Select Committee on Trade and Industry Minutes of Evidence


Examination of Witnesses (Questions 100-119)

UK OFFSHORE OPERATORS ASSOCIATION

25 JANUARY 2005

  Q100 Chairman: Good morning, Mr Webb. Perhaps you could introduce your colleagues.

  Mr Webb: I have with me David Odling who is the Gas and Commercial Issues Manager for UKOOA. I am joined as well by colleagues from BP.

  Mr Peacock: Good morning. I am one of BP's business leaders in the North Sea. Hopefully I can deal with your questions particularly about the upstream part of the business. Alan Haywood is from our Northern European gas business unit, and hopefully he can address questions about gas prices and markets.

  Mr Webb: Chairman, we are here as two separate witnesses and not one.

  Q101 Chairman: There is always a problem about getting people and whether it is the right idea to have you and Shell in together, but we decided to do it this way. Feel free to answer questions as and when; but if there are things which are quite clearly yours then elbow your way in! We asked the previous witnesses about a number of things regarding the impact of gas; but from you what we would like to do is not so much talk about the mediums, but there seems to be a degree of uncertainty about the future availability of gas supplies and this arises from the decline in UK Continental Shelf production. It has been suggested it is as much a consideration of the lack of full market liberalisation within Continental Europe. How much weight would you give to these factors as being major contributors to the increase in the price, the decline of the UK's share, or our increasing dependence on what might be regarded as ill-liberalised markets in Europe?

  Mr Webb: I think that certainly had some impact. Why have the prices increased? One of the reasons for it, we say, is market sentiment, and some of the market sentiment is around nervousness on those issues and we are going into a different territory now. In fact, it is probably worth reminding ourselves that we are reverting to a period when we imported gas into this country; this is not novel for the UK, and we were importing a significant proportion of our gas from Norway in the 1990s, so we are going back to that. I think it has had some impact. That the UK market is now connected to Europe through the Interconnector is also certainly true as well, and that has had an impact. Maybe I should defer to others who have more knowledge of the market on that, and point out that UKOOA, of course, is really a representative organisation for the producing companies in the upstream and our interest clearly stops at the beach.

  Mr Haywood: I think in the case of pricing then the price which we see in Europe—which has been well understood to be connected to the price of oil—clearly has an influence on the UK prices. The price of European gas does have an impact on UK prices. To the extent that there is available capacity within the pipeline (the Interconnector) it means that European prices will provide something of a floor to UK prices. I think then there is a question: is all gas that is available in Europe capable of flowing to the UK, should the economics demand it? There we have questions still about: what is the liquidity of gas markets in Europe, such as the Zeebrugge hub? I think what we would say is that that liquidity is improving but it is not complete yet. There is a relationship between European prices and UK prices and there is an inter-connectivity, and liberalisation is helping that to improve.

  Q102 Chairman: There seemed to be a heady brew round about the late summer when we had increasing awareness of these factors, which we have just referred to; but mixed in with this were media scare stories about gas shortages, power cuts and every prospect of the worst winter in 30 years. Do you think you might have been the subject of mischief-making by the media as much as anything in the earlier stages and there was an over-reaction to these stories?

  Mr Webb: I am tempted to give a one word answer to that which is, yes. There was a lot of uninformed comment in the press and in the media, and a lot of scare stories about availability from the UK. They proved to be groundless as well and if we see where the markets have gone now that has borne that out.

  Q103 Chairman: In the intervening period a number of people have made a lot of money.

  Mr Webb: Some people may have made some money through that but I am not aware of that.

  Q104 Chairman: Would you attribute a lot of this change just to market sentiment? Do you think this is the kind of market that is sufficiently volatile that it is going to be subject to this kind of vulnerability to scare stories?

  Mr Haywood: I think that the real time in question here is September. They were certainly looking at a market in which there were genuine concerns about supply and demand fundamentals. We were also working on a high base price because of that connectivity to Europe. The question is, as we go into that winter period: what is the right insurance premium which should be associated with that potential concern? There was talk at the time about an extremely cold winter; but I think what we saw was people expressed that concern in the forward prices in a way which subsequently turned out not to be the case because a winter did not materialise as some people feared; because field reliability was much better than perhaps it had been in the past. Therefore, on the insurance premium (which I believe to be somewhat understandable) the question is: what is the scale of that premium? It was right that there should be concern—however, it turned out not to be necessary.

  Q105 Chairman: It may not be a temporary blip, because it is a bit bigger than that, but on the other hand do you take the view that the Government is saying, "Well, really it's not going to last forever. We're getting new pipelines. There are going to be LNG facilities. We're going to be able to more than compensate for the decline in the UKCS and really in the medium-term everything is for the best in the best of all possible worlds"? Do you share this Panglossian mood?

