Memorandum submitted by Oil and Gas Independents
Association Limited
THE OGIA
The Oil and Gas Independents' Association is
a group of 31 oil companies (approx 25% of the total) actively
engaged in exploration and production in all areas of the UKCS.
Our membership (see list in Annex 1) includes a wide spectrum
of companies from UK divisions of large well-established multinational
organizations through to small start-ups and from companies with
an active exploration drilling capability to purely financial
investors.
In 2005 our members participated in :
— 28 of the 78 (36%) UKCS exploration
and appraisal wells spudded
In the 23rd Round our members received licence
awards as follows:
— Participated in 61 of the total of
152 awards
— 29 out of 69 (42%) Traditional Licence
Awards (16 as operator)
— 30 out of 77 (39%) Promote Awards (27
as operator)
— 2 out of 6 (33%) Frontier Awards (both
as operator)
OGIA's membership is, in general terms, more
focused on investing in the discovery, appraisal and development
of new sources of hydrocarbons on the UKCS than exploiting legacy
assets.
OGIA does not represent the major production
operators on whose behalf UKOOA are making a separate submission.
CONTENTS
Executive Summary
Major Tax Increases Impacting Oil and Gas Since 2002
The Scale and Contribution of UK Oil and Gas
Challenges and Opportunities Facing the UKCS Upstream
Industry
UK Investors
International Investors
Lack of Alignment between Industry and Politicians/Civil
Servants
The Problems
Some Possible Solutions
Investment—The Lifeblood
UKCS Oil and Gas Policy
Oil and Gas, The Offshore Industry and the Environment
Attachment 1: Summary of OGIA Submission to EPR,
April 2006
Attachment 2: Extract from OGIA Submission to EPR,
April 2006
Annex 1: List of OGIA Members
Annex 2: OGIA Contact Details
Annex 3: References
Annex 4: Bibliography
Annex 5: Glossary
EXECUTIVE SUMMARY
1. Importance of Investment and Resources
The realisation of the potential of the UKCS
requires the Oil and Gas Industry to continue to invest wholeheartedly
in people, equipment and opportunities to maximise the remaining
life of the North Sea.
2. Importance of Exploration
Exploration, which represents an estimated 9
billion boe of remaining potential, is inherently risky. If the
UKCS remaining potential is to be realized then exploration investors
need to be confident of the non-negotiable incentive of an appropriate
and proper reward.
3. Importance of Investor Perception (including
investors from overseas)
Hostile tax changes, of which there have been
three in the last four years, create perceptions that the government
is more interested in short-term revenues than developing an industry
for the long term. Board-level perceptions are crucial in company's
decision-making processes.
4. Importance of Supply Chain
The UKCS must remain attractive to the supply
chain not just to the operators. Since the 2005 PBR some contractors
have rebalanced their resources away from the UK. Ultimately without
a supply chain there are no prospects for the basin.
5. Competition for Resources ("Cancelled
Projects" issue)
Each company has a portfolio of opportunities
from which to prioritise via risk benefit analysis. Portfolios
need to be worked and replenished aggressively to assure a flow
of future projects. Policies which lead to portfolio stagnation
will result in the UK failing to realise its potential.
Projects that have been worked up to sanctionable
status are rarely cancelled.
6. Importance of Medium Term
The present fiscal regime encourages short-termism
from the industry and is resulting in an increased proportion
of development wells and a decreased proportion of exploration
wells. Plans for `06 were already fixed at the time of the PBR
last December but it will be future years that are impacted
Oil and Gas currently provide 25% of total CT
receipts. From 2010 onwards:
— where will government find these
billions?
— how will Government deliver on fuel
poverty?
— how will Government provide for security
of energy supply?
Policy choices made in 2005-06 raise issues
in all these areas.
7. In summary the OGIA is looking to a predictable
fiscal regime that—
— Supports international competitiveness
in a basin recognised to be mature.
— Provides for predictability with
regard to PRT.
— Attracts the required investment
and resources to enable full development of UKCS Oil & Gas
Reserve Potential.
— Recognises that oil pricing is volatile
and beyond the control of UK government and the offshore industry,
recognises all costs and cost movements (including the cost of
financing) and does not deter investment at lower oil prices.
