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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