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Hope for UK oil industry at Offshore Europe conference

The conference in Aberdeen presented a "do or die" challenge for the UK's offshore interests amid tough circumstances

With all the large and relatively straightforward fields going or gone and oil prices in the doldrums, the gloomy contents of the industry’s economic report for 2014 came as no surprise to delegates attending the Offshore Europe conference in Aberdeen.

But the crisis could be turned to the industry’s long-term benefit, presenting it, as it does, with a “do or die” challenge. Successfully addressed, it could force the industry to abandon its traditional approach to its problems and thereby ensure the maximum output from the North Sea at the least cost.

And delegates said the outlook would be much bleaker now if it were not for the coalition government’s prompt implementation of the highly influential 2014 Wood Review, dedicated to maximising the economic recovery from the UK, which it commissioned a few years ago. It included the creation of the Oil & Gas Authority as the dedicated offshore regulator for licensing and production.

In its annual report, Oil & Gas UK, representing operators and contractors active on the continental shelf, found that more money went offshore than came back after tax last year. At an aggregate £14.8bn ($22.5bn), investment was sharply up. But this year’s first-half and possibly full-year on year gain in production – the first since the peak production year of 2000 – is coinciding with an era of low prices. The investment figure will consequently taper off sharply towards the end of the decade, absent a major recovery in global demand, limping home at a forecast £3bn by 2019.

Tax

The head of OGUK Deirdre Michie told delegates 9 September that if the oil price does stay lower for longer, as many senior oil executives believe, then “the government needs to revisit the headline tax rate, perhaps.”

The government cut taxes for producers in the last budget, following a tripartite approach between the industry, the finance ministry and the newly-established Oil & Gas Authority under the chief executive Andy Samuel. This approach was also among the recommendations of the Wood Review, a document which was frequently referred to during the course of the conference, and according to Samuel it led to “exceptional” changes in the Budget.

The review included other recommendations to maximise the economic recovery of the UK North Sea’s oil and gas, where total output to date already totals some 43bn barrels of oil equivalent, mostly from very big fields which have not been replaced with recent exploration activity. It is thought that half as much again remains to be extracted, if all goes well. At the moment though the UK is producing oil far faster than it is replacing it with new finds.

The tax changes reflect the maturity of the basin, and the lower oil price and tax reductions will continue as the environment becomes harsher. The overall average tax rate is now set at 40%. The government is to consider not just the profits a company earns but also the wider economic benefits that its activity brings. “The UK needs to be globally competitive,” Samuel said.

But there was recognition too that the offshore needed to bring costs down further and should share the burden. Speaking for Shell UK at a panel session immediately after Michie, Paul Goodfellow said that the industry also needed to do its bit, before falling back on pleas for lower tax.

The professor of petroleum economics at Aberdeen University, Alex Kemp, has argued that there are greater gains for the industry from cutting costs than by cutting tax by the same percentage.

But other kinds of tax changes could make a difference too, he said. At today’s oil prices, enhanced oil recovery – a key plank in the Wood Review – remains unprofitable using saline flooding; gas; or polymers, he said.

But if the government has set the precedent for taxing cushion gas differently in storage sites to the benefit of the operator, treating it as plant, then why not apply the same principle to the gas or other injectants that the operator buys to improve oil production? That would increase a field’s production. The earlier such injection plant is installed in a project’s life, the bigger the rise in the recovery rate. Ideally it should be considered as part of the initial design, he said, to secure the best possible results.

Collaborate

The downturn in the oil price has gone for so long now that the pain of cost-cutting – any industry’s kneejerk response to a downturn – has been felt everywhere with redundancies and project deferrals abounding. But much still remains to be done to make the UK sector of the North Sea – already one of the most expensive regions the world has to offer a producer – a profitable province again.

