WHAT THE INDUSTRY EXPECTS IN 2008

Active year in UK continental shelf amid market and legislative uncertainties

Alexander Kemp, University of Aberdeen, Scotland

The year 2007 has been another active year in the UK Continental Shelf (UKCS). Exploration and appraisal drilling has been running at slightly higher levels than those achieved in 2006, while development drilling has been slightly below last year’s level. A substantial number of new fields have come onstream, including Buzzard Field in the outer Moray Firth with estimated recoverable reserves exceeding 500 million bbl.

Escalating operating costs. While high oil prices have been beneficial for production revenues, the operating environment has not been unambiguously rosy with continuing cost escalation. In the central North Sea the lifetime development and operating costs of a new field now exceed $25/boe. In the northern North Sea they now exceed $27/boe, while in the Southern Gas Basin, traditionally a low-cost area, the unit field costs exceed $20/boe. The result is that some potential development projects are being re-assessed. This is particularly the case with gas fields, because the wholesale gas price has not increased in line with oil prices, but has suffered the same cost escalation.

This year saw the completion of the 24th Licensing Round with 246 blocks being awarded. This was a high number, and an encouraging feature was the significant number of new entrants (17). Closer inspection reveals that a large proportion of the awards were in the form of Promote Licenses, which are intended to provide opportunities for small players to undertake geophysical and geological studies with the benefit of discounted fees for the first two years of their licenses. However, the round produced only a modest number of commitment wells, and many of the blocks awarded under the Promote License scheme may be relatively high risk.

Indicative of the challenges facing the industry was the ongoing work of the government-industry West of Shetland Task Force. Its purpose was to examine the possibility of a commercial development solution for the group of undeveloped gas fields located in the region. Around 2 Tcf of discovered gas has been identified, with an upside potential of another 2 Tcf from discoveries, and possibly another 4 Tcf of undiscovered potential. However, the discoveries are located over a wide area and each is of moderate or small size, and new pipeline would be required to transport the gas to the UK mainland.

It is clear that a cluster development with a communal hub and pipeline would constitute the most economical form of development, but the Working Party has not found a scheme that is economically attractive. The hub could be at various onshore or offshore fields, and the Task Force has examined all of these, but the discovery of an attractive scheme has proved elusive. The work will thus continue into 2008.

Petroleum Revenue Tax. Another feature of 2007 was the launch of a Consultation Document by the UK Treasury on the long-term future of the tax system in the UKCS. Of particular interest to the Treasury is the position of Petroleum Revenue Tax (PRT), which is paid by fields developed before March 16, 1993. The yield of this tax will fall over the next few years with the depletion of these older fields, followed by a period when its yield will be negative due to the reclamation of tax paid through the relief for the decommissioning expenditures.

A negative tax yield is unappealing to any Ministry of Finance, and the Treasury has proposed to the industry that PRT could be phased out in various ways, allowing relief for decommissioning expenditures. Finding neutral format between the interests of investors and the Exchequer is not straightforward. For example, if the PRT is abolished when the present value of expected tax payments becomes equal to the present value of the expected PRT relief for decommissioning costs, the effect depends on the discount rate employed. Estimating decommissioning costs several years in advance is subject to error with high risks due to inaccuracy.

The industry proposed that tax reliefs should be provided to encourage new field developments, citing the major cost escalation in recent years. Reducing the burden of the Supplementary Corporation Tax could produce worthwhile increases in the number of new field developments over the next 20 years, but the Treasury is concerned about the effect on tax revenues, with the possibility of tax losses from fields which would have been developed without reliefs looming large in any assessment.

Decommissioning concerns. Another consultation process that took place in recent months between the government and the industry was over the question of financial security for decommissioning. In the UK there is joint and several liability among co-licensees for the decommissioning obligation. Furthermore, at the time of asset transactions involving mature fields, if the government is concerned about the ability of the buyer to meet its decommissioning obligations, it can insist that the seller be liable in the case of a default. Sellers are unhappy about this, and Oil and Gas UK has proposed the use of a Decommissioning Cost Provision Deed, which would provide security to all partners and enable the seller to be released from any further obligation. This is being discussed with the government, which is adapting a very risk-averse approach to the problem.

In 2008 there should continue to be a high level of activity in the UKCS, but likely less than the amount of investment in 2006, due to the completion of major projects and the lack of large new developments.

Hopefully the next year will bring clarification to the legislative position regarding taxation and decommissioning. It is too optimistic to hope for stability in the oil market and in the markets for equipment and supplies, and thus the industry has to continue to manage these and other external risks. 

THE AUTHOR
	Alexander G. Kemp is the Schlumberger professor of Petroleum Economics at the University of Aberdeen. He previously worked for Shell, the University of Strathclyde and the University of Nairobi. For many years, Professor Kemp has specialized in petroleum economics research, with special emphasis on licensing and taxation. He has published more than 100 books and papers in this field. Professor Kemp is director of Aberdeen University Petroleum and Economics Consultants, providing consultancy in petroleum economics.