How is the low oil price affecting the UK North Sea oil industry and our wider economy?

Over the past 12 months, oil price fluctuations have had a profound impact on the vast majority of companies operating in the UK North Sea, arguably leaving the United Kingdom’s Oil industry in a state of flux. It certainly is a challenging time to be working within the UK Oil Industry and a direct consequence of the low oil price has meant that companies are under intense pressure to control and reduce their operating expenditure, increase production to cover costs and somehow deliver a return to shareholders. Not an easy job most would agree.

In the vast majority of cases, investors at present recognise the fact that oil, like all commodities, is susceptible to the volatility of supply and demand. The UK North Sea, along with other international oil hubs, appears to be caught up in a cross fire and global power struggle with OPEC and emerging markets such as the American unconventional shale revolution. As a consequence, here in the UK North Sea, we are facing one of the most challenging times since conventional oil production began on the continental shelf back in the 1960’s.

In this article, I want to highlight some of the challenges that oil companies are facing in the UK at present. I will analyse how the low oil price is affecting the wider UK economy, current UKNS production and review the thoughts of some of our associated subsurface professionals.

Since the Brent crude oil price started to decline from its peak of $114 per barrel in June 2014 we have seen a steady decrease in the oil price, bottoming out at $45 per barrel in August 2015.

The vast array of theories as to why the oil price first started to decline shall be left for another day, however, in simple terms global oil production is outweighing demand. According to this month’s article of “World Oil”, global consumption currently sits around 93 million barrels per day. As it stands, the world is producing more oil than it consumes which directly impacts on the commodity price.  Interestingly enough, the excess production fluctuates between 1-3% of global consumption which in comparison to the 250% reduction in the commodity price is staggering.

It is well documented that in order for the price of oil to recover, the OPEC group of countries need to curtail production in order for the commodity value to increase. This poses an interesting challenge for governments and Independent oil companies to influence the outcome, when the majority of the world’s oil production and reserves are controlled nationally by countries whose economies are primarily driven by oil revenues. Additionally those countries within OPEC also control 81% of the World’s Oil reserves.

In stark contrast to the current state of the oil industry, a low oil price has not disadvantaged the overall UK economy. PWC recently documented an article earlier this year stating that a low oil price is causing other industries in the UK to flourish. “One man’s loss is another man’s gain” so the old idiom goes.

Companies that rely on raw materials produced from oil are thriving at present as their raw product cost base is so much cheaper. Industries such as Agriculture, Transport, Aviation, Manufacturing, Haulage, Distribution, and other service sectors have all welcomed the lower oil price as it directly adds profit to their bottom line as their key input costs are falling.

So what effect is the declining oil price having on Company’s producing in the UKNS then?

A recent article from the Telegraph widely publicised using statistics from the International Monetary Fund that the UKNS is the most expensive area in the world to produce a barrel of oil. There are a vast number of oil fields currently in production within the UK, and the mean operating cost is around $40 per barrel in comparison to $5 per barrel in countries such as the UAE, Iraq and Kuwait. Please be aware that this is a mean figure and do not assume that all fields are operating at that OPEX cost base in the UKNS. This is not the case and there are a large number of fields that have operating costs well in excess of $40 per barrel, in most cases the operating cost is higher  than the current oil price meaning the fields are running at a loss.

The consequence is that companies are under significant pressure to reduce their current cost base. Across the industry we are seeing Service Company contracts being terminated, major reorganisations, many redundancies and a major realignment of the operating cost base. Companies are a lot more conscious of investing in the UK North Sea and capital expenditure programs for new Greenfield projects coupled with investment in Exploration programs have been significantly reduced.  Some economists argue that the oil industry within the UK is close to collapsing.

So why are operating costs so much more expensive in the UK?

Over the past few weeks, I have conducted some of my own research by engaging with an array of UKNS subsurface management. Fortunately I am in a strong position interacting daily with the UK North Sea’s technical management and it has been interesting to hear varying and conflicting opinions about the future of our oil industry.

In summary, there is no set formula or timing for when things will improve as each company has different circumstances. There are a huge number of variables that come into play like the state of the company’s assets, what stage those assets are at with their production life cycles, what capital commitments are forthcoming(i.e. maintenance, decommissioning costs etc.) and the overall financial position of the company. What is safe to say though, and a consistent message that most people are resonating throughout the UK oil industry is that the majority of oil companies are tasked with producing more oil, with less people and doing it more efficiently.

Yesterday, I had an interesting discussion with one of our associate consultants and current interim Chief Reservoir Engineer around what he felt was causing OPEX costs to be so much higher in the UK than other international countries. In his opinion, a potential reason is lack of planning and shortsightedness.

“Operators have largely responded to the drop in oil price by attacking discretionary costs. These tend to be projects that support future production enhancement and the staff that develop and deliver these projects. The result may not impact production in 2015, but will increase production decline in 2016/17; as a result any savings in opex/bbl in 2015 will be mostly wiped out in 2016/17 as production declines faster. Further, reserves replacement will disappear and reserves will be written down as field life is shortened, ultimately destroying value.

The question remains of how these short term cost strategies can really address the root causes of high operating costs which stem from short term production and development strategies. In reality it is the opposite effect that results. Low cost development and production strategies lock in poor efficiency and high operating costs, deferred production enhancement leads to increase production decline, deferred proactive maintenance and intervention shortens field life as the delayed activity becomes more expensive with time – these strategies are mutually supporting, a tightening spiral of decline further exasperated by production decline.

In contrast, a focus on production enhancement, well intervention, operating efficiency improvement and losses management at a time when rig rates and vessel rates are low and the impact of production outage is lessened by low prices would seem to be the forward thinking, reinforcing strategy far more likely to lead to long term cost efficiency and maximising economic recovery.  Now is the time to focus on these asset management strategies, starting with a reinstatement of the discretionary spend that will create a different future.”

In conclusion, like most people, I feel the oil price will recover, when? Is the difficult question to answer. The future of the UK North Sea along with other international oil hubs will all welcome a slowdown in production to increase the oil price sooner rather than later. The stance OPEC have taken with their decision not to decline oil production has also impacted on certain OPEC nations themselves as not all are equal in terms of their reserves distribution and production. An article produced by the BBC earlier this year, made reference to the winners and losers from certain OPEC nations around the declining oil price. It appears that most of the OPEC nations are also heavily reliant on a high oil price to maintain a resilient economy.

Across the industry in recent months, we have seen significant cost reduction measurements being implemented to lower the overall expenditure. One thing that is clear is that these cost reduction exercises are necessary for re-balancing the cost base within the UK North Sea to rebuild a sustainable long term Oil industry here in the UK, and therefore safe-guarding long-term Employment for future generations of Oil & Gas workers in the UK North Sea.

Over the forthcoming months, what we are likely to see happening in the UKNS is more consolidation. Due to the high Barriers to Exit of Projects where Billions of Pounds have been invested, in Oilfield Services, we have seen the $34.6 Billion Dollar Merger of Halliburton/Baker Hughes and the UK is likely to see continued pressure for similar consolidation.It has been claimed that this merger would save $2billion a year in costs, if this type of deal is replicated globally would see the industry emerge stronger and more nimble.

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