Examination of Witnesses (Questions 222-239)
SHELL UK LIMITED
25 JANUARY 2005
Q222 Chairman: Good afternoon, Mr Smith.
Perhaps you can introduce Mr McFadyen and yourself and we will
get underway?
Mr Smith: My name is James Smith,
and I am the Chairman of Shell in the UK. If you will allow me,
I would not mind saying a couple of words of introduction. Would
that be acceptable to you?
Q223 Chairman: To be frank, we do not
encourage it, because we say that that is what you provide us
in the form of written evidence, but I do not think you as an
organisation have been before this Committee before or for some
time, so we will make an exception.
Mr Smith: You are very kind, Mr
Chairman. I will be brief. What I wanted to do was summarise the
main points of my submission, but perhaps Kieron would like to
introduce himself first?
Mr McFadyen: I am Kieron McFadyen.
I am Shell's European Technical Director for Exploration and Production.
I am also directly responsible for exploration and production
operations here in the UK and, as a result, based in Aberdeen.
Mr Smith: Thank you, Chairman.
Briefly, I think there are three points I would like to highlight.
First of all, in a competitive energy market like the UK we believe
the market fundamentals will out, that therefore prices will be
set by the supply and demand balance and that therefore the best
way to mitigate prices for the long term is to bring new supplies
to the market, which brings me to the second point. I believe
we have been working very hard to bring new supplies to the market
from the UK Continental Shelf to extend on the plateau in a period
when a mature province is going into decline. A new field called
Golden Eye that you know of was brought into production which
meets 3 per cent of UK needs last year, a field called Penguins
that we will open up in due course—so spending something
of the order of $1.7 billion a year in the UK Continental Shelf—that
comprises the sum of our money on operating costs and capital
investment on the UK Continental Shelf, but also bringing gas
from further afield as well. You will have heard of the Orman
Lange field in Norway which has the capacity to meet 20% of UK
needs. There is also a new pipeline coming in from the Netherlands
to the UK that could meet about 8% of UK needs. If you add all
of that together, we are talking about a capacity that would meet
30 odd percent, about a third of UK needs. Our ownership interest
in those fields is about 6% overall in the UK market. My third
point is this. Part of the reason for saying that is these are
long-term projects (20 years or more) with a great deal of up-front
investment, a great deal of technical uncertainty and market uncertainty.
Prices are high at the moment, but it was in 1998, when the oil
price was $10 a barrel. We could expect over the life of projects
like these maybe three seven-year cycles of that kind. We see
in front of us technical uncertainty and market uncertainty and
we look, in those circumstances, because I know this is a subject
for discussion, for fiscal stability over that period. We believe
that is the best means to avoid any unintended consequences of
leaving oil on the ground for the nation. We want to maximise
production. Maximising production brings hydrocarbons to market—that
has the impact of minimising prices—security of supply,
balance of payments, a quarter of a million jobs. So our request
is fiscal stability in the long-term as an incentive for us to
invest.
Q224 Chairman: We might come to the question
of fiscal measures somewhat later on, but if we can start with
the question of the UKCS's maturity. The fact that yourselves,
perhaps somewhat more spectacularly than others, but nonetheless
a number of oil companies have been revising downwards their views
on reserves. Could you maybe explain to us why you had to make
quite a substantial downward revision of your reserve figures?
Mr Smith: I can do that. I think
that question, if I understand it correctly, is about reporting
under the SEC regulations, which about a year ago we had to go
public and say that we had looked at it again and found we had
made quite a substantial error in reporting the reserves and we
had to correct that. If you also have a question about the actual
reserves in the ground in the UK Continental Shelf and how those
will get produced in the long-term, I am sure Kieron will be happy
to deal with that. We did not comply fully with the SEC regulations.
That is what we discovered when we looked at it. We had to make
the correction. It is very regrettable, but we have put procedures
in place now to ensure that we measure those reserves correctly,
proper training, better standards, audit and review.
Q225 Chairman: The other thing that we
would want to ask particularly about the UKCS is this. Would you
say that the geological and technical problems are greater than
you had anticipated? I remember teaching in the 1970s and getting
stories of how difficult things were and the scale of the technological
achievements to get the rigs in place and to get the oil back
to the UK. Difficult though it was, you seem to have been able
to do it with quite a considerable degree of success. Are things
more difficult than you had anticipated, or are we simply getting
to the more difficult fields which are that much more remote and
smaller and the like? Perhaps you could give us your understanding
of it.
