Independent oil and gas producers are moving into traditional producing areas of the UK Continental Shelf (UKCS) as major companies move toward technologically the region’s challenging frontiers or out altogether.
Royal Dutch Shell PLC, Chevron Corp., and ExxonMobil Corp. recently have begun selling UK North Sea fields, following BP PLC and ConocoPhillips last year. Increasingly taking their place are companies like Fairfield Energy Ltd., Oilexco Inc., and Venture Production PLC.
Attracting the smaller companies are fields too small for the exiting majors but still plentiful enough to represent much of what remains a large target for exploration and production. The trade group Oil and Gas UK estimates potentially recoverable oil and gas reserves for all the UK at 25 billion boe.
Access by independent operators to existing production platforms and other equipment set in place by the majors and to seismic data acquired in the past improves the allure. And the UK government has stimulated activity by encouraging the transfer of licenses to companies eager to work.
But problems remain. They include tax and cost increases, equipment and worker shortages, and the indirect effects of a global credit squeeze.
UK attraction
The ability to develop small North Sea oil and gas fields via tie-in to the large production facilities installed years ago by major producers has long been recognized as an attraction to independent operators.
In addition, active asset trading has enabled relatively small companies to establish positions on the UKCS quickly. The government has helped.
“The Department for Business, Enterprise, and Regulatory Reform [formerly the Department of Trade and Industry] has simplified the paperwork for asset trading and improved the process for third-party access to infrastructure,” said Geoff Gillies, lead analyst for Europe at Wood Mackenzie. “The fallow-fields initiative, where unworked acreage and discoveries are recycled so that companies can’t just sit on them, has created opportunities and helped attract independents to the UK North Sea.”
Jim Stockley, treasurer of the Oil & Gas Independents Association (OGIA), which represents small to medium-size companies with approximately 5% of UKCS production and 27% of the exploration well count, said the availability of seismic data has also lured explorers to the UK North Sea. But not all companies have the geophysical talent they need to interpret the information.
“Lots of people are retiring, and some are opening up their own consultancies and are a lot more expensive,” Stockley told OGJ.
Although the government launched a data-access initiative to help independents secure seismic data and well information from major operators at cost, there have been problems.
“Some majors put in overhead costs, but they have to pay for those people who are diverted from what they were doing to run off the data,” Stockley said. “The data that is public is 10 years old, and some of this is not useable because it’s on tape.”
Government policies
Encouraging activity by independent producers has been an aim of UK licensing policy.
In 2002, the former Department of Trade and Industry introduced promote licenses, offering them at reduced cost to small producers willing to generate prospects and commit to prompt work programs by themselves or others. It also introduced the fallow initiative mentioned by Gillies, a system for transferring licenses with no activity to companies agreeing to aggressive work programs.
According to North Sea consultancy Hannon Westwood, the initiatives have stimulated exploration and appraisal in general and work by operators new to the UKCS in particular.
Hannon Westwood Technical Director Andrew Vinall noted recently that 37% of more than 3,600 individual working interests on UKCS acreage fall under pressure for early activity from the promote program or frontier licenses, which encourage operators, not specifically small producers, to generate and promptly drill prospects in unusually challenging areas such as deep water. He also cited the fallow initiative.
“Fallow wells are important as they tend to examine riskier but larger structures compared to traditional joint ventures targeting near-field accumulations,” he said. “We have seen farm-in exploration wells on fallow acreage outperform regular joint-venture-funded wells by a significant margin.”
Jim Hannon, founding partner of the consultancy, said drilling in the past 2 years “exceeds the 50 or so wells per year that are necessary to adequately explore and appraise the remaining potential of the UKCS at a reasonable pace.”
According to a Hannon Westwood report, 116 UKCS exploratory and appraisal wells drilled in 2005-06 found an estimated 1.2 billion boe of oil and gas and confirmed through appraisal a further 1.415 billion boe.
The report, Hannon said, showed that exploratory and appraisal drilling in the 2 years under study had “returned to levels not seen since before 1998.” Companies new to the UKCS, he added, “are a real driving force” in the activity.
“At the end of 2006 there were 124 ‘new entrant’ companies holding between them more than 1,200 working interests in UKCS blocks and participating in just over 50% of all E&A wells in 2006,” he said.
