The sector faces intense scrutiny from investors as it looks for ways to cope with a collapse in prices that if sustained, severely undermine the viability of current and future production.
Maximising economic recovery in the mature UK Continental Shelf basin, access to finance and strategies for stimulating activity, are key issues for the industry, against a backdrop of sliding oil prices – down to $78 (*£52) at the time of this forum last November. Tight margins have been further exacerbated by a dramatic rise in both supply chain and development capital expenditure costs over the last decade.
Analysis of what makes up UKCS oil barrel costs highlights the extent of the problem. “The finding cost is roughly $10 (*£7) a barrel, the government take is about $20 (*£13) and the unit OPEX and capital development costs in the supply chain to deliver a barrel is $50 (*£33). That’s $80 (*£53) a barrel cost to get the oil line down. At $78 (*£52) a barrel the numbers just don’t add up,” warns Caroline McGovern, Finance Director of MOL Energy UK Ltd, the UK subsidiary of Hungarian oil and gas company MOL Group.
But more than just an issue for the operators, the knock on effect for the supply chain and the industry’s servicing companies is not to be sniffed at. A significant portion of that $50 (*£33) is the cost to develop major projects and bring them on stream.
The landscape is changing as new financial markets open up and new players try to muscle in. However, these smaller independents don’t have the same access to the traditional financing base, typically the secure debt based on a balanced portfolio and reserve space lending. While there is an appetite for risk among investors to fund some of the developments and new funding opportunities are emerging, the downside is they tend to be more expensive.
Accessing third party infrastructure
In order to encourage more investment into the UK Continental Shelf, access to existing third party infrastructures – in particular pipelines and facilities, to deliver some of the smaller remote opportunities, is critical. And yet it’s an area that remains hugely challenging, not least in terms of thrashing out commercial terms and economic rates that are acceptable to both parties.
“What we constantly see is that the balance of power lies with the owners of the infrastructure and there’s a great reluctance to share the economic benefits equally in order to make these new developments economically valuable,” McGovern explains.
One way to unlock this issue could be a new approach to infrastructure access, possibly a standardised agreement and a balancing of the costs and rewards, although McGovern concedes such an approach is unlikely to be very popular with the infrastructure owners.
Removing security requirements
Removing some of the security requirements for new entrants into the North Sea could also provide a much needed boost to the market. “The credit rating that is required by the current Decommissioning Security Agreement Standard is AA-minus. Given that there are only five banks internationally that qualify as AA-minus, that makes that decommissioning security very expensive when you need to post letters of credit.”
Punitive tax regime
At the same time, the government has tended to react to energy company price increases with punitive fiscal changes. “That gives a long term sustainable problem for us in terms of how we make our businesses cost efficient and profitable,” explains Mike Brown, Managing Partner of Anderson Anderson & Brown LLP Chartered Accountants.
From a tax perspective, there are calls to make field allowances available to all, as well as making them front- rather than back end loaded and based on capital spend. Meanwhile, increasing the Ring Fence Expenditure Supplement from its current six years, to a minimum of 10 years is widely seen as beneficial.
“An efficient tax system should not deter investment that is economic pre-tax and needs to balance the UK’s lead an fracker, and technologically challenging exploitation, as well as exploitation of mature assets,” added Luke Morris of Larking Gowen and MMA.
Neil Robertson, Wells Director at MOL Energy UK Ltd, says the criticism of rising costs is often unfairly levelled at the supply chain. “But to a large extent the supply chain is being driven by the operator and the way that they are being asked to produce pieces of work.”
Supply chain collaboration
At MOL the selection process for supply chain partners will be based on the new British Standard 11000, which focuses on collaborative working. “We want to work with those people. The flip side is we need to understand what we need to give them in terms of standardisation, flexibility, clear deadlines and clear wires,” Robertson adds.
The focus also needs to shift away from cost and instead towards creating value, Robertson adds. “That’s where the whole relationship and trust then comes in. How can we create value for return.”
But he also concedes that getting collaboration into the mainstream is no mean feat. “Our supply chain business is like everybody else’s, so us trying to effectively change the group mindset as well is also quite an interesting task.”
Rachel Willcox is a freelance business journalist and writes about accountancy and finance, management and technology issues. She is a regular contributor to accountancy titles including Accountancy, economia and The CA.
Energy and Natural Resources Group, February 2015
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