UK offshore oil and gas - Energy and Climate Change Contents


Examination of Witnesses (Question Numbers 140-159)

MR MALCOLM WEBB AND MR PAUL DYMOND

19 MARCH 2009

  Q140  Mr Weir: One other point we have not covered in this is as well as the problem with credit there is the rising cost to the industry. You say that last year the cost of developing and producing a barrel of oil or gas rose by 12% compared with 2007. Why have costs risen so dramatically over the last few years and do you expect them to start falling?

  Mr Webb: With regard to the second point, yes, I do expect them to start falling and there are signs that they will fall. We need to be careful about not believing that is going to happen overnight, it will be a slowish process and that is what history tells us, that when we have been through these periods of recession before it will take some time for the costs to come down, and we are working on that. The whole of the industry is taking a responsible attitude towards that. Why did they go up? They went up because there was a global pressure on the system to find and bring more oil on to production. Furthermore, you will recall a few years ago particularly for the offshore oil and gas industry we had some particular events in the Gulf of Mexico with hurricanes taking out an awful lot of capacity there as well. It was a mixture of global pressures and a need to go and find oil and gas combined with some physical problems that happened that took out an awful lot of capacity. Those two things combined gave rise to inflationary pressures on the industry and that was where we saw a great increase in the costs, particularly in the costs of mobile drilling vessels, for example, supply boats and support vessels which were in short supply.

  Q141  Mr Weir: That takes us on to future investment particularly in the North Sea. Have the companies you represent begun to scale back investment in view of the current economic situation and what do you expect the trend to be over the next couple of years?

  Mr Webb: That is a very good question and it maybe goes to the heart of our discussion today. In some ways this is quite a simple business. The success of the North Sea or the UKCS offshore generally comes down to attracting and spending capital. You will have seen from our report that we believe, going back to the Chairman's original comment about the 65% of our oil supplies in 2020, if we can keep capital investment coming through at the sort of levels that we have been having of late, round about five billion a year, then that is achievable. That is the core of it. What is happening at the moment, for the reasons I explained a moment ago, is across the basin there is a problem in getting that capital through the system. For the first time ever, in our activity survey this year we gave a range of possibilities on the capital expenditure for this year and that reflects the uncertainty within the industry as to what is going to happen and on the worst of those range of possibilities we are saying that over the next two years capital investment could halve to two and a half billion from the current five billion. We think the answer, hopefully, is not going to be as bad that, that is an awful lot of jobs lost if we get there besides the impact it will have upon the ultimate recovery picture. We hope that can be mitigated. I am sorry to sound like a chipped record but that is why we are saying to the Government strongly there are things that we in the industry need to do but there are things that you, the Government, desperately need to do and you need to do it urgently now with the fiscal system and with regard to helping these smaller companies.

  Q142  Mr Weir: Is the pressure on the oil companies to reduce cost feeding down to the supply chain and what effect is it having? The SCDI and Scottish Enterprise produced a report a few weeks ago saying the supply chain was £14 billion but that was only up to the end of 2007, if memory serves me correctly. I just wonder what impact the decisions taken by your members in exploration and development are going to have on that supply chain within the next couple of years given the current economic situation.

  Mr Webb: There are two issues there. Is the supply chain reacting to cost? Yes, I think it is as best it reasonably can. Remember, a number of these rates are locked in and it would be a noble thing for some people to give up contractual entitlements on rates, so it will take some time for some of these rates to come down. I am seeing a lot of responsible actions within the supply chain on that. You are right, there is also pressure from the employing companies on costs and everybody is doing what they can to get that message across within the industry, that we need to get to a different place on cost, but it will take us time to get there. On the worst case, if we saw capital investment fall by two and a half billion over the next two years we are going to see 50,000 people lose their jobs, that is one of the impacts on the supply chain that will happen and that will be very, very serious.

  Q143  Mr Weir: I was going to ask you what the Government could be doing to facilitate investment but I think you told us that pretty comprehensively earlier on when you talked about the tax regime.