According to Premier Oil’s Robin Allan, speaking at a panel session, most of the savings from renegotiations with contractors and so on have still not brought costs down as much as needed. Comparing the UK unfavourably with Asia, he said that attitudes and approaches to changes in the shift system – even in unionised Vietnam, for example – were far more flexible and change there had been implemented almost overnight. “Unless the collaborative effort goes to a whole new level, I am not optimistic. The UK is not a competitive basin for companies who are able to work internationally,” he said.

The industry has already put in place initiatives such as the creation of task-forces to address efficiency and increase collaboration between the stake-holders. But their work is yet to bear fruit.

An efficiency charter with standards on how to collaborate is due at the start of November. This would include an online inventory for sharing or selling equipment. “It would be tragic if companies failed to share efficiencies,” an official from Oil & Gas UK, Stephen Marcus-Jones, representing the offshore community on an efficiency-raising task-force, told Petroleum Economist.

He said that almost half – other delegates cited figures between 45% and 48% – of lost production offshore was due to gas compression outages, which could amount to 50,000 boe/year. Hence the apparent smooth running of very old platforms as they do not have compression and may flare limited quantities of gas instead. Incidentally this an area where the OGA, whose focus is maximising the economic recovery of the North Sea, potentially comes into conflict with the environment ministry, which is seeking to limit flaring.

Poor compression could come from a number of causes, perhaps not obviously related to the problem; and if the approach to maintenance is not coherent these problems will continue to disrupt performance, Marcus-Jones said. A study into that would be completed by the end of the year.

Don’t waste a good crisis

Amec Foster Wheeler’s European president John Pearson told delegates that they must not “waste a good crisis.” It was only by reacting intelligently to the disparity between costs and oil prices that the industry could squeeze out the inefficiencies, in the same way that other sectors of manufacturing such as aviation and automobile had stayed afloat in the past. This had led to lasting improvements in the system.

He divided up industrial response to falling prices into three, partly overlapping phases: the first nine months are spent in cost reduction, which can bring cost savings of 10-15% – and so far UK jobs are down to 375,000; months 5-18 are spent in efficiency improvements that may bring the savings up to 25% at best; and months 12-36 bringing savings of 40% thanks to transformational change. This crisis is so grave as to make the latter achievable, he said and the downturn is now over a year old.

But there are problems with imposing collaboration too. The majors do not promote people for being nice to their rivals, but for putting one over them. “It is a fiercely competitive environment,” Premier’s Allan said. So while he sees that the OGA is heading in the right direction, there is the risk of its initiatives being “slammed down” by a judicial review by companies keen to keep things as they are.

But there is not much time to lose. Two companies have already “gone under” owing at least in part to the majors’ “selfish behaviour” in UK waters, blocking third-party access to infrastructure.

Samuel told the conference that every industry has to reinvent itself at difficult times. Presenting his agency’s progress report on the first six months, he said that there were other problems to deal with than aggressive individualism. For example, the technical quality of the last 100 wells drilled had been poor, even though there are “very good plays out there.”

The Hurricane-operated Lancaster, which was granted oilfield status – the first official step on the way to oil production – was a case in point. “We need to do better highlighting those areas,” he said. Government-funded seismic data will be made available early next year.

He told journalists that for every positive story there was a negative story, but it was acting as a broker trying to forestall issues before they can develop into problems. He had not heard anything of a judicial review and he said that the OGA would engage with the legal community and hear their concerns.

One size fits all

Efficiency gains through sharing technology and infrastructure, using standardised parts – “there is no intellectual property in a ball valve,” one industry expert told Petroleum Economist – and working collaboratively rather than competitively are among the industry’s weapons in the war on costs which have risen sharply in the last five years. The start of this war predates last summer’s fall in the oil price.

The executive director of the International Association of Oil & Gas Producers, Michael Engell-Jensen, told Petroleum Economist that standardising equipment would save money. As it is, companies benefit from the engineer’s traditional preference to over-specify parts. And operators prefer to replace the part with the same one, reducing the order size and pushes up manufacturing costs.