Tax issues
While encouraging activity by independent operators, the UK government has increased the supplementary corporate tax to 20% in the past 5 years, leaving producers grumbling about poor fiscal stability and the diminished economic viability of developing risky and expensive fields.
The current corporation tax rate is 50%, and the total tax rate on production from old fields is 75%. The producing industry commented on the fiscal regime in a consultation with the government that closed in September.
Stockley told OGJ that independent operators are seeking lower taxes to accommodate for diminishing discovery size.
“Everyone would like to see corporation tax coming down,” he said. But he conceded that, in comparison with Norway, where costs are 30% higher, the UK is not a high-taxation environment.
Wood Mackenzie’s Gillies said: “The future of Petroleum Revenue Tax (PRT), which applies to fields that had development approval before 1993, is an issue for the industry. By 2020 it is likely that PRT will become a negative tax to the government due to the anticipated high levels of decommissioning around this time.
“It’s currently a 50% revenue tax, and any PRT losses generated through decommissioning can be carried back against previous years’ PRT profits to generate a PRT repayment. A change to PRT could mean that some companies will gain and others will lose out due to the nature and age of the fields in their portfolios.”
Stockley stressed: “Some individuals are making cases for a different tax regime for gas projects because of the volatility in gas prices, which are not comparable with oil.” Low gas prices, increased production costs, and uncertainties threaten to curb development in the UK North Sea’s Southern Gas basin. Gas prices have slumped because of a surplus of gas since the winter of 2005-06.
Wood Mackenzie has estimated that 15 exploration wells targeting gas will be drilled in 2007, compared with 23 last year. The reasons: low gas prices and lower perceived prospectivity in the Southern Gas basin.
Soaring costs
Rising costs and equipment shortages, meanwhile, have hit independent producers on the UKCS.
David Smith, of Celerant Consulting, noted that independent producers typically operate more efficiently than major international oil companies (IOCs) do.
“Many IOCs have responded to cost by out-sourcing,” he said. “Sometimes this saves them money, and at other times they lose control and cost increases. But with smaller companies this is not always an option.”
Mike Wagstaff, chief executive of Venture Production, Aberdeen, has criticized contractors for what he sees as inefficiency manifest in low margins at a time of high prices. He has called for producers and contractors to “rip up the way they do things,” saying, “The net unit cost in the Gulf of Mexico is lower, and contractors there make bigger margins.”
Celerant’s Smith pointed to low productivity of offshore workers resulting from poor project planning. On a typical 12-hr work shift, only 3-4 hr is usually productive, Smith told OGJ. The rest of the time is spent waiting for equipment or permits.
Skills shortage
Also raising costs are the salaries companies must pay to lure workers into oil and gas jobs to fill a skills shortage not confined to the UKCS. Operators say the problem is jeopardizing projects.
According to Sam Olsen, energy sector strategist at Celerant, small companies understand the importance of recruitment and retention of talent.
“Independents can’t afford the high bills associated with high turnovers, so there needs to be good management,” he said. “With IOCs, staff can be there for 1½ years and leave because they become annoyed, and it is fragmented as they move from one major to another.”
Olsen said independent operators need to adjust their assumptions about the potential of technology to the availability of talented and experienced workers.
“The IOCs can use proprietary technology to develop technologically advanced fields in the world and decrease the manpower needed on them,” he said. “Smaller companies don’t have access to that technology because of cost, and so they need to pull on other levers if they are to have their unique selling point.”
Credit squeeze
The credit squeeze on general financial markets potentially threatens activity by independent producers in the North Sea.
Hannon told OGJ that he believes there will be a shortage of funds with $1-1.2 billion required to drill 40-60 wells/year over the next 10 years.
“Around 40% of that money is already missing from the outset. We’re talking about $400-500 million that companies need to raise,” he said. Farm-ins from larger operators can help ease this, but moving from exploration into appraisal and production drilling requires $17 billion/year, Hannon added. “In the ‘70s and ‘80s, the majors financed these projects themselves, but now they’re leaving. Small companies will need to consolidate to help with finances.”
Steve Mills, senior director of oil and gas projects and export finance at the Royal Bank of Scotland, is confident that the UK oil and gas industry can survive credit difficulty because it has established a good record in delivering oil and gas (OGJ Online, Oct. 1, 2007). He cautioned that it is still early to judge the full impact of the credit squeeze, adding: “I feel the banks will ride this comfortably because it is long term and it’s about regular cash flows.”
