North Sea—life in the old dog
There's still plenty more value to be eked out of the maturing basin, according to one of the region's most experienced operators
Serica Energy wasn't a name on many people's lips until last November, when the UK-based minnow revealed a deal to acquire a cluster of BP's North Sea assets. The proposed purchase of controlling interests in the Bruce, Keith and Rhum (BKR) fields would turn the company into a significant regional player at a stroke—but this isn't a role that daunts Tony Craven Walker, Serica's co-founder and executive chairman, who has done it all before.
Craven Walker's involvement with the region's oil and gas industry dates back to the 1970s, when he worked for BP and the North Sea's glory days still lay ahead. Since then, he has been a prominent figure in the independent oil sector, founding Charterhouse Petroleum and then Monument Oil and Gas, which was sold to Lasmo in 1999 for $460m in shares.
That was a time when larger oil companies were regularly snapping up North Sea rivals—Lasmo itself was subsumed into Amerada Hess a couple of years later. Now the dynamic has changed completely, as big players seek to sell off their acreage in a declining basin.
Craven Walker is well aware today's mature North Sea is a very different place to do business, but says the fundamentals remain the same and so do the opportunities.
"Monument was built in a similar way to how we're doing Serica," he told Petroleum Economist. "You build up the foundations with production, you run the production efficiently, and then use your income and your tax position to do exploration. It was much easier 20 years ago, but basically it's the same."
Getting a North Sea deal done is certainly a different proposition now. In the first few years of the 2000s, banks still tended to see North Sea exploration companies as a sure-fire bet. This attitude fast disappeared with the 2008 financial downturn and the 2014 oil-price crash.
'The earn-out deal structure put forward by Serica has made other companies think about their own positions'
"Three years ago, I couldn't raise $8m, despite a track record of building successful companies," he said. "Because of the lower oil price and the feeling that the end of the oil world was nigh—even though that was exactly the time you should be doing something."
However, a shift in focus away from exploration towards production, plus a willingness to work with creative financial structures and perseverance now seem to be paying off.
Serica's first steps into North Sea production came in 2015 with the purchase of BP's 18% stake in the Erskine Field, a high-pressure, high-temperature (HPHT) gas and condensate area operated by Chevron.
Serica's share of production averaged 2,800 barrels of oil equivalent a day in the first half of 2017. But that figure was dragged down closer to 2,000 boe/d for the year as a whole, by production disruptions and the temporary closure in December of the Forties Pipeline System. This takes Erskine's output to shore.
The company also has plans to exploit the undeveloped Columbus gas condensate field, in which it holds a 50% stake. The field is located in the central UK North Sea, 8 km north of the Lomond Platform. The platform was recently acquired by Chrysaor as part of Shell's recent sale of North Sea assets to the private-equity backed firm.
Creative deal structure
However, the BKR acquisition promises to move Serica into another league, potentially increasing its share of production by around sevenfold to around 21,000 boe/d, based on first-half 2017 data, with potential for further increases. Meanwhile, net 2P reserves attributable to the BKR assets, as of January 2018, are estimated at some 47m boe—over 85% of this being gas—adding substantially to Serica's existing net reserves of around 3m boe from the Erskine field.
The company will assume operatorship of all three of the adjacent fields, which are located to the east of Shetland. In Rhum, Serica will hold a 50% stake, with the Iranian Oil Company holding the other 50%. In Bruce, Serica will hold a 36% stake, partnering Total (43.25%), BHP (16%), and Marubeni (3.75%), while BP will retain a 1% stake; and in Keith, Serica will hold 34.83%, partnered again by Total (25%), BHP (31.83%) and Marubeni (8.34%).
Serica will pay BP £12.8m ($16m) up front with further deferred payments totalling up to £39.1m, contingent on the extent of gas production from the Rhum field. A third well, R3, is due to be brought onstream later in 2018, adding to volumes. Serica will also pay BP a share of cash flows over the next four years.
Finally, although BP is taking on the future decommissioning costs of existing infrastructure on the fields, Serica will pay an amount equivalent to 30% of those costs (post-tax). Decommissioning costs haven't been itemised, though BP has said it expects to receive around £300m in total from Serica, most of it in the next four years.
This type of deal structure, featuring deferred payments based on future revenues is likely to become more prevalent in the North Sea, as fields near the end of their lives. It enables majors, for whom the region is no longer core to their business, to offload assets to smaller companies prepared to make the effort, but without the financial clout to do so on their own.