  Mr Webb: Yes. It needs to do three things and they are all sort of interlinked in some way. It needs to help these small companies by releasing these exploration pools that are accruing at 6% cost to the Government, so that should not be too much of a problem for them I hope. The second thing it needs to do is really take supplementary corporation tax off new developments. As you heard from Alex Kemp, we need some very clear messages on that. It is quite clear that Government recognises the problem here. This value allowance is not the industry's suggestion, it is the Government's suggestion, that was where it came from. It came out of discussions we had at the beginning of this year when the oil price was in a completely different place, so if it was valid at that oil price it is doubly valid now and needs to be much more potent now than it was then to help with these short-term problems. The third issue is there is a problem around decommissioning costs and the securitisation of the decommissioning costs. Because of the way that it has set up the tax regime, the Government is effectively requiring companies of all sizes, small, medium and large, to make security provision for 100% of the eventual decommissioning costs of these fields. That is an unrealistic number because that is a tax deductible expenditure, therefore why are companies being asked to make security for 100% of the cost when actually at least 50, if not 75% of the cost is going to be a tax deductible event. That is putting strain upon the industry. By the way, it is also putting strain upon the banking system right now. As a little aside on that, we have got, and our Association has been at the forefront of developing this with then BERR, now DECC, decommissioning arrangements or agreements and those set out how we can cope with all of these problems and they rate the securities that can be provided. Bankers' letters of credit seem to be the instrument of choice of the Government and also of parts of the industry as well. Unfortunately, the number of banks that now pass the credit rating for those bankers' letters of credit has fallen, including the market leaders in that area, and people are seeing the credit rating of the Royal Bank of Scotland has fallen and it has taken them out of the banks that qualify for that. That whole area of security for decommissioning also needs to be looked at and needs to be looked at urgently.

  Chairman: This is clearly all part of the fiscal and regulatory approach.

  Q144  Sir Robert Smith: You have made a strong case that with extra incentives there is a rosier future, more jobs sustained, more energy supply and more long-term tax revenues. Have you thought about what level that value allowance should be pitched at to make a meaningful difference to future investment?

  Mr Webb: High. As high as possible. I think it should be set at such a level that it takes supplementary corporation tax off. There is a problem here as well. You may have heard some very big numbers being floated around and you need to be careful about that. You need to set the value allowance so high to produce an after-tax effect that is quite restrictive really. I would not want anyone to think that when Professor Kemp was talking about 100 million or whatever that means there is 100 million of value allowance going to be paid to oil companies, it does not work that way. I think 100 million produces an after-tax effect of about ten million. That is another issue. We did say to the Government that the value allowance is not our preferred way of dealing with this because we think it adds further complexity to the taxation system, but they have persuaded us that is the only game in town and that is why we continue to talk to them on that and we want to be as constructive about it as we can, but it should be big.

  Q145  Sir Robert Smith: You are engaged in negotiations on bringing forward the exploration relief to try and get the cash flow to smaller companies sorted.

  Mr Webb: We certainly are, yes.

  Q146  Sir Robert Smith: On the narrow question of whether there should also be incentives for incremental developments on existing hub platforms, a lot of this tax consultation discussion started in a different climate where there was a recognition by Government and industry that there were smaller fields, cost challenges and so on, but the snowball increased in size as the credit crunch hit and now we are seeing things that were being discussed in a calmer environment being needed as tools to rescue things in a really quite serious situation. Do you think there needs to be that extra incentive to get those hubs protected by encouraging incremental investment on them?

  Mr Webb: Yes, I think there is a case for saying all new projects is what we should be stimulating now. If we go back to that point, we need to be sending a very clear signal that this mature UK offshore province is a competitive place to come and invest in and it is active and open for business. The industry can do its part on that but, frankly, as we said in our submission, we have a fiscal regime that is no longer fit for purpose and it needs to be changed rather urgently.

