Government policy issues dominate outlook for activity on the UK Continental Shelf

Professor Alex Kemp, University of Aberdeen 

Budgetary and tax matters. The Budget on Oct. 30 unveiled changes to the Energy Profits Levy (commonly termed Windfall Tax) applied to the North Sea oil and gas industry. The EPL rate was increased to 38%, producing an overall headline rate of 78%. The duration of the Levy was again extended, this time to March 2030. Of more importance to investors was the decision to remove the Investment Allowance applicable to new projects. A consultation has also been launched on what should constitute the tax system post-EPL. 

Independent modelling by the present author has established that the effects of the EPL are likely to have negative consequences on investments in new fields (especially smaller ones) and on incremental projects in mature fields. The removal of the Investment Allowance plays a significant role here. A further effect of the increase in the EPL is to encourage delays to investments, in order that a higher proportion of the related profits occurs after the termination of the tax.  

Insufficient licensing. The new UK government has a lukewarm attitude towards issuing new exploration licences and to the development of discovered fields. The context is long-term production declines in both oil and gas, from a peak in the year 2000. The UK is now a major net gas importer and substantial net oil importer. From an economic viewpoint, there is a strong case for permitting new field developments with safeguards for the associated environmental costs, including CO₂ emissions. The independent Climate Change Committee has produced long-term UK oil and gas consumption estimates compatible with the achievement of Energy Transition to Net Zero by 2050. Alongside the central estimates of UK oil and gas production produced by the North Sea Transition Authority, there is a need for large net imports every year to 2050. Permitting new field developments with safeguards would result in a higher UK GDP and tax revenues. 

Scope 3 emissions. The issue of the relevant safeguards is a live one. Reducing Scope 1 CO₂ emissions (i.e. from production operations) is already being achieved at a very substantial pace, as are Scope 2 emissions (i.e. from the activities of contractors to the production operations). The issue of Scope 3 emissions (i.e. those from the use of the final oil and gas products, such as petrol and diesel) is the subject of much debate. A legal decision has confirmed that Scope 3 emissions need to be taken into account in the permitting process.  

Independent estimates of the economic cost of emissions vary considerably, but there is general agreement that they will increase over time. This contributes to the finding of our research that the result will be an acceleration to the timing of field cessation of production. In late field life, the emissions per barrel produced increase, thus effectively increasing the unit operating cost.  

Producer consolidation. With the growing maturity of the UKCS, consolidation among producers is a natural economic reaction. The announcement by Shell and Equinor to form a single, joint 50:50 company is an example. It will be able to obtain synergy advantages, including financial ones. Thus, the new company will be able to utilize tax losses, which would otherwise not have been readily possible. Equinor is understood to have such allowances. A single company is more tax-efficient in this situation, compared to a joint venture between two separate companies, such as historically occurred between Shell and Esso on the UKCS. 

Renewables investment. For some years, the UKCS has seen growing investments in windfarms, including both fixed and floating generating facilities. Floating facilities are based on the technology developed for FPSOs that are used in relatively deep waters. In the context of wind energy in the UKCS, it has been found that wind productivity is sometimes greater in locations with deep water. Thus, more reliable electricity can be generated to the extent that this advantage outweighs the higher cost. The intermittency problem may be less.  

Over the years, the development costs of offshore wind have decreased significantly. However, more recently, cost inflation has led to substantial increases in wind farm construction cost. The result has been that the incentive scheme for offshore wind, based on guaranteed electricity prices, resulted in no bids being made for offshore acreage. As a consequence, this has necessitated an upward revision having to be made to the guaranteed prices under the Contract for Differences scheme. Despite the presence of this, investors are still keenly aware of the risks involved. This situation is likely to continue, so long as cost inflation is present. 

The UK and Scottish governments are both very keen to accelerate the development of electricity from renewable sources. To promote this, a state company named Great British Energy has been formed amid much publicity. While full clarity on its activities has still to be revealed, its headquarters will be based in Aberdeen, though its chief executive will be located in Manchester. Its key function will be as a co-investor in renewable sources of electricity. Thus, there will be cost, risk, and reward sharing with private sector companies. In the present investment environment, this should be regarded as a positive feature. While it may be expected that GB Energy will always see policy issues primarily from government’s prospective, operating experience should result in the perspectives of private sector investors being fully appreciated. 

To achieve the Energy Transition to Net Zero by 2050, it will require not just very large investments in renewable sources of energy. Given the intermittency problem inherent in wind energy, storage facilities will be important, as well the need for a huge expansion in the electricity transmission and distribution system. At present, the back-up capacity for power generation is provided by natural gas via capacity payments. To replace this will require major investments. Similarly, the replacement of gas for heating homes will also require major increases to the electricity transmission system. The evidence indicates that there will be much transmission of electricity from Scotland to England, involving both onshore and offshore lines.  

CCS development. A long-standing element of UK energy policy has been to develop carbon capture and storage. Many schemes have been studied but not implemented. At last, a very large scheme has been sanctioned by the UK government at Teesside on the Northeast coast of England. This will gather CO₂ from a variety of industrial sources and transport it over 45 miles offshore, to be buried in saline aquifers. There may be as much as 4 million tonnes of CO₂ injected annually for around 25 years. Unlike the schemes discussed over the last decade, there is no EOR involved. In round numbers, the investment cost could be £4 billion. Both the UK and the Scottish governments are keen to encourage further CCS schemes and several are currently being studied. 

A major economic question for the energy sector is whether the growth of renewables can compensate for the long-term decline of the oil and gas sector. Clearly this is a very big challenge. Offshore and onshore wind developments do not have the same day-to-day operational requirements as is required for oil and gas. The UK content of the investment in renewables is currently not very high. A combination of effective incentives, well-targeted education and training schemes, and learning by doing can produce a vibrant industry. 

ALEXANDER G. KEMP is Professor of Petroleum Economics and Director of Aberdeen Centre for Research in Energy Economics and Finance (ACREEF) at the University of Aberdeen. He was formerly Lecturer, Senior Lecturer and Reader. He previously worked for Shell, University of Strathclyde and the University of Nairobi. For many years, Professor Kemp has specialized in petroleum economics research, particularly licensing and taxation issues, publishing over 200 papers and books in this field. He has consulted on petroleum contracts and legislation to many governments, the World Bank, the United Nations, various oil companies, the European Commission, the UK Know-How Fund and the Commonwealth Secretariat. He was a specialist adviser to the UK House of Commons Select Committee on Energy from 1980 to 1992 and also in 2004 and 2009. He is also an editorial adviser to World Oil. From 1993 to 2003, he was a member of the UK government’s Energy Advisory Panel. In May 1999, Professor Kemp was awarded the Alick Buchanan-Smith Memorial Award for personal achievement and contribution to the offshore oil and gas industry.  Professor Kemp was awarded the OBE in 2006 for services to the oil and gas industry. He was a member of the Council of Economic Advisers to the First Minister of the Scottish Government. He has written The Official History of North Sea Oil and Gas, which was published in 2012 in two volumes. In March 2012, Professor Kemp received the Lifetime Achievement Award at SPE’s Offshore Achievements Award ceremony. In October 2022, he was given a Lifetime Achievement for the Advancement of Education for Future Energy Leaders award by Abdullah Bin Hamad Al-Attiyah International Foundation for Energy & Sustainable Development in Doha, Qatar.