Memorandum submitted by the Oil and Gas
Independents' Association (OGIA)
OGIA
The Oil and Gas Independents' Association is
a self-help group of 34 oil companies active in the UKCS. Our
membership includes a wide spectrum of companies from UK divisions
of large well-established multinational organisations through
to small start-ups and from companies with an active exploration
drilling capability to purely financial investors. We do not admit
major production operators. Our focus is principally on exploration
and appraisal issues although many of our members are non operated
producers.
INTRODUCTION AND
EXECUTIVE SUMMARY
As a group generally representing smaller UK
companies and UK based subsidiaries of multinational oil and gas
investment companies in the UKCS we have taken the liberty to
respond more fully on those issues which are more directly relevant
to the bulk of our members' experience:
— Exploration and appraisal (E&A)
drilling for the discovery of new hydrocarbon accumulations, mainly
in the "mature" areas of the UKCS.
— Access to existing infrastructure
issues.
— The fiscal/investment environment.
We feel that Oil and Gas UK will adequately
and perhaps more effectively cover issues relating to West of
Shetland, Skills and Infrastructure and decommissioning.
In summary, OGIA feel that the UK is now at
a critical crossroads in determining how the future of the UK
hydrocarbon resources will be developed and exploited. The mature
nature of the basin means that there needs to be significant consideration
given now on how we encourage the finding and development of the
remaining resources (much of it yet to be discovered). What may
have been appropriate 20 or 30 years ago when large discoveries
were still regularly being made and when the ability for the UK
to attract significant investment inflows was still high, are
no longer appropriate for the future of our basin. Both the nature
and desires of the players involved and the nature of access to
the required investment capital has changed significantly. From
a security of supply perspective as well as the knock on employment
and skills issues, we need to ensure that we maximise the production
of our own indigenous hydrocarbons as well as ensuring that the
investors and the public purse get a fair return for the risks
and resources they both invest. Above all we need to ensure we
encourage an efficient industry where we maximise the use of existing
infrastructure to economically produce the smaller fields we are
discovering. After all, much of the large infrastructure assets
have effectively been paid for by the public purse, and as such
the public should have an expectation that they should be used
for the public good of extracting the maximum resources for the
UK, not provide a low risk revenue streams for companies who wish
to reinvest much of that in other parts of the world.
Every barrel of oil and cubic foot of gas that
remains undeveloped and undiscovered in the UK, pays no taxes,
provides no jobs, and requires that we have to import its replacement
from a place where we have no control over its production, its
environmental impact or its use as a foreign policy tool.
How can the UK's remaining offshore oil and gas
reserves be exploited most effectively? What barriers are there
to exploiting such reserves? What steps need to be taken to unlock
resources west of Shetland?
1.1 Significant oil and gas remains to be
recovered from the UKCS. Other than from those fields already
in production or under development, it is impossible to accurately
quantify the volume of hydrocarbons not yet discovered. The broadly
accepted number is that possibly up to 9 billion barrels of oil
equivalent still remain to be found. This undiscovered volume
is by far the largest single portion of the UKCS's remaining potential.
It will certainly be more difficult to find and commercially exploit
than the geologically simpler and more obvious structural discoveries
of the 70's and 80's. With basin maturity the probability of commercially
successful exploration drilling becomes less and less, which,
combined with the significantly smaller average discovery size
(<15mm bbls) for the wells which are successful has meant that
those companies whose skills and capital were required to initially
exploit the UKCS no longer find it attractive to seek new hydrocarbon
discoveries in the UKCS (West of Shetland excepted). Materiality
and increased risks mean that their shareholders capital is better
directed to sedimentary basins where more material discoveries
are likely to be made, even though fiscal terms in these areas
may be seen as more onerous than the UK. At the risk of making
an overly broad generalisation, these companies now see the UK
as a source of relatively predictable cash flow to finance exploration/exploitation
in other areas, increasingly enhanced by low risk tariff income
for use of "their" infrastructure.