— Delivers clarity on the treatment
of decommissioning in a way that reduces risk and does not distort
investment.
— Delivers a regime that is fair, and
competitive against other energy sectors and other business sectors.
MAJOR TAX
INCREASES IMPACTING
OIL AND
GAS SINCE
2002
— 2002—Introduction of 10% SCT.
— 2004—Advanced phasing of CT
payments, solely for Oil & gas Industry.
— 2005—Doubled SCT to 20%.
THE SCALE
AND CONTRIBUTION
OF UK OIL
AND GAS
1. In 2004 the UK was the world's 4th largest
gas and 13th largest oil producer. The UK has been a net oil exporter
for 25 years and is expected to remain so until at least 2010. By
reducing the need for imports the UK upstream industry currently
reduces the balance of payments deficit by about £35 billion
per year.
2. Upstream oil and gas companies contribute
over £12 billion pa in taxes and pay a quarter of all Government
CT receipts. The upstream industry currently invests above £10
billion per year.
3. To end 2004, 34 billion barrels of oil
and gas equivalent had already been recovered from Britain's hostile
offshore environment and almost £350 billion had been invested,
contributing over £200 billion in tax revenues without risking
any public money. (Most statistics referenced above from UKOOA's
2005 Economic Report, ref 5, updated where available.)
4. Until recently UK surplus indigenous
gas production has reduced gas and electricity prices to some
of the lowest in Europe (still lower in real terms than in 1985)
with a dramatic reduction in the number living in "fuel poverty"
because of rising incomes and decreasing fuel bills, particularly
as a result of low gas prices (reflected indirectly in electricity
prices using gas as a power station feedstock as well as directly
through low gas prices). Furthermore HM Treasury claims to be
directing some of the "windfall" SCT receipts into Winter
Fuel Payments so there have been three ways in which the upstream
Oil and Gas industry has contributed to alleviating fuel poverty.
CHALLENGES AND
OPPORTUNITIES FACING
THE UKCS UPSTREAM
INDUSTRY
5. The UKCS is a high cost, geologically
complex mature basin.
6. Finding costs ($/bbl) are high in the
UKCS, twice those in the Netherlands and five times those in Norway
over the 1994 to 2003 period on a pre-tax basis (source UKOOA).
Norway and Netherlands offer greater tax relief on exploration
so on a post tax basis the comparisons are even worse. Under the
current tax regimes, post-tax UK $/bbl finding costs are 12 times
those of Norway for a company currently paying tax (and the multiple
is even higher for those start-up companies not yet paying tax)
and 2.2 times those of Netherlands (source CW Energy Associates).
7. Operating costs, already high in the
UKCS, are under constant pressure and currently increasing sharply.
Recent high levels of activity, driven largely by high oil prices,
have created additional pressure on the supply chain and led to
an approximate doubling of the cost base overall, more in some
areas.
8. Typically new developments are modest
in size with high development costs but they allow existing infrastructure
to remain economically viable for longer, extending recovery from
the host field.
9. Drilling rigs, and other vital resources,
are currently leaving the North Sea in search of more attractive
contracts elsewhere. Historically, the rig market is global, and
rig owners prefer to place their equipment where there are best
returns, often defined by length of contract in a stable regime—not
the situation in the UKCS at present. And once resources leave
the UKCS it is extremely difficult ever to attract them back.
10. However the UKCS has advantages with
good access to extensive infrastructure, a shared sense of urgency
within the industry, a wide diversity of investors (139 vs. 30
in Norway despite the latter having much bigger reserves), a dynamic
sector of new entrants and ready access to gas markets.
11. Commercial developments, championed
by the dti, and adopted by the oil and gas companies, have made
ullage in this infrastructure more readily available. If some
projects are delayed beyond the lifetime of the infrastructure
they will not simply be postponed but lost for ever. Hence the
importance of near-term exploration and appraisal.
