The Fuse

New Shetland Islands Oil Discovery to Revive Production in UK Waters?

by Nick Cunningham | March 28, 2017

On March 27, Hurricane Energy, a small-cap energy company based in the UK, announced a major oil discovery near the Shetland Islands, a discovery that is being described as one of the largest in UK waters this century.

Hurricane drilled the “Halifax Well” near its existing Lancaster oil field, and the results were very positive for Hurricane. The hydrocarbon column stretches over 1 kilometer in depth and it could hold enough oil to make it “the largest undeveloped discovery on the UK Continental Shelf.”

Hurricane Energy’s find raises questions about the possibility of a revival in the fortunes in UK waters and the North Sea, which has declined in both importance and production for the better part of two decades.

The massive discovery is likely to spark interest from much larger drillers. Royal Dutch Shell and BP recently won exploration licenses in the areas not far from the discovery. Hurricane Energy’s find raises questions about the possibility of a revival in the fortunes in the UK waters and even the North Sea, which has declined in both importance and production for the better part of two decades.

Declines in the UK Continental Shelf

Producing oil in the rough waters in the UK Continental Shelf and the North Sea is expensive. The oil fields are mature and have been in decline for years, making ongoing operations costlier and less attractive. The UK’s oil production peaked in 1999 at roughly 3 million barrels per day (mbd), falling to about 1 mbd today.

The UK’s oil production peaked in 1999 at roughly 3 million barrels per day (mbd), falling to about 1 mbd today.

The collapse of oil prices beginning in mid-2014 was an enormous blow to the North Sea and its surrounding areas, hitting the industry harder than elsewhere. In a global market in which investment dollars have become increasingly scarce, the North Sea and UK offshore production have struggled to compete against cheap oil in the Middle East, lower risk and short-cycle U.S. shale, and even expensive offshore oil fields in relatively less explored places like South America, West Africa or the Eastern Mediterranean, where the upside potential is much larger.

Recent metrics have not looked good. Companies that produce in UK waters have seen ballooning debt positions, according to Oil & Gas UK, an industry trade group. Total expenditure on the UK Continental Shelf has fallen for several years, down from £26.6 billion in 2014 to £19 billion in 2016. Greenfield development is also down, with only one project moving forward last year compared to five in 2015. Brownfield development does not appear much better, with the number of projects approved falling to five last year, compared to ten in 2015. The decline in investment has led to the loss of 120,000 jobs. Ultimately, rising debt for companies in the UK could delay any new investment resulting from a rebound in prices.

The UK’s decision to leave the European Union adds additional challenges for the oil industry, according to Oil & Gas UK. The withdrawal from the EU will be a distraction for an industry struggling to find its footing; the industry could also lose influence over policy development in Brussels; political uncertainty may deter investment; and the loss of access to the EU common market could make the procurement of goods and services trickier, depending on the outcome of future trade negotiations between the UK and the EU. All of that will occur before another potential referendum on Scottish independence, which could raise sovereignty questions regarding North Sea oil fields.

A rebound in the UKCS?

Oil drillers in UK waters are squeezing more oil out of existing fields.

But there are signs that the UK oil industry is turning a corner. The cost to produce a barrel of oil in the UK’s waters has plunged by nearly half since 2014, falling from $29.30 per barrel to $16 per barrel by 2016. As a result of these efficiency gains, “there has not been a widespread rush to cease production on the UK Continental Shelf (UKCS) as may have otherwise been expected,” Oil & Gas UK said in its 2016 Economic Report.

Moreover, oil drillers are squeezing more oil out of existing fields. In 2015, output jumped by 10.4 percent, the first increase in over 15 years. The trend continued into last year, with production up 5.7 percent in the first half of the year compared to the same period in 2015.

Still, that increase in production largely stemmed from record levels of investment between 2011 and 2014 when oil prices routinely traded above $100 per barrel. As those projects come online, there are only few behind them to add new sources of supply. “The lack of new development projects must be urgently addressed if we are to avoid a repeat of the sharp production decline that dominated the early part of this decade,” Oil & Gas UK warned late last year. “As an industry, we are producing at four times the rate we are discovering new reserves–this is unsustainable.” Decommissioning costs are also rising sharply, doubling to £2 billion this year from £1 billion in 2015. Lack of new investment combined with ballooning costs for decommissioning old oil fields could lead to a death spiral for the industry.

Hurricane to the rescue

Hurricane Energy’s oil discovery is located in what is called “fractured basements,” or fissures in hard rock located below the much softer sedimentary sandstone from which most of the oil in the area’s waters has been extracted.

The discovery by Hurricane Energy could provide a jolt to UK offshore production and the North Sea. The recently announced success at its Halifax well was the third consecutive well drilled by Hurricane in less than a year. Hurricane says it will need to raise $400 million to develop its Lancaster prospect and will make a final investment decision this year. It hopes to bring oil production online as soon as 2019.

The small company will likely need to partner with larger firms to develop the prospect. The exciting exploration results should make that an easy task. The string of successes come after a positive result from the latest auction. On March 23, the British Oil and Gas Authority awarded 25 licenses for 111 blocks to 17 different companies. The auction was the first in two decades to focus on underexplored areas of the UK Continental Shelf, including the Shetland Islands. “While exploration activity has undoubtedly suffered as a result of the difficult market conditions, we are now seeing highly encouraging success rates and finding costs on the UK [continental shelf],” the UK Oil and Gas Authority said in a statement.

northsea

Oil majors Royal Dutch Shell and BP won licenses not far from Hurricane Energy’s discovery. The locations are relatively less explored areas west of the Shetland Islands. Most of the UK’s largest oil fields—such the once-prolific Brent and Forties fields—are located east of the Shetlands. This new frontier west of the Shetlands could potentially lead to a revival of the UK’s North Sea oil industry, although it is still very early to tell.

However, Hurricane Energy’s discovery contains one wrinkle: the oil is located in what is called “fractured basements,” or fissures in hard rock located below the much softer sedimentary sandstone from which most of the oil in the area’s waters has been extracted. Producing from these fractured basements is a lot more complex than most drilling, raising questions about the significance of Hurricane’s discovery. The company’s CEO, Robert Trice, is undeterred. “I firmly believe that fractured basements will change the face of the UK oil industry,” he told the FT in a January interview.

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