1.2 This situation was recognised by the
Government in 2001-03, and reforms were put in place to attract
new entrant and smaller companies whose appetite for risk was
somewhat higher, and where smaller discoveries still remained
material. Much, and probably a majority, of the exploration and
appraisal work of recent years has been undertaken by these newer
entrants and smaller companies. A number of significant discoveries
have been made that would not otherwise have happened. Credit
crunch aside, to encourage the full exploitation of the UK's remaining
hydrocarbon resources will require development of an environment
that encourages risk taking companies prepared to explore for,
and ultimately develop, new accumulations.
To maximise the remaining potential we need
to:
1.3.1 Encourage sustained, but sensible levels
of exploration/appraisal drilling to establish new fields for
future production, and encourage the development of existing discoveries
that are not economic investments in the current fiscal environment.
1.3.2 Simplify the process for producing these
new (mostly smaller) fields via existing infrastructure, ensure
that the owners of the infrastructure do not extract a disproportionate
share of the value by creating delay or offering inappropriate
tariffs and liabilities in relation to the risks they take. The
current voluntary Infrastructure Code of Practice (ICOP) is NOT
making any significant differences and many bad behaviours and
practices still remain. This actively discourages exploration
and appraisal for new fields as the risk reward balance is significantly
skewed in favour of the infrastructure owner rather than the risk
taker. Legislation for guaranteed access terms or "common
carrier" status should be seriously considered.
What can be done to minimise the environmental
impact of exploiting the reserves? How should this be encouraged
and/or financed?
2.1 The UK already has one of the most highly
environmentally regulated hydrocarbon provinces in the world.
Whilst we should continue to mandate adherence to high environmental
standards and practices, we should also bear in mind that we cannot
unduly burden the industry to achieve standards significantly
in excess of other areas. Adherence comes at a cost, both financial
and also in terms of leaving undeveloped and unrecovered hydrocarbons
in the ground. Every barrel of oil or cubic foot of gas that cannot
be extracted from the UK will have to be imported from an area
where such environmental standards will likely not apply. We should
take care not to simply shift the problem elsewhere whilst at
the same time reducing our security of supply. If necessary, fiscally
neutral changes will need to be considered to ensure that we achieve
acceptably low levels of environmental impact for our production
whilst not promoting the production of less environmentally acceptable
oil or gas from elsewhere.
2.2 Carbon storage in Hydrocarbon reservoirs
or in saline aquifers identified by hydrocarbon exploration is
a significant way in which both the skills and technology of the
oil and gas business can be redeployed and also used to mitigate
the environmental impact of exploiting the reserves. The regulatory
and fiscal framework for this major potential business is not
yet clear and needs acceleration and clarification.
How effective is the current fiscal and regulatory
regime in which the industry operates?
3. The UK fiscal regime is extremely complex
and a result of 40 years of constant tinkering. It was developed
when fields containing hundreds if not billions of barrels were
being found. It is now recognised as a fiscal environment with
significant risk of (adverse) change. For investors to invest
they will always make assumptions about the stability of the tax
system prior to investing. The UK does not fare well in this regard,
particularly as it requires very significant upfront investments
over a number of years prior to cash flow. One actual example
would be an exploration investment made on the basis of a 30%
tax regime in 2001, which then changed to a 40% regime whilst
the discovery was being evaluated for development, and finally
became 50% when the bulk of the development capital (totalling
$3 billion) had already been committed. Is this an environment
that encourages sustainable and long term investment? The industry
understands that the UK needs a fair return on the development
of its resources, however we need to consider a tax regime that
is above all predictable, encourages new investment in maximising
the development of remaining hydrocarbons from the basin, perhaps
it should now be linked more directly to the product price. Above
all the government needs to consider whether we have a fiscal
regime that will attract the investment risk capital for the discovery
and then exploitation of the oil and gas we have yet to find.
What effect are the recession and the credit crunch
having on the industry? What is the impact on the financing of
exploration and development?
4.1 The move to an environment where much
of the exploration and appraisal (E&A) drilling is being undertaken
by smaller companies than those that have traditionally worked
in the North Sea has meant that the recent "credit crunch"
and turmoil in the equity markets has had a disproportionate effect
on E&A activity in the UK. Companies can no longer access
equity or new debt funding for activity in the UKCS. Indeed some
existing debt facilities are being withdrawn, with a recent notable
example. As much of the UK's E&A activity is now undertaken
by such companies, activity levels are more directly driven by
the availability of relatively high cost equity capital and by
the availability and cost of debt and quasi debt financing. The
credit crunch has driven investors to reduce price and reduce
exposure to risk. The Oil and Gas business is by its nature a
high risk/high reward business and it has been disproportionately
affected by this change. Indeed RBS, one of only two significant
lenders for the North Sea, recently announced that they would
be withdrawing from project finance.