  Q147  Sir Robert Smith: We are a new Committee because there is a new Deprtment and all sides have welcomed the fact we now have a Secretary of State who is a champion for energy and climate change and that is bringing together two departments that should be together.

  Mr Webb: We lobbied for it. I cannot say that we affected the result of it!

  Q148  Sir Robert Smith: You have expressed concern about it being under-resourced and you think the 60 million from the licence fees should be doing more to give resources to the Department. What are the problems you are experiencing because of what you see as under-resourcing?

  Mr Webb: I have to be careful here. We deal with a lot of very dedicated, hardworking civil servants and I would say we see them working too hard these days really. The system feels like it is under strain and under stretch. There are a few people we deal with and we see them having to deal with everything more or less and I do think there is a problem. I cannot quote you figures, but I think there are unfilled vacancies within the oil team and I have concerns as to the resources that are available to that team. I also have another concern that with the splitting out of this new Department we are now going to have another departmental bureaucracy put on top of that Department and I hope they are not playing the zero sum game and we find more resource is taken away from the front facing people within the Deprtment and goes back into the bureaucracy. You mentioned the 60 million number and I do not know if you saw it but last year The Guardian produced an excellent chart showing what total Government expenditure was on a departmental basis, a total of 586 billion for the year 2007, and when you looked at BERR, the Department for Business, Enterprise and Regulatory Reform, which was where energy was before, the total spend was 8.3 billion but 7.3 billion of that was going to nuclear decommissioning. When you looked further down you saw that energy supply and clean energy was a total of 0.068 billion, which is 68 million, which did not seem to me to be an awful lot. That is why we are interested in that 60 million number. It looked like the licence fees being paid for the North Sea were financing the whole of the energy section of BERR and I do wonder what is happening within DECC. We support DECC, but DECC has got to be able to deliver and has got to have the right resources to do that.

  Q149  Sir Robert Smith: One other thing on the new Department and its role. One of the jewels in the crown of the North Sea has been the huge expertise built up there that has now earned a worldwide reputation and a big export market, so there are the jobs that have come on the back of the North Sea, we get the security of supply and the tax revenues and the jobs, but do you have any concern that when energy was in BERR it was in a department that was also thinking of economic development and jobs? Do you still feel that there is a champion within Government for that export, skills and jobs side of the industry and the benefit that brings to the economy?

  Mr Webb: That is a very good point and I am not sure that we have linked up correctly with that yet. I think it is in BERR, but we have not found it yet and we should find it. You are right, there could be a diffusion of attention there as well. I was surprised to see the other day that there is an energy section still within BERR, I am not quite sure what it is doing but maybe that is the section we go through and look for some help on that.

  Q150  Chairman: Can I press you on one point in your submission about the EU ETS? You expressed concern that the next phase could reduce production, presumably because of the auctioning?

  Mr Webb: Yes.

  Q151  Chairman: First of all, do you not think auctioning is the fairest way? Secondly, do you not see that there are potential benefits from a rise in carbon prices, particularly in terms of driving a number of changes in production methods and also the potential for CCS storage in the future?