12. Much of HMG seems to have little understanding
of how oil companies take investment decisions and their concerns
about risk. Risk in UKCS terms relates not just to geology, reservoir,
reserves and recovery but also to exploration, development, operating
and decommissioning costs, product price, environmental constraints,
future tax regimes etc. Companies are conscious that in countries
dependent on petroleum for wealth/foreign earnings there has been
far less interference in the industry than there has been in the
UK.
13. The tax changes of 2002, 2004 and 2006
have eroded the competitiveness of the UKCS which the 2005 PBR
Regulatory Impact Assessment (RIA, ref 6) failed to address. Furthermore
the RIA ignores the supply chain completely (stating "The
options set out above will affect 120 or so entities undertaking
oil and gas exploration and production activities in the UK or
on the UKCS", so failing to acknowledge the impact on the
contracting industry which is a much larger employer in the UK
than those 120 companies).
14. The UKCS must remain attractive to the
supply chain not just to the operators. Since the 2005 PBR some
contractors have rebalanced their resources away from the UK (ref.
Alistair Locke, Abbot Group 10.1.06, ref 7). Ultimately without
a supply chain there are no prospects for the basin.
UK INVESTORS
15. Increasingly many listed UK based Oil
and Gas companies do not invest in the UKCS (eg: Cairn, SOCO,
JKX etc) or have a minimal proportion of their investments in
the UK (eg: Premier, etc).
16. This is despite the fact that the vast
majority of their directors, management and senior staff are British,
whose formative careers were in the UKCS.
INTERNATIONAL INVESTORS
17. Investors in the UKCS are usually allocating
funds between a portfolio of worldwide opportunities.
18. Hostile tax changes, of which there
have been several in the last few years, create perceptions that
the government is more interested in short-term revenues than
developing an industry for the long term. Board-level perceptions
are crucial in company's decision-making processes.
LACK OF
ALIGNMENT BETWEEN
INDUSTRY AND
POLITICIANS/CIVIL
SERVANTS
19. The Oil and Gas Industry works to a
long term timetable.
20. A consortium formed to bid for a licence
will perhaps take over 25 years to progress from discovery (though
only a minority of prospects achieve commerciality) through production
to decommissioning.
21. It appears to business that politicians'
timescale is too short term (five years max). The government's
poor track record on long-term infrastructure issues such as pensions,
transport, energy, housing and water supports this concern.
22. The widely criticized White Paper on
Energy in 2003 is a particular example. The outcome of the recent
dti Energy Review (widely understood to be pre-destined) is a
particular concern.
THE PROBLEMS
23. In 2002 when the Supplementary Charge
was introduced the UKCS was ranked below 30 among the most economically
attractive basins in which to do business.
24. By removing value from the fields at
that time the Supplementary Charge made exploration economics
worse, but was partly offset by accelerated depreciation for those
companies in a tax-paying position (but not start-ups for example).
25. Rising prices have improved field economics,
but have also led to rising costs worldwide. Prices appear to
have peaked but cost escalation is increasing, apparently at an
ever faster rate.
26. In 2004 the phasing of CT payments from
the upstream oil industry were advanced to give a windfall benefit
to HMG.
27. The further increase in Supplemental
charge in December 2006 removed 16% of the value from most fields.
This damages the viability of small marginal prospects and high
risk plays.
28. The closing window of opportunity caused
by the limited life of existing infrastructure makes it imperative
to explore for and develop the many small prospects near this
infrastructure so that product can be brought to shore before
the infrastructure is decommissioned.
29. As production from the host and existing
user fields declines unit costs for new fields increase which
makes their development less attractive, and early exploration
and development even more urgent.
30. Small gas fields are particularly at
risk because they rely on pipeline infrastructure to take product
to market whereas oil can be shipped by tanker in some cases.
31. While we recognise the need for the
state to secure a fair economic rent from the UKCS we believe
that the Supplementary Charge is a very blunt instrument which
has helped to drive resources, including rigs, away from the UKCS
and has made the economics of many marginal prospects unattractive.
Although we see no reason to single out the oil and gas exploration
industry for super-taxation, as an interim measure, targeted allowances
will help overcome the adverse effect of the super-tax.
