The Fuse

Low Prices Accelerate Decline of North Sea Crude Oil Production

by Nick Cunningham | October 01, 2015

While North Sea crude oil production has been in its twilight years for some time, the collapse in oil prices appears to be accelerating the region’s decay. With little hope for a price rebound, the UK needs to further diversify its economy beyond North Sea oil. 

Aging Fields and Rising Costs

A September 9 report from Oil & Gas UK, an industry trade association, made some stark warnings about the future of North Sea hydrocarbon production. Not only has production been in a long-term decline, but the collapse in oil prices may push investment off a cliff. The report projects that capital investment in North Sea oil and gas could fall by £2 to £4 billion in each of the next three years, down from the £14.8 billion the industry invested in 2014.

Not only has production been in a long-term decline, but the collapse in oil prices may push investment off a cliff.

The massive decline comes after years of extraordinary spending. The industry posted record levels of investment for four consecutive years between 2011 and 2014 while prices remained elevated. The amount of money poured into the North Sea couldn’t fully stem output declines, and profits fell as costs spiraled upwards. In 2014, the British offshore industry posted a £4.2 billion cash-flow deficit, the largest in nearly forty years.

That deficit is, in part, the result of inflationary cost pressure. Operating costs increased by 12 percent on a compound annual growth rate between 2004 and 2013, and supply chain costs also climbed. In 2014, the growth rate tapered slightly, but operating costs still jumped by another 9 percent. Not until recently, following the oil price crash, did offshore companies squeeze savings out of their operations through lower rig rates, lay-offs, and other cost-saving measures.

Nevertheless, with oil companies slashing spending across the globe, exploration budgets are coming under pressure. This is occurring in a region that averaged only 55 million barrels of oil equivalent in newly discovered recoverable reserves over the past three years, the lowest level since the UK opened its continental shelf decades ago.

Compounding the problem, decommissioning costs are rising, as aging infrastructure and depleted fields need to be shuttered. Decommissioning costs are expected to double from £1 billion to £2 billion between 2014 and 2018. The Oil & Gas UK report concludes, around “475 installations, 10,000 kilometres of pipelines, 15 onshore terminals and 5,000 wells will eventually have to be decommissioned.” A separate report from Wood Mackenzie estimates that as many as 140 oil fields could be shut over the next five years.

In a sign of the waning interest in the North Sea, Russian billionaire Mikhail Fridman has been trying to unload North Sea assets under an order from the British government, but has been unable to attract sufficient interest. Fridman’s LetterOne fund acquired North Sea assets from RWE, the German energy company, but Western sanctions on Russia stemming from the Ukraine crisis have forced him to unload these holdings. Fridman hoped to sell the oil and gas fields for $1.2 billion, but so far has only received offers of $750 million, according to Reuters. The tepid interest prompted LetterOne to ask the British government for more time to allow it to hunt for buyers.

From prominence to structural decline

Britain became a prominent oil and gas producer as a result of the oil fields in the North Sea, but the UK’s best days as an oil producer are clearly behind it.

Oil production in the UK comes almost exclusively from its offshore oil fields in the North Sea. Companies such as BP and Royal Dutch Shell made major discoveries in the early 1970s, transforming the North Sea into a significant oil and gas producing region. These discoveries included the Forties field, as well as the iconic Brent oil field, which allowed for the establishment of the crude oil futures benchmark.

Thus, even though the North Sea put Britain on the map as an oil producer, its best days  as a producer and exporter appear to be behind it. The UK produced almost 3 million barrels per day (mbd) as recently as 1999, but is now below 1 mbd.

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Although the Brent benchmark is a reference point for international oil prices and contracts, very little oil actually comes from the Brent field today. The field once produced 400,000 barrels per day during its peak in the 1980s, but Royal Dutch Shell, its operator, is currently in the process of decommissioning the field.

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Any hope of revival?

The UK government has taken steps to boost the country’s oil and gas industry. It cut taxes for the industry in early 2015 in a bid to stem the basin’s decline. Taxes on oil and gas revenue were slashed from 50 to 35 percent, and corporate tax from 30 to 20 percent. The government will also foot the bill for new seismic surveys, hoping to boost interest in exploration.

The UK government has taken steps to boost the country’s oil and gas industry, but it’s unclear whether these actions will be enough.

Not all news from the North Sea is bad. The North Sea will see a slight uptick in oil production this year, as several projects initiated years ago reach completion. Companies are also finding some savings from their operations. The cost of producing a barrel of oil equivalent is expected to fall from £17.80 per barrel in 2014 to £17 this year, and then drop by another £2 to £3 per barrel by the end of 2016, according to Oil & Gas UK.

If oil prices rebound, so could interest in the North Sea. According to Sir Ian Wood, one of the most respected voices for the British oil sector, the North Sea could see a slight revival in 2017 or 2018. He conducted a review on behalf of the British government to look into how to boost the competitiveness of North Sea oil. Moreover, the North Sea has not gone completely dry. In October 2014, BP and GDF Suez discovered a new oil field, which BP dubbed “Vorlich.”

Terminal decline

“The industry will lose jobs, whole teams, plants and equipment. But we must be really careful we don’t lose infrastructure, as the damage will then be permanent.”

However, there simply aren’t enough new discoveries for any substantial recovery to occur. The North Sea is becoming increasingly uncompetitive, and as international oil companies trim their spending, they will focus on other oil basins around the world that are more attractive. The declines in capital investment expected over the next few years guarantee that fewer discoveries will be made. Once the current queue of projects is worked through, there will be a dearth of new projects. Against this backdrop, production declines could accelerate.

“The industry will lose jobs, whole teams, plants and equipment. But we must be really careful we don’t lose infrastructure, as the damage will then be permanent,” warned Sir Ian Wood.

As more fields are decommissioned, the costs to maintain operations rises for the companies that remain. The burden of maintaining critical infrastructure will be shared by fewer companies after their peers have left, and they will then face even more pressure to pull out. “The domino effect is now a significant challenge. If some of these fields are shut in, it will affect the whole basin,” a director at Total E&P UK said at an industry conference in June.

The United Kingdom is better positioned than the many national economies that are not diversified away from oil and gas. However, even if production declines can be halted, any efforts to rescue North Sea crude oil will be short-lived. “By the middle of the century, the UK will have largely exploited its offshore oil and gas reserves,” Sir Ian Wood advised.