  Mr Webb: Yes, yes, yes, and yes. I agree with everything you have said. ETS is a good mechanism for dealing with this sizeable problem we have and we need a fair price on carbon. If you do not get a fair price on carbon then you can forget the CCS because it is only a fair price on carbon that is going to drive the CCS. We have no problem with that and as an industry we have never had any problem with ETS. Gas flaring, for example, is within the ETS system and we have no problem with that either. We are not anti-ETS. This is a slightly more difficult industry-specific issue. There is no alternative but to generate our electricity offshore in these platforms and using the resources that are at hand, which is the gas and the production on the platform. It is impossible to think of retrofitting new equipment on to these old platforms. If the offshore industry is required to buy all its allowances for that electricity generation then on our estimation operating costs are going to increase by between 20 and 40% on platforms offshore and that will give rise to the premature decommissioning of some of those platforms. When those old hub platforms go then that will take out satellite production from around them, so we believe up to a billion barrels of oil and gas are threatened by this. However, there is some good news. As you may know, the EU has a trade intensity test linked to the carbon leakage and it is very clear, and we have agreement with DECC on this, that these offshore installations of the offshore oil and gas industry qualify for that. That resolves some but not the entire problem. It resolves half of the problem because the emissions relate in part to electricity generation but also to other direct power uses offshore, so we are still left with half of the problem and we believe we need to find a solution to that other half too. To use that carbon leakage term, this is pure carbon leakage. If we do not produce this oil and gas from areas around our shores we will have to import it from elsewhere and assuming we achieve all of the Government's renewables targets, which we hope we do, we know, for example, we will still be reliant on oil and gas for 70% of our primary energy supply in 2020. The UK offshore, I am sorry to say, will not be able to meet 100% of that but it is vital we close that gap as much as we can, both in terms of energy security and also for the economic benefit of this country because that is an awful lot of expensive imports.

  Q152  Chairman: It certainly is.

  Mr Webb: That is the issue there. We have no problem with ETS, no problem with a sensible cost of carbon, that is going to be vital to drive some of the environmental investment that needs to happen, and no problem with CCS, CCS is an area of opportunity for our industry, particularly the supply chain, but there is a specific problem around ETS Phase III which the Government is fully aware of.

  Chairman: Can I just touch upon the issue of environmental impact. The industry is well established and, generally speaking, its record has been pretty good on environmental management but, of course, as you push out into the undeveloped areas, particularly into the west of Shetland, deepwater, extreme weather, there are concerns about the potential environmental impact and also in relation to sensitive areas. David wanted to ask a question on that.

  Q153  Mr Anderson: The various environmental bodies have told us that regulation control is generally good but sometimes compliance is not, do you accept that?

  Mr Webb: I would have said that levels of compliance within our industry on environmental issues are pretty sparklingly good, frankly.

  Q154  Mr Anderson: What procedures have you got in place to make sure that they work?

  Mr Webb: Do you mean self-policing it from an industry viewpoint?

  Q155  Mr Anderson: Yes.

  Mr Webb: We do not double up on the work of the regulators, we help the regulators who are doing that, but we do keep an open dialogue with regulators right across the piece and try and make sure that we are as constructive as we possibly can be in these areas.

  Q156  Mr Anderson: Is complying with regulations a burden on the industry? Is it driving people away from investing in the UK?

  Mr Webb: Is it a burden? Of course it is a cost, but I do not think there is anything we would point to where we would say because we have got these environmental regulations people are not coming to invest in the North Sea, no.

  Q157  Mr Anderson: In terms of the decommissioning process, what challenges do you face there?

  Mr Webb: The challenge is to try and postpone it for as long as we possibly can actually and keep this infrastructure in place so that we can get the 25 billion barrels recovered. That is the first and foremost challenge. As to the other challenges, I think we are well up to them. We have got a magnificent supply chain here and we have the confidence and capability to do it. Some of this decommissioning is already going on, by the way, we are not complete novices on this and I have every confidence that we can deal with the issue. The problem around decommissioning is the way that—I do not want to sound like I am kicking the Government all the time on these tax—

  Q158  Mr Anderson: We are used to it!

  Mr Webb: —the decommissioning regime is based upon some false premises. It is relying upon two things. It is relying upon corporate governance and bankers' letters of credits. If the banking crisis teaches us anything it is that is not where we should be and we need a new system whereby we can have properly established retirement funds for these assets financed on a post-tax basis.

  Q159  Mr Anderson: The RSPB have told us that they would like a better survey of seabirds and wildlife, particularly west of Shetland. Is that something the industry would support and, if it supported it, would it help to fund it?

  Mr Webb: The industry has had a good track record of working with the RSPB upon surveys in the past. We have got a lot of data and we would be very happy to share it with them and talk to them about that issue. You did say support it and not fund it.



 
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