A ball-valve manufacturer, exhibiting at the conference, endorsed this assessment, and said the French major, Total, was trying to standardise its equipment on the rigs. But inertia is proving a difficult force to overcome. Each platform has its own valve design, and whoever wrote the original specification had his own way of doing things, he said.

“Many specifications were written thirty years ago, but if the engineer orders a different replacement and it goes wrong, he takes the responsibility,” he said. This is despite the fact that the variations between two valves may be measurable in only thousandths of an inch. Replacement on a like-for-like basis leads to costly over-specification.

“They use exotic materials that are intended to last longer than they are needed. They should aim to get value out of the parts for ten years, and then change them, rather than use duplex steel [which does not need anti-corrosion coating] and paint it so that it lasts forever. We are trying to educate customers not to do things that are unnecessary,” he said. However, deciding which specification to use from the hundreds out there will be challenging.

Statoil, across the median line in Norwegian waters, has been pioneering a new approach to keep down offshore costs – among the world’s highest – in order to fast-track projects. Using off-the-shelf equipment for all but the most complicated parts and cutting down on design time and money and brings gas and oil to market more quickly. 

But the state-owned company has the benefit of involvement with most developments, and can influence them. Samuel told delegates that it could not force operators to act differently.

Balancing act

Another aspect of the problem facing mature provinces such as the UK is the conflict between markets and governments. An asymmetrical situation, where the government is able to exert pressure on companies to act against their commercial interests will drive investors away to cheaper, more laisser-faire jurisdictions. That will harm UK energy security.

The OGA will have the powers to impose fines on companies who do not subscribe to the new regime, but the fine is not that great at £1mn. The implication from today’s standpoint is that the OGA will take a carrot and stick approach where the marginal barrel is concerned or risk losing it.

Such an approach might need to be rethought in the case of infrastructure-only companies, such as Antin and North Sea Midstream Partners. They rely on third party traffic and have no production of their own. They might have different ideas about profitability than the government of the day but their attitude to tariffs will be critical in the struggle to keep fields alive. The OGA is very keen on separating ownership of transport from the means of production.

The newly-created Oil & Gas Authority is already involved in the renegotiation of the Sullom Voe terminal contracts between the operator BP and the different groups of companies using the facilities. Set up to handle gas from the Brent and Ninian systems in the east of Shetlands, and still taking some 150,000 b/d from there, it is now also taking some 100,000 b/d from the west of Shetlands too, creating a series of new problems.

The question is likely to provide much work for lawyers. On the one hand, the terminal contracts guarantee counterparties’ rights and normally may only be terminated by agreement and compensation. On the other, the contracts are decades old and reflect a very different time and way of doing business. Retaining them might not be compatible with the objectives of the Wood Review.

A BP spokesman said that to ensure the economic viability of Sullom Voe in the short, medium and long-term, its owners and users were exploring the potential for a change to the contractual relationships which allocate costs to all the fields using the facility. “To secure this, all existing cost share agreements will require to be restructured and, while this has not yet concluded, good progress is being made. The OGA has and continues to provide assistance to this process via independent facilitation of the discussion,” he said.

Nevertheless, despite the complexity of Sullom Voe, it appears to be moving faster than talks at Theddlethorpe, a gas terminal where the situation offshore no longer reflects the terms of the contract. The OGA is also involved in talks in Theddlethorpe but since the OGA published its 6-month update the relative positions of the two has switched.

Bring contractors in early

Among the desirable changes, say the services sector would be for the operators and services companies to work together at an earlier stage.

GE’s senior executive for subsea systems Neil Saunders told PE that earlier involvement could allow synergies to be captured earlier on. Rather than going from the front-end engineering and design (Feed) to tender two contracts, one for subsea production services (SPS) and one for subsea umbilical, risers and flowline (Surf) services, there is value for the operator in drawing companies into the project at the opening stage, for example by running a Feed competition.