  Mr Haywood: What I think we have seen this winter is that actually the market has coped. There has been strong demand because demand is increasing, and yet there was enough supply. What it does take is a combination of field production, gas in storage and gas flowing through the Interconnector pipeline. What we have going forward is actually increased supply coming in and increased connectivity to other sources of supply. Yes, it is my view that there will be enough supply, but it is very important that the market pricing signals be allowed to establish themselves, which will then give rise to those new sources of supply.

  Q106 Chairman: Perhaps I could ask UKOOA, in   your memorandum comparing gas prices throughout Europe you have produced evidence which in many respects contradicts what other witnesses are telling us that UK industrial customers are having to pay more for their gas than their European competitors and you say this is not the case. Could you perhaps explain why your figures do not seem to stack up alongside some of the other evidence we have had?

  Mr Webb: I should say again, we are not experts in the downstream market, but what we did, Chairman, was we went to a thoroughly reputable third party source, Heren (and those data are not our data, they are data from those published sources) and they show just that—that UK prices for all types of consumers are not out of line and, indeed, are cheaper than in a number of European countries.

  Q107 Sir Robert Smith: What are those prices? Are they spots on that day?

  Mr Odling: No, there is a scale up on the top right-hand which gives you small, medium and large volumes per year.

  Chairman: We may want to take this up with you later on in writing.

  Q108 Mr Clapham: If I could just move on to the decline in UKCS. For some considerable time now we have realised that UKCS is a mature field, and that gas exploitation was likely to see a decline. However, there have been some recent predictions that do suggest that production rates have been revised even further downwards. Why is this? Is there any particular reason?

  Mr Webb: Maybe I can address that. Actually the very latest evidence, which will be published later this week which will be the UKOOA Activity Survey, does not show that. I am pleased to say that overall when one looks at the whole of the UKCS oil and gas, which we are now predicting, there is an increase in forecast production of about 5% over the period from now to 2020. We think that is extremely important and extremely significant and that we have turned something of a corner—the corner we turned, frankly, in 2002 when we were confronted with unexpected tax increases which had a very detrimental effect on investor confidence. For the last four editions of the UKOOA Survey we have not been showing that optimistic a prediction, but things are now improving. We are not seeing that situation degrade. As far as gas is concerned the increase is not so great there and there is yet more work to be done. You are quite right to say that this is a very mature province. We have produced now about 34 billion barrels of oil and gas from the UKCS. Our model—and that is a model we share with the DTI and Wood Mackenzie—indicates there is a further possible 28 billion of reserves out there yet to get, so there is quite a prize yet to play for. However, that prize is more difficult to achieve than it has been in the past. If you like, we have found all the elephant fields, we are now after very much smaller prey. The discovery size is half, for example, what it was 10 years ago now. It is getting more difficult. There is a difficult job to be done out there, but we think that the signs are somewhat encouraging. As long as all the players continue to do the right things we think we should be able to achieve the majority of that prize for the country.

  Mr Peacock: Within that overall picture UKOOA painted of either slight decline or maybe close to flat in the near term, I think it is helpful to understand if, for example, we were to do nothing other than run the fields that we have today out in the North Sea the rate of decline would actually be something in the range of 15-20%. It is only through continued investment that actually we are able to mitigate that decline and keep it either at a very much more modest level or even close to flat. It is absolutely crucial that we as an industry do continue to invest in that future.

  Mr Webb: There is another crucial reason why we carry on with that as well. I think we do starkly face now two futures, and the two futures that UKOOA can model out: one is of rapid decline. If we face that rapid decline we see 40% of the offshore infrastructure being decommissioned in 2020; that offshore infrastructure will not be put back and it will lead to serious loss of ultimate recovery. It is hugely important that we do not let that happen and that we increase the production flowing through the existing facilities so that they are kept in place. We have another model which is the higher production model, and if that is there then all the main elements of that infrastructure can be kept in place and we will recover the majority of that prize I talked about, but it is going to be tough going.

  Q109 Mr Clapham: There will obviously be another effect as well if there was rapid decline where we see price increases?

  Mr Webb: It is specifically in the gas market you would be losing a very significant element to the UK gas market, yes. We believe that offshore gas can be still supplying 60% of the UK's requirement in 2010 and significant proportions beyond that. If you go into rapid decline you will have lost an important element to the UK gas supply.

  Q110 Mr Clapham: A little earlier you gave the impression that perhaps the pessimism which led to an underestimation of the resources was caused by the tax regime. Is there any evidence for that?

