The latest research from the University of Aberdeen provides detailed independent financial confirmation of the constant refrain in industry – that without meaningful and sustained cost reduction the UKCS basin will not be economical in the short to medium term and maximising economic recovery will not be achieved. It is an important contribution in illustrating the impact of costs on returns in our industry.
From a positive perspective, the authors, using a base price of $70, illustrates that with E&A cost reductions of 30% and a reduction of 20% in development and operating costs new field economics can be meaningfully improved into positive returns.
The level of cost inflation over the past decade has been staggering. According to Oil and Gas UK’s 2015 economic report, capital costs per boe have grown at 18% CAGR and opex at 12% CAGR. Accordingly, achieving this level of cost reduction – although regrettably involving personal pain for many individuals – does not appear particularly ambitious.
The authors touch upon the question of how to stimulate exploration activity and suggests, including consideration of the introduction of a refundable tax credit.
Taxation policy can be an enabler and primer of activity and development but cannot change the fundamental economics of the industry, which is in the hands of operators and the supply chain.
The paper only deals with North Sea economics as a standalone analysis. However IOCs and global capital providers are not concerned solely with ensuring a positive return, they have capital allocation decisions to make. In a world of considerably reduced oilfield capital investment and ongoing excess of supply over demand, it is not sufficient to move North Sea returns into positive territory. The basin needs to move up the comparative league in order to generate investment.
Furthermore, as the life cycle of exploration, appraisal, and development stretches over many years; the investor needs to be convinced that cost reductions are sustainable over the medium term before committing capital.
The industry may be well be on route to achieving 20% to 30% savings in the current and next year through removing fat from the industry, which has become bloated in recent years. At Offshore Europe, we heard a lot of presentations on the high level themes of industry transformation, collaboration and standardisation. However, have these yet really permeated into the DNA of the industry?
We regularly hear anecdotes from the supply chain that when replying to requests for price reductions that they put forward constructive suggestions on alternatives or alterations to scopes that can save cost (but protect their margins) only to be met with the reply “No, we wanted what we had before but you need to cut cost by 20%”. In the current climate, the customer will probably obtain the reduction but not through collaboration or a true change in approach that moves the industry towards a more sustainable footing.
Until those making investment decisions over a long term development are convinced on the sustainability of cost reduction and industry transformation, then the period of reduced activity and investment could be prolonged.
This has particularly significant consequences in a mature basin with ageing infrastructure, and increasing decommissioning which may change the unit economics of the remaining, existing and potential future fields.
Alan Kennedy is the head of oilfield services at KPMG UK.