as a mainstay of the local economy over the last 40 years.
The current difficult situation will get significantly worse if the pipeline of new activity is allowed to run dry. Operators will extract what they can from existing fields at the lowest possible costs, output, employment and revenue will fall and the sector will begin the process of closing down.
Some hope that the situation will be rescued by a rise in international oil and gas prices. Short of a revolution in Saudi Arabia or a dramatic surge in oil and gas demand that feels like wishful thinking.
Both oil and gas are in surplus on a worldwide basis. Every oil producing country has an incentive to compensate for the price fall by maximising production. Iraq is back in business and despite all the internal conflicts is producing at record levels. Iranian production is also slowly rising after last year’s nuclear deal.
In the natural gas market excess supply is a universal problem. The US has so much shale production that it has now become an exporter – selling liquefied gas to Europe. Russia is determined to maintain or increase its market share by building a new pipeline – Nordstream 2 – into Germany and then onto Western Europe. These new supplies could swamp an already saturated market in which demand is falling.
We have entered an age of plenty in energy supply and the consequence will be a long period of low prices. For operators and investors that means that they have no economic interest in going ahead with new developments.
The oil and gas – between 12 and 24 bn bbls worth according to the Wood Report published two years ago – will stay in the ground.
But the operators and owners are not the only people with an interest in seeing the North Sea developed to its maximum potential. There is a national interest to be taken into account as well – a Scottish interest and an interest for the UK as a whole.
The UK Government has been very slow to respond to the deteriorating situation. Small tax changes have been made but there has been no shift to the Norwegian system which incentivises new exploration.
That is necessary but probably still not sufficient because at current price levels very few companies are paying much tax at all.
The key issue if activity is to be maintained is financing. New money has to be brought into the sector. The Oil and Gas Authority has a strong mandate to maximise production and needs to look urgently at ways to achieve this.
In the 1970s when North Sea activity got going the balance of public and private interests was protected by the creation of a public sector company – BNOC, later Britoil. Something comparable is needed now – not an operating company but a financial investment vehicle which can work with the private sector, sharing risks and rewards in a way which allows the numerous projects now at risk of being dropped to go ahead.
Of course, North Sea output will still decline over time and an orderly process of decommissioning will be necessary for some fields which are genuinely exhausted.
But billions of barrels are in place which could and should be developed. Cost reductions over the last two years have already begun to change the economic prospects of some fields. Technology, especially on recovery rates and reservoir management, is advancing all the time. What is needed now, urgently, is a new injection of funds to sustain activity for another decade and perhaps longer. The Government has managed to come up with lavish and ingenious packages of funding for the development of new nuclear power in Britain.
There is no reason to believe that a comparably creative mechanism could not be put in place to ensure that the North Sea oil and gas industry can avoid entering a decline which would be terminal.
Nick Butler is Visiting Professor at Kings College London. He was formerly Group Vice President for Strategy at BP and subsequently senior policy adviser to Prime Minister Gordon Brown.
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