SOME POSSIBLE
SOLUTIONS
32. Suggested ways to counter the adverse
economic impact on exploration are:
(i) Play-opening exploration wells to be
rewarded by consequent developments having an exemption from the
Supplementary Charge (SC), and/or enjoy other tax incentives so
as to accelerate payback of costs + cost uplift to reflect risk.
(ii) All new fields should be eligible for
an oil allowance of (5) million tonnes.
(iii) Gas production from new fields should
be exempt from the SC.
33. These targeted allowances will help
encourage risk taking in the search for new oil and gas basins,
will remove the impact of super-taxes on many marginal prospects
that should not bear them, and will help improve security of gas
supplies as indigenous production declines. Together these improvements
should help to:
(i) restore confidence not only among operators
but also, importantly, among the key suppliers and contractors
to our industry
(ii) improve production and security of energy
supplies
(iii) enhance job opportunities, particularly
in Scotland
(iv) promote technological innovation
(v) provide more security to those who are
trying to build an export business on the back of a strong domestic
business
(vi) and strengthen the Scottish and UK economy.
INVESTMENT—THE
LIFEBLOOD
34. Estimates of full life cycle UKCS potential
suggest we are just over half-way through, approx 34 billion boe
has been produced to date and a further 23 billion boe remains
of which approx 9 billion boe is classed as "Yet-to-Find"—ie:
not yet been encountered by the drill bit (ref 21).
35. The realisation of these volumes assumes
that industry will continue to invest wholeheartedly in people
and equipment to maximise the remaining life of the North Sea.
There is also some allowance for the expectation that technology
will continue to advance. It may not be obvious to the casual
reader that these numbers are inherently fragile.
36. To maximise recovery from existing fields
one must renew and maintain equipment and conduct infill drilling.
Such incremental investment to sweat existing assets requires
a proper assessment of uncertainty and, as fields become ever
more mature, requires increasing effort for decreasing reward.
37. Exploration, which represents 9 billion
boe of remaining potential, is inherently risky (and subject to
all the above uncertainties). If the UKCS remaining potential
is to be realized then exploration investors need to be confident
of the non-negotiable incentive of an appropriate and proper reward.
38. As the basin becomes increasingly mature
all investment becomes closer to the margin. While fields found
many years ago may in the past have been robust to low product
prices, high costs or increased taxes, they are now vulnerable
to such factors and these might result in their early abandonment.
39. Investors look to policymakers to sustain
the fiscal & regulatory environment that will support their
increasingly marginal investment decisions. The confidence of
investors (many of whom are headquartered overseas) is key. This
can be addressed by reassuring investors that if product prices
should fall materially from current levels there would be a re-examination
of the level of SCT, a re-assurance HMT has so far refused to
offer. Other measures worthy of consideration include:
— encouraging investment in new technologies
such as HP/HT and heavy oil, perhaps through some sort of "early
adopter allowances" and boosting R&D credits,
— the Removal of SCT on tariff receipts
akin to the removal of PRT on those receipts,
— provide a level playing-field for
new entrants through increasing the interest rate on unrelieved
field losses.
40. There is also a timing issue. Any loss
of momentum to secure these remaining reserves will lead to them
slipping permanently beyond our grasp. This is due to the design
life of host infrastructure which may come due for retirement
or abandonment by—say—2020 which may be sooner than
the life of a new discovery made in—say—2010. Additionally
the later such new discoveries are made the greater their unit
cost to produce and the more likely they are to fail an economic
test.
41. There is an analogy here with the UK
coal industry—the closure of mines in the 1980s led to the
permanent loss of reserves and skills which may soon, in the context
of high energy prices and reduced security of supply, be confirmed
as regrettable.
42. The UKCS industry has recognized the
excellent efforts of the dti in recent years and a variety of
initiatives, launched co-operatively, in partnership with industry
have resulted in a welcome resurgence of exploration effort.
UKCS OIL AND
GAS POLICY
43. Companies that invest in the UKCS to
produce oil and gas generally have many alternative petroleum
basins around the world to choose where to invest. Most companies
have more opportunities than they have resources to develop those
opportunities (Ref Sheila McNutly in FT, 5.4.06, ref 8).Therefore
they have to prioritise their investment opportunities. This is
done on a basis of perceived risk and return.