Serica would have struggled to raise the finance to pay for the assets upfront. The company would also have been reluctant to take on decommissioning costs that are just a few years away for the Keith field and possibly not much longer for the other fields, depending on Serica's success in prolonging their lives.
Craven Walker said some North Sea asset sellers were still keen to offload all decommissioning costs on to buyers. But this was likely to deter smaller firms with limited resources from taking the asset, given uncertainties over the final decommissioning bills. The prospect is even less attractive at the moment, as tax breaks on decommissioning related to a field's financial and tax history are not transferable from one operator to the next. However, proposed UK legislation may change that in coming months.
Serica's share of the decommissioning bill is also capped at the company's total cashflow from the fields. So if, hypothetically, the fields had to shut down immediately after the deal was completed, the company's share of costs would be zero.
Craven Walker praised BP's willingness to adopt the "earn-out" model that Serica proposed for the sale. "A lot of people have been very complimentary to us and BP about the structure—I think it's made some companies stop and think about their own positions," he said.
However, there's still work to be done before completion on the BKR deal, which is unlikely to happen before September 2018. That's largely because of the Iranian Oil Company's 50% stake in Rhum—which dates back four decades to the days of the Shah. It means Serica must obtain an Office of Foreign Assets Control (OFAC) licence from the US Treasury Department, if it wants to use US-sourced personnel or equipment, due to US sanctions on Iran.
BP already has an OFAC licence and Craven Walker is confident that Serica will also be granted one, given the development is in UK waters and is UK-operated. However, the US Treasury is unlikely to rule on this until just before BP's current OFAC licence expires later in the year, effectively preventing the deal going through before then.
The BKR acquisition promises to move Serica into another league, potentially increasing its share of production by around sevenfold to around 21,000 boe/d
The hiatus will also give Serica more time to bring its partners on board with its field development plans. This is no straightforward task. Some partners would probably prefer to sell their stakes and will need convincing of the value of investing in assets they had sidelined. In particular, Serica hopes to "align" the different partners in Rhum and Bruce, as more investment in Bruce to extend its life would also prolong that of Rhum, which uses much of the former's infrastructure.
The Serica executive chairman is confident that Serica can pull this off, noting that the economics of the North Sea industry have improved of late. On the Erskine field, in which Serica became a minority partner in 2015, production efficiencies reduced the firm's operating and transportation costs from $23/boe in 2016 to $14/boe in the first half 2017. These improvements have helped increase recoverable reserves and extend the field's life.
However, outages such as the recent shutdown of the Forties Pipeline System highlight the vulnerability of smaller players' income in a region with ageing infrastructure. The pipeline was closed for more than two weeks for the repair of a hairline crack, before reopening at the end of December.
Serica is currently a 'virtual' company employing around half a dozen people—including its highly experienced chief executive Mitch Flegg—and bringing in experts and contractors as needed. But, with the BKR deal, the firm will be taking on almost the entire BP team already working on the developments, some 110 people. That should smooth the transition to operatorship and even improve motivation, now the fields' future is assured, he contends.
"People (located) offshore bond with the assets they're working on—they want them to perform, so if investment is not happening, they don't like it," he said. "When we went offshore to talk to the BP staff, they didn't talk about their pay packets, they talked about what we were going to do to improve the performance of the platforms, about well stimulation and new ideas."
The UK's Oil and Gas Authority will also need to approve the deal, as it wants to ensure that new North Sea developments are structured in a coordinated way that maximises oil and gas recovery.
Craven Walker said he thought Serica's development plan should satisfy that criteria. On completion, the company intends to push on with work on the R3 well on the Rhum field, which is already drilled, but is currently suspended while hydrates are removed. On Bruce, Serica intends to continue with work already started on well stimulation and improved recovery, as well as possibly carrying out further drilling, if it can convince its partners Total, BHP and Marubeni.
The Keith field's future is less clear. "In theory, it's near the end of its life, but they've been saying that for some time," he said. "When you've got a well chugging along at 1,000 barrels a day and doesn't seem to be stopping, then there may be scope to add small additional reserves—it's not something BP would do necessarily, but we could."
In Craven Walker's view, the BKR deal is a win-win situation, bringing benefits to both BP and Serica.