Mr McFadyen: I have a couple of
points to make, Mr Chairman. First of all, as James mentioned,
we are about halfway through the development of the North Sea.
I think if we add it up, the producers in the North Sea have produced
something like 30 billion barrels. We subscribe to the view that
we are about halfway through. In other words, there is about another
30 billion barrels to play for. When I look at Shell's resource
base and I compare it with that 30 billion barrels, it kind of
makes sense. As I said, I can subscribe to that. It was difficult
for the first 50 years. What is absolutely certain, in my mind,
is it is going to be much more difficult for the next generation;
so that remaining 30 billion barrels is going to be much more
difficult to extract for the very reasons that you mentioned yourself.
It is technically more difficult, accumulations are smaller, accumulations
are technically more risky and that means technical risk, construction
risk and for us a greater investment risk; so it is going to be
more difficult. The other thing I would add is that the kit that
we put out there over the last few decades is requiring more and
more maintenance, for obvious reasons; and, as you well know,
out there it is a pretty hostile environment. Be it sub-sea installations
or be it jackets or platforms, it is still very hostile.
Q226 Chairman: Do you anticipate that
this more difficult process of extraction will nevertheless be
smooth in the sense that the supply lines will be fairly consistent,
that you will not have peaks and troughs of supply, which doubtless
would be reflected by a change in price?
Mr McFadyen: My great hope as
an investor out there is for investment stability, be it economic
stability, fiscal stability, but also planning stability. One
of the things that I strive for as technical director is making
sure that drilling installations are well planned, so semi-subs
or jackets, the supply chain are behind that and we are putting
in place good plans. If we have good stable plans in place, we
have got a much better chance of better execution; so stability
for me is king.
Q227 Mr Clapham: Before looking at some
of what the Government is saying about new pipelines and facilities,
etc, could I ask on carbon sequestration, is that something, Mr
McFadyen, that you are looking at or is it a technology that you
think needs a great deal more development before it could be applied?
Mr Smith: I may have a go at that,
if you like. It just so happens that in Shell centre that the
launch of the international climate change taskforce took place
this morning with Stephen Byers and Adair Turner and Jonathan
Porritt. As you know, tackling climate change is one of the Government's
two main themes for G8. The reason I mention that is sequestration
of carbon falls within that heading. We are committed to look
at climate change as well, so we look at those technologies too.
As regards sequestration of carbon, there are a number of ways
to do it and one of them is to scrub it from the flues of power
stations and to reinject it into oil wells or oil fields, repressurise
the oil fields and get more hydrocarbons out. There was an article
in the Sunday Times, which you may have seen, on that. The answer
is that in the long-term solutions like that may well be practicable;
they may be more practicable in some places than others. For example,
there is an existing infrastructure in the United States that
enables that. At the moment they take CO2 from geologic sources.
If you can get it from power stations you get a double benefit.
It does not happen in the UK sector of the North Sea. I would
not rule it out, but we have no specific plans in the UK sector
of the North Sea at the moment, although I can assure you that
the technologies for carbon sequestration, because you can mineralise
carbon as well, there are a range of things that you can do with
those technologies which we examine fairly carefully.
Q228 Mr Clapham: A little earlier you
talked about bringing the resource to the market. Within that
context do you share the Government's confidence that the new
pipelines and other production import facilities that are being
planned are sufficient to offset the decline in UKCS?
Mr Smith: I believe so, yes. As
we know, things will be a little bit tighter over the next couple
of winters, but there is every confidence that there will be sufficient
gas over the next couple of winters. Thereafter, as I mentioned,
some projects in which we are involved—I did not mention
one in which we are also involved in Ireland, which reduces the
call to Ireland for UK gas, so that helps our position. As you
know, there are LNG projects that are coming into the Isle of
Grain and to Milford Haven, if you put all of that together, it
looks as if there will be substantial quantities of gas coming
in to meet the market.
Q229 Mr Clapham: You are confident that
we can meet some of the problems that are likely to arise in Europe;
that we may be, shall I say, cushioned against those. When I refer
to problems, I am thinking in terms of the gas, a third of the
world's gas, being imported from Russia. That is where most of
the European gas is coming from at the present time.
Mr Smith: I think we are moving
into a new period. Of course, we have been fortunate enough to
be self-sufficient for some while. Some other major countries,
Germany and Japan in particular, have not been—they have
come to terms with that—principally by diversification of
supply. We will still have substantial indigenous production,
but there will be imports from a variety of routes, and I think
that diversity of supply can give us some confidence.