44. The oil price is an international factor
which is essentially the same throughout the world. With the advent
of LNG projects and the increasing gas pipeline links between
Europe and the UK the UK gas price is no longer just a local issue.
45. Hence high product prices do not necessarily
encourage investors to increase their investment in the UKCS.
If the UKCS tax regime is perceived as regressive and if there
are concerns at the tax increases of 2002, '04 and '05 investment
in the UK may be reduced in favour of other countries perceived
as more attractive.
46. Oil companies have sophisticated ways
of estimating technical risk and uncertainty, but where commercial
and regulatory issues are concerned, confidence is key.
47. Therefore the UK needs a fiscal and
regulatory regime which is perceived by oil companies as being
stable, internationally competitive and encourages the maximum
economic recovery of UKCS oil and gas reserves. This requires
different parts of Government, the contracting industry and the
oil companies will all have to work together more effectively
than in the recent past.
48. Currently the UKCS provides jobs, security
of supply, a balance of payments benefit and, not least, a very
significant source of revenue for the Treasury. As we go down
the UKCS decline curve we will lose some, and, in the long term,
all four of these benefits.
49. The challenge to policymakers must be
to ensure that the UK manages this decline in a manner that maximizes
our total UK benefit. To achieve this goal the messages that Government
sends to industry must be delivered in a way that industry can
understand and relate to.
50. Fig 2 (above)—"The UK will
have declined in importance by 2010 for the Majors" Source:
WoodMackenzie (ref 9)
51. UK Energy Policy must also respond to
the needs of the new breed of investor now arriving in the UK.
For most of the life of the North Sea the great majority of investment
has been funded by the international majors. However in other
international provinces this has been commonly found to fall to
50-60% in late life. WoodMac (Fig. 2 above) has forecast that
the importance of the North Sea to established majors is due to
halve over the next five years (ref 9). However a number of new
arrivals, especially from continental Europe, North America and
the Far East, are keen to increase their UKCS activity and have
been active in acquiring assets from the majors recently. There
has also been a wave of start-up companies, encouraged by the
Promote License, Fallow Acreage and Fallow Discovery initiatives
that seek to bring new ideas and energy to the sector. The dti
have been keenly aware of, and have actively encouraged, these
new entrants.
52. The oil and gas industry's supply chain
has been an ongoing success story with particular impact in Scotland.
The contracting industry has always been innovative and the UKCS
has provided a valuable test bed. Looking to the future we need
to foster the jobs and activity that can be supported by an increase
in exports, but government support to date has been disappointing.
53. Unless we maximise indigenous production,
in particular of gas, energy prices will rise further which will
reduce UK plc competitiveness and profits and hence tax revenue.
OIL AND
GAS, THE
OFFSHORE INDUSTRY
AND THE
ENVIRONMENT
54. Natural gas has more than anything else,
enabled the UK to achieve major improvements in its environmental
performance and exceed its Kyoto commitments. The decrease achieved
in UK CO2 emissions from 1990 to present (see Consultation Document
page 22[7])
has arisen primarily from the UK closing (or at least downscaling)
its reliance on coal fired electricity generation capacity and
moving to gas (the "dash for gas").
55. Gas produces approximately 70% of the
CO2 per GJ of heat output as oil and 50% as coal. (Source Open
University, ref 10). Natural gas also contains very little sulphur
so switching to gas generation enabled the UK to meet its targets
for reducing SO2 emissions which contribute to acid rain without
having to fit expensive flue gas desulphurization to existing
coal-fired power stations. CO2 emissions from power generation
fell from 198 million tonnes in 1990 to 147 million tonnes in
1997 (source dti, ref 4) but this was more than compensated for
by rising emissions in the transport sector.
56. It is the UK Upstream Industry that
has found and produced this gas. In conducting our offshore operations
the upstream industry has a generally good track record of environmental
performance and continuing improvement in regard to tightening
regulations, voluntary codes of practice and innovative market
mechanisms (eg early adoption of emissions trading).
Attachment 1
SUMMARY OF
OGIA SUBMISSION TO
DTI ENERGY
POLICY REVIEW,
APRIL 2006
1. Fundamental changes to the UK energy
supply mix will take some 20 years.
