Challenges for oil & gas

The UK oil and gas industry remains the country’s largest industrial investor, but faces major challenges to maintain its potential to deliver significant wealth over the coming decades, writes Mike Scott

There have been few times in recent history when the oil and gas industry has not been at the centre of the global geo-political landscape – and 2014 is no exception.

The Russian annexation of Crimea and continued instability in Ukraine has heightened Europe’s awareness of its reliance on Russia’s gas, while it faces a different threat from the other side of the Atlantic in the form of a competitive disadvantage caused by the United States’ shale gas revolution, which has slashed North American gas prices.

Although the situation is currently calm in the major Middle Eastern production areas, unrest on the fringes of the region, in Syria, Egypt, Libya and Turkey, is among factors that have kept the global oil price above $100 a barrel for a prolonged period. Strong demand from emerging markets has been another factor. