Making the most of the UKCS Cultural shift key to maximising economic recovery of oil and gas Contents Executive summary 1 1. It is getting harder – all change please! 2 2. Is MER UK the answer? 6 3. Implications: A party of three 15 4. Conclusions 20 Contacts 21 About this report The report is based on in-depth interviews with 23 senior oil and gas executives and investors from 18 organisations. The series of interviews were held between June and October 2014. Acknowledgements We would like to thank all companies interviewed for participating in this report, including: Allianz Global Investors Europe Petrofac BG Group Premier Oil Centrica Royal Dutch Shell Enquest Sanford C. Bernstein Fairfield Energy Schlumberger Halliburton Subsea 7 Dana Petroleum Wood Group PSN Nexen Xcite Energy None of the views and opinions outlined in the report are directly attributable to the participating companies. In this publication, references to Deloitte are references to Deloitte LLP, the UK member of DTTL. Executive summary The UK Continental Shelf (UKCS) has provided the UK with substantial energy and income for decades. Although production levels have been declining since 2000, it remains a highly valuable asset. Another 15 billion barrels of oil equivalent could be extracted, worth about $1.3 trillion, assuming a $90 per barrel oil price. But this prize will not be delivered unless the industry, the new regulator and HM Treasury adapt to match the challenges of the basin today. Time for change The UK government has recognised the need for change and commissioned Sir Ian Wood to write the UKCS Maximising Recovery Review, published in February 2014, which provides a wide-ranging set of recommendations. But are the Wood Review’s recommendations the right ones? Will they be sufficient to maximise economic recovery of UK resources? And what are the implications for the industry? Deloitte conducted in-depth interviews with 23 senior oil and gas executives and investors from 18 organisations to understand their views. Uncertainty deters action Support for the Wood Review’s main recommendations is unanimous: the need for the new regulator, the Oil and Gas Authority, and fiscal reform are undisputed. But much remains unclear, deterring investment and decisive action in the industry, and many are sceptical that real change will be achieved. What the industry, the Oil and Gas Authority and HM Treasury need to do Behaviours and leadership need to evolve. Whilst sustaining the high health, safety and environmental standards the industry has achieved, work patterns and behaviours suited to a bespoke, high production environment need to be challenged both in industry and government. • A new style of organisation and leadership is needed that focuses on cost-efficient solutions that deliver asset integrity and high production efficiency in this late-life environment. • A strong regulator is needed with a clear vision and priorities, and the ability to encourage, incentivise or enforce new ways of working in the UKCS. • More drilling is key. Deloitte’s Petroleum Services Group estimates that current drilling activity levels need to double to more than 90 wells drilled annually over the next 20 years. Regulatory and fiscal incentives, perhaps emulating the Norwegian model, are needed to stimulate exploration and appraisal drilling activity. • Access to key infrastructure must be ensured. Creating a fiscal and regulatory environment where key infrastructure will be maintained and access to it is facilitated will be crucial. • A fit-for-purpose fiscal regime is needed. The fiscal regime must be simplified and predictable to restore investor confidence in the UKCS, incorporating the flexibility required to meet the needs of the diverse basin. • Closer collaboration between companies, the Oil and Gas Authority and HM Treasury is vital for maximising economic recovery in the UKCS. It is crucial for controlling costs, managing risks and increasing operational effectiveness. Collaboration is needed across the value chain from exploration to decommissioning, in a range of ways including new business models, sharing of equipment, and co-development of capabilities and learning. While the changes required may not come as a surprise, achieving these changes will not be easy and efforts must not compromise safety. Time is critical to avoid decommissioning of key infrastructure. Although it will take time to establish the new regulator, the industry and government must not wait to push forward with these changes and maximise the benefits of the UKCS for all. Making the most of the UKCS Cultural shift key to maximising economic recovery of oil and gas 1 1. It is getting harder – all change please! Challenges in the UKCS The UKCS is one the world’s most established offshore basins. It has been a significant contributor to UK energy security: indigenous oil and gas production accounted for over 70 per cent of the UK’s primary fuel in 2013.1 It is also a provider of substantial income for HM Treasury, with oil and gas production adding £30 billion to the balance of payments in 2013.2 The UKCS has supported thousands of jobs across the country for over five decades, and in 2013 it provided employment for some 450,000 people.3 However, doing business in the UKCS has become more difficult in recent years as deteriorating asset performance demonstrates. Rapid production decline – While it is expected that oil and gas production will fall as reservoirs gradually deplete, the rate of UKCS production decline has taken many by surprise: oil and gas production has fallen 38 per cent in the last three years. Production efficiency is a key driver of decline, as shown in Figure 1, falling from around 81 per cent to 60 per cent between 2004 and 2013. Figure 1. Production efficiency and UKCS oil and gas production 1,400 81% 90% 80% 79% 77% 76% 80% 1,200 72% 70% 70% 62% 60% 60% 60% 1,000 60% 800 50% mmboe 600 40% 30% 400 20% 200 10% 0 0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Production efficiency (%) Oil and gas production (mmboe) Sources: Deloitte’s Petroleum Services Group (PSG) and Oil & Gas UK Rising costs and less production leading to lower tax yield – Operating costs have been rising steadily and reached record levels in 2013 (see Figure 2). Higher activity levels that are putting pressure on the supply chain, more stringent safety and environmental regulations, increased talent costs and lower efficiency (higher maintenance costs for ageing assets, inefficient purchasing practices and lack of standardisation) have all contributed to cost inflation. Although crude oil prices have been historically high over the last three years, lower production and rising costs reduced HM Treasury’s North Sea income from £11 billion in 2011–12 to £6.1 billion in 2012–13. It declined even further to £4.7 billion in 2013–14.4 Figure 2. North Sea tax revenues, operating costs and Brent crude oil price 14,000 120 12,000 100 10,000 80 8,000 60 £ million 6,000 $/barrel 40 4,000 2,000 20 0 0 12 13 -92 -98 -02 10 11 1990-911991 1992-931993-941994-95 1997 1998-99 2000-01 2011- 2012- 1995-961996-97 2001 2002-032003-04 2004-05 2005-06 2006-07 200 7-082008-09 2009- 2010- 1999-2000 Total tax revenues (£ million) Operating costs (£ million) Brent crude oil price ($/barrel) Sources: HM Revenues and Customs and BP Statistical Review of World Energy 2014 2 Smaller discoveries and less successful drilling – As Figure 3 shows, discoveries in the UK North Sea are getting smaller and exploratory programmes are becoming less successful. With ‘easy oil’ in the UKCS shallow waters gone, fields are getting more remote, deeper and technically more challenging. Therefore, it is becoming more difficult to deliver production volumes at an acceptable cost and there are fewer economically attractive investment opportunities. Figure 3. Average discovery size and average well success ratio 900 70% 800 60% 700 50% 600 500 40% mmboe 400 30% 300 20% 200 10% 100 0 0% 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Average discovery size (mmboe) Well success ratio (%) Source: Deloitte’s PSG Note: Data includes discoveries made up to 18 September 2014 Less drilling – As Figure 4 shows, rising costs and riskier exploratory programmes have coincided with less drilling in the UKCS. While the maturity of the basin is a reality, the lack of drilling will inevitably precipitate production decline as the pool of reserves shrinks. Figure 4. Exploration and appraisal and development drilling 350 300 250 200 150 100 Number of wells drilled 50 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Number of exploration and appraisal wells Number of development wells Source: Deloitte’s PSG Fiscal regime not fit for the basin – Interviewees argue strongly that the fiscal regime is not fit for the characteristics of the basin. The level of taxation is high and the fiscal regime is perceived as unpredictable and complex. In the global world of oil and gas, the combination of these factors has a negative impact on the basin’s attractiveness to international investment. Making the most of the UKCS Cultural shift key to maximising economic recovery of oil and gas 3 Why has so little been done to address these challenges? Many of the challenges in the UKCS have been well known and documented for at least a decade. The issues have been extensively discussed at conferences, roundtable meetings and in white papers and there have been numerous initiatives to address them.