2. Until then hydrocarbons will continue
to be the main contributor to the UK's primary energy requirement.
3. It is very much in the UK's national
interest to maximize the contribution of our indigenous oil and
gas resources. Exploration has a key role in this endeavour. The
UK needs a fiscal and regulatory regime that:
(a) attracts investment funds in competition
with other petroleum basins around the world,
(b) recognises and responds to long project
cycles and to technical and commercial risk and uncertainty, and
(c) is integrated across all government departments.
4. The Government should recognize that
the current UKCS fiscal regime actively discourages the risk-taking
that is necessary to discover and exploit the UK's remaining unfound
oil and gas resources. It does this by taxing those who produce
from relatively low risk legacy assets that have already "paid
out" in exactly the same way as those who wish to take significant
financial risks to discover new sources of hydrocarbons.
5. The OGIA believes that a fiscal regime
should be developed that encourages and rewards those who are
prepared to take the necessary risks to find and develop the UK's
remaining undiscovered resources.
6. With such a regime in place the UKCS
upstream industry would be focused on maximising its contribution
towards the UK's economic needs through:
(a) increased efforts in exploration,
(b) development of marginal discoveries,
(c) exploitation of existing fields, and
(d) extending the life of existing infrastructure.
7. The appointment of a Secretary of State
for Energy, a position of cabinet rank, heading a Department of
Energy and acting as a single point of contact between industry,
government and other stakeholders, would greatly assist alignment
and stability in pursuit of these objectives.
8. The contribution, to the Scottish economy
in particular, of the oil and gas supply chain (and potentially
a similar supply chain in renewables) and the future potential
for exports should not be underestimated by government.
9. If government policy does not evolve
to encourage investment in indigenous oil and gas then either
fuel poverty will get much worse or the government will have to
find very large resources from elsewhere to make up for the contribution
that the Oil and Gas industry has made.
Attachment 2
EXTRACT FROM
OGIA SUBMISSION TO
DTI ENERGY
POLICY REVIEW,
APRIL 2006: ACTION
REQUIRED TO
ADDRESS FUTURE
GAS IMPORTS
REQUIREMENTS
Source: UKOOA
1. The above UKOOA slide illustrates the
tremendous potential of moving from the curve labeled "Current
Plans in Place" to the one labeled "The Potential Future"
which is something the Industry (both the contractors and the
oil companies) and the dti are working very hard to achieve.
2. The dti estimates (ref 21) that more
than 23 billion boe remains to be recovered from the UKCS and
there are substantial rewards for the UK if we can sustain the
attractiveness of the UKCS.
3. The Consultation document reads "By
2020 we are likely to be importing around three quarters of our
primary energy ... " (Consultation Document p 5). This
seems very pessimistic unless it is government policy to discourage
future investment in the UKCS and accept this 75% import dependency
and the significant loss of UK taxation revenue and employment
and the impact on the UK balance of trade which it implies. Provided
industry and government create the conditions where investment
can flourish in the UKCS, OGIA believes indigenous production
of oil and gas can provide around half the UK Primary Energy supply
in 2020.
4. The industry values the good work of
the dti in the last five years in particular in promoting the
use of fallow acreage and discoveries, the arrival of new entrants,
the opening up of infrastructure systems, the establishment of
a trans-median line agreement with Norway, the promotion of good
stewardship etc.
5. Government should establish fiscal and
regulatory frameworks which actively promote investment to maximise
the production of the UK's own oil and gas reserves. This will
require the UKCS to be internationally competitive with other
petroleum basins worldwide and the government to regain the confidence
of (largely overseas) investors. Current fiscal policy is demonstrably
unstable and will not in its current state achieve the desired
result.
6. The investment environment will benefit
from recognition by the Treasury of the fundamental difference
in risk profile between exploration and production. Retaining
an identical tax regime for legacy fields and for exploration
that can contribute significantly to "the better future"
may result in the major investment being directed towards the
low risk exploitation path, which has less growth potential. Such
a direction would be unlikely to maximize the production of the
UK's indigenous reserves.
7 Not published. Back
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