“We see some of that behaviour, for example in west Africa, but not in the UK,” he said: “A different model is welcome, and will drive changes in the North Sea remaining viable and competitive.”

He said that if there was a positive element to the market today, it was the meaningful attempt to standardise. “It is now seen as being a necessity to make the segment more competitive,” he said. “We knew we were cost-challenged even before $40 oil and we are encouraged to see more openness from operators and the original equipment manufacturers.”

He sees this leading to new commercial terms and new business models. GE is able to bring not just the equipment but also the financing, but GE also needs the industry to be successful and competitive, earlier involvement will help that. “It is not about nickel and diming but moving the decimal point,” he said.

Attendance at the conference was, at just 5% lower than last year, still considered a great success and the second highest ever, last year’s being higher. But those stands and tickets would have been sold at higher oil prices. Conspicuous by their absence this year were many of the majors and many of the middle-tier producers, although French Total, US Chevron and Shell UK all had big stands – as did the OGA.

Interview: Michael Engell-Jensen, IOGP

The executive director of the International Association of Oil & Gas Producers struck a relatively upbeat note about the oil price – given the circumstances – at the Offshore Europe conference in Aberdeen. “These downturns are always very painful,” Michael Engell-Jensen told PE. But the International Energy Agency (IEA) forecasts that in 2040 oil and gas will still account for half of the total primary energy demand, so “there is a fundamental need for our production, this is just a temporary feature.” 

In the meantime companies have to lay off a lot of good people and projects get cancelled, so “it is a mess.” But it is difficult to see how it could be different, he points out. Producers are not in control of the oil price: it is a matter of supply and demand. Saudi Arabia has taken the decision to produce a lot of oil. This is not sustainable for Saudi Arabia in the long term – it is eating into its currency reserves – “but what is the long term? The oil price will rise again, and expansion will be on the way.”

Another way of saving money is through standardising equipment. Rather than risk a gratuitous failure, every company will prefer to use its own Christmas tree or ball-valve, or replace the ball-valve that it used before. This pushes up manufacturing costs. 

“But there is no intellectual property in a ball-valve,” he points out. “It is low-tech equipment.” 

However, deciding which specification to use from the hundreds out there will be challenging. The World Economic Forum is pushing for the adoption of common industry specifications, perhaps at the Davos conference in January. The Norwegian company Statoil has been pioneering a new approach to keep down offshore costs in Norway – among the world’s highest – in order to fast-track projects. 

Using off-the-shelf equipment for all but the most complicated parts and cutting down on design time and money and brings gas and oil to market more quickly. But it has the advantage over the UK of being a state-owned company involved in most field developments.

Another aspect of the problem facing mature provinces such as the UK is the conflict between markets and governments. An asymmetrical situation, where the government is able to exert pressure on companies to act against their commercial interests will deter investors, meaning either granting them more concessions to stay, or risking their departure and so losing more production earlier than under the hands-off approach the UK government took in the first 40 years. 

This might smack of central planning, but for Engell-Jensen, the government is doing the right thing with its creation of the Oil & Gas Authority and the separation of licensing from environmental issues.

“The choice is between no business and a profitable business for all,” he said. “The challenge is how to reconfigure the elements, to split the pie differently. And this applies to most mature provinces.”

On shale gas production in Europe, IOGP is clear that the potential is there. “There seem to be good formations in the UK and France,” he said. But what is lacking is honest debate. “There is a refusal to have the discussion,” he said. “The onus has to be on us to get into the room, and to say that we are here to help society. Can we please talk about the facts?”

A key aim of the industry – and the theme of the conference – is inspiring the next generation, including those just out of university. To complement rather costly graduate programmes, the industry should be looking at say one-year internships and placements. A year with a good supervisor on a good project would equip the intern with the experience and references to set him/her up on a career. Otherwise there will be a gap in managers when it is all hands on deck once more. 

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