  Mr Webb: No, I am sorry I did not wish to imply that that led to an underestimation of the reserves. What it led to was a falling off in activity in the North Sea, and that is what would be extremely injurious to the ultimate recovery if it was repeated. For example, exploration and appraisal wells fell from about 60 a year to 40 a year in the two years following that tax increase. I am pleased to say I think our survey will show that they climbed to about 60 last year, and we are forecasting that they could go on improving this year and maybe get above 70 for this year. We have come out of something of a slough and we seem to be heading into much more purposeful territory. I am bound to say that is due to a lot of hard work within the industry and within government.

  Q111 Mr Clapham: Given what you have said about 60% by 2010, does that suggest that the geological or other technical problems that were previously anticipated, again, were perhaps over-emphasised?

  Mr Webb: No, I do not think so. I think we have just been working harder at them.

  Mr Peacock: Absolutely not the case. I think it still remains that it is a relatively challenging environment in the North Sea. Due to the stage of its life that the basin is in, the reservoirs that are remaining are generally deeper, they are generally smaller and they have new technology challenges associated with them. For example, we have remaining reserves just within our company estimated at about 4.5 billion barrels, so plenty yet to play for; but about one-third of that is in a category we would say has considerable technology challenges associated with it. We should not underestimate the challenge that remains to get the potential that is there.

  Q112 Mr Clapham: Is carbon sequestration likely to be a technology that we could use to help to exploit the oilfields and the gas fields further—but particularly the oil fields?

  Mr Webb: Carbon sequestration as such—in other words the storing of carbon dioxide in depleted reservoirs or aquifers—would not in itself have any particular impact on the production level of the North Sea. It is espoused by some, however, to be one of the things that should be looked at when looking at the CO2 emissions issues, but I do not believe it has any particular impact upon recovery. Carbon dioxide can be used in enhanced oil recovery techniques, it is true.

  Q113 Mr Clapham: You do not see that being of any use in the North Sea?

  Mr Peacock: It is not a direct influence on survival investment or recovery from traditional oil and gas fields.

  Q114 Sir Robert Smith: A quick question on the challenges, geology and technical side. Is one of the consequences of being in a mature province and finding ways round these challenges that we are building up an expertise and an industrial base in this country that is actually finding markets in other parts of the world to export skills learnt in the North Sea?

  Mr Peacock: Yes, and in fact that works both ways. The skills we are creating and have available in the UK are of benefit overseas; and when people have been overseas it is also of benefit to bring those back into the UK.

  Q115 Sir Robert Smith: One other question on production. How much of the next generation of gas finds and production will fetch from mixed fields as opposed to purely gas for industrial use?

  Mr Webb: Currently the production is about 50:50 between the two. 50% is a dry gas and 50% is from associated gas.[1] I think we would anticipate that there could be an increasing proportion of that from the associated fields.

  Mr Odling: There is evidence of that. There is not a huge amount of dry gas left, other than some very poor quality dry gas.

  Q116 Sir Robert Smith: For the layman that means the next generation of gas is likely to come from fields which are also looking for oil?

  Mr Odling: Correct.

  Q117 Linda Perham: Can I move on to gas supply contracts. The conventional main explanation of the gas price increases is the link with oil prices in the contracts between producers and wholesale buyers. Why does that link exist, the link with oil prices in the contracts between producers, wholesalers and shippers, in this case?

  Mr Haywood: I think we have to actually cast our mind back to when there was not a gas market and gas producers were looking to obviously encourage demand but also thinking about the risk which the consumer was taking, and how that risk was likely to be averted—with linkage to an alternate fuel, namely oil. A number of these contracts were actually indexed to well-established markets at the time. In fact there tends to be a basket of indices for these long-term traditional supply contracts—a combination of oil, electricity and, in some cases, gas and also inflation. It gives a link to oil, it is not necessarily a one-for-one link but you are right to imply the way oil prices rise some of these gas supply contracts will rise in price as well.

  Q118 Linda Perham: Is there anything to prevent the use of contracts not linked to oil?

  Mr Haywood: For new contracts going forward, there is nothing to stop that and, in fact, a number of new contracts are being signed indexed exclusively to the gas price. To some extent consumers and producers have a choice as to exactly how they wish to price those contracts. I would say that the trend at the moment is towards more gas pricing.

  Q119 Linda Perham: Do you think it would be in the UK's national interest if there was not a significant element of oil price in the indexation formulae? You said, movement towards gas, but if there was not a significant element of oil price?

  Mr Haywood: Putting aside the tricky question about which one will give cheaper prices, because the truth of the matter is sometimes one contract will give cheaper, sometimes it will give more expensive, I do think that there is a logic in having what I call gas on gas competition. The true fundamentals of the commodity determine the price because that will send the economic signals to both buyers and sellers as to how they need to act in the future.


1   Note by witness: In fact, 30% is dry gas and 70% is from associated gas. Back


 
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