Mr McFadyen: I just want to stress
importance of the UK market for us in that regard. I think on
a number of occasions I went out to many stakeholders to share,
in essence, a key strategic strand that we have here in Europe,
which is very simplistically known as `gas to market'; so we are
confident that within Europe the supplies are there, the infrastructure
is there (and if it is not we can put it there) to bring gas to
the UK markets, and other markets indeed. I think the confidence
is implicit in our strategy in a sense.
Q230 Mr Hoyle: We can rest assured the
lights will not be going out. You are going to keep them on for
us!
Mr McFadyen: Shell will play its
part.
Q231 Chairman: You are confident that
within three years the nervousness which was apparent last autumn
will not be present.
Mr Smith: There are substantial
new supplies coming within three years.
Q232 Mr Hoyle: You are not worried about
the security of some of those supplies?
Mr Smith: I think diversification
is the important thing, and it seems fairly diversified on our
own indigenous energy and from various places—gas from Norway.
Q233 Chairman: Can I take you on to gas
supply contracts. What, if anything, is preventing the use of
contracts not linked to oil prices?
Mr Smith: I do not know that anything
is necessarily inhibiting it. I am just trying to think what the
question behind the question might be. I know it has been said
that gas prices have gone up because of the links to oil prices.
I think, and we have said it in our submission, that the energy
markets are connected by energy sources and we know that coal
has gone up, gas has gone up, oil has gone up, and these things
have overlapping uses so you do get connections among those energy
sources within a global energy market, and I say `global' because
things are becoming more and more connected geographically. I
think what we are going to see is that there will be a general
trend in energy prices so it will not be surprising to find that
gas and oil and coal prices are moving in sync. We have seen in
the US where those linkages have not taken place, that gas prices
increased very significantly and in fact now have been a bit higher
than in the UK and Europe. There is no necessity for linking oil
and gas prices in contracts but I would not necessarily assume,
if those linkages were broken, that that would reduce the gas
price automatically.
Q234 Mr Hoyle: Do you not feel it is
like coal: it just goes up because there is an opportunity within
the energy market to get more for your product? If gas and oil
are pegged obviously people are looking for another energy source
and so that is a way of increasing your price because it is an
alternative?
Mr Smith: That is not what we
see. What we see is that there are trends.
Q235 Mr Hoyle: I did not expect you to
see it but is that what happens?
Mr Smith: I do not think so. As
I say, there are general trends in energy demand and there are
sources of energy to meet those demands and those sources of energy
are likely to move in sync in terms of prices.
Q236 Mr Berry: If there is no necessity
for the link why is it there?
Mr Smith: What we found in the
early days was that a number of our customers wanted to have the
link there partly because at least they were in the energy market,
they had energy needs, the oil market was a bigger market and
was reflective of bigger trends and therefore for an energy price
linkage they needed some pricing mechanism, but frankly we needed
a pricing mechanism as well that we understood. You can put in
time delays and you can put in averaging that reduces volatility,
so there was certainly a good logic for having it.
Q237 Mr Berry: But in your submission
you make the point that if you look at energy price indices gas
prices follow a similar trend with oil as the lead energy, and
you go on to say, "This is the case for systems that are
indexed to oil as well as those that are not". That begs
two questions: what precisely is the difference, and you have
said that you cannot see any reason why there should be a link;
and if there is no reason for there being a link it still comes
back to the question, why does one observe that in practice?
Mr Smith: That they move in trend?
It is observed because gas and oil and coal are sources of energy
for a more general energy market. It is what I am trying to convey
but maybe not very ably.
Q238 Mr Berry: Would it be better, would
it be in the UK's national interest, if there was not a significant
element of the oil price in the indexation formula? You have said
that many people historically have liked to have that explicit
link. Would it be better if that were not there?
Mr Smith: I do not know that it
would necessarily be better or worse. Certainly in our contracts
there is a variety of mechanisms for indexing of prices—gas
prices, oil prices, inflation, other energy prices as well. If
for some reason all of that link to oil was removed tomorrow for
UK Inc it is not obvious to me that you still would not see gas
moving in harmony with oil and coal prices because of the connectedness
of the markets.
Q239 Mr Berry: That I understand. You
have said that in the past and in the present there are those
who like an explicit link. You have said that you do not see that
linking is necessary. You are saying you do not know what would
happen if there was not a link. What am I supposed to make of
that?
Mr Smith: I cannot know with certainty.
If there was not a link I am saying that the prices would tend
to move in harmony because they are part of a global energy market.
That is what I was trying to convey.
| 