4.2 The Government has already recognised
that companies principally undertaking exploration and appraisal
activity were at a significant fiscal disadvantage to those companies
with significant production cash flows, as they could not write
of these sunk costs against income in the same year. Such costs
simply accumulated until sufficient cash flow was achieved. In
part recognition of this problem, HMG allowed these cost pools
to escalate at 6% per annum. The lack of further equity and debt
now means that these costs are likely to be trapped for significantly
longer or in some cases simply remain unused. The advancement
of these existing tax pools followed by annual repayment for those
unable to use them (as is the case in Norway) would have a two
fold effect.
4.3 Firstly it would provide a source of
much needed near term capital for companies to immediately reinvest
in further UKCS E&A activity and thus help mitigate the upcoming
slump. In addition it would help sustain many of these companies,
the supply chain and of course their employees through the current
downturn until the equity and debt markets become available again.
4.4 Secondly, the equity markets would recognise
that such a move would make their investment in smaller companies
exploring and developing in the UKCS much more attractive as their
investment capital would be significantly more efficient, as much
of it wouldn't be effectively sterilised until they became significantly
cash flow positive. Such a move would be a strong and positive
signal to the equity providers and may help promote additional
equity investment in such companies sooner that would otherwise
be the case and in addition mark out the UK as a more attractive
place to explore for and develop hydrocarbons.
4.5 A large part of the North Sea's critical
resources now come from the service business—both consultancies
and technology companies. This interplay provides R&D ideas,
data and outsourced subsurface teams to generate new exploration
plays and optimise the development of smaller fields through innovative
technology. The credit crunch has had a number of high profile
casualties which have produced major problems for unsecured creditors.
Knock on effects are likely to be increased requirement of pre-payment
and escrow facilities before work can commence, lack of earnings
for those businesses affected, even higher cost of capital for
all concerned and reduced the availability of investment funds
for R&D for new technologies that may increase the recovery
rate from existing fields.
How are the skills needs of the sector being met?
How transferable are those skills?
5.1 In general the oil and gas industry
relies on a steady supply of science and engineering graduates,
there is an increasing shortage of both of these skills both generally
in the UK when combined with our unfashionable status and perception
as a legacy industry over the past 15 years has caused and will
increasingly create critical skill shortages. In particular the
upstream skills needs of the sector are from a small and shrinking
pool—UK based specialist MSc's and to some extent PhD courses
in Geology, Geophysics and Petroleum engineering. This is exacerbated
by competition for geoscientists and engineers from the increase
in environmental science based courses.
5.2 Overall oil sector demographics also
give continued cause for great concern. The UK workforce has been
working on average almost for as long as the North Sea infrastructure,
and this will give rise to major capability reductions in the
next 5-10 years. Such skills can of course be imported; however
the cost of these skills would add significantly to the industries
cost base, as such management and decision making for UK assets
from remote locations may become increasingly the norm.
What are the implications of an ageing existing
infrastructure on the security of supplies from the North Sea?
6. The infrastructure is already significantly
older than it was expected to become when commissioned. Maintenance/Integrity
is clearly an issue that the industry is currently addressing.
The discovery of new fields which can be produced via this infrastructure
is the simplest way to extend its economic life, as well as having
the added benefit of recovering additional volumes from the original
field that would otherwise not have been economically recoverable.
As mentioned earlier access terms must be simplified, streamlined
or mandated.
Is the right policy framework in place to manage
the decommissioning of that infrastructure as resources are depleted?
7. The industry is currently in a period
of great uncertainty in understanding what the policy is attempting
to achieve. First, the industry will be able to offset the costs
against tax. However we are expected to post pre-tax guarantees,
this is costly and does not reflect the company's actual financial
exposure. Secondly many of the Letters of Credit are issued by
RBS, these are no longer acceptable under government regulations
as the bank no longer meets the required credit ratings!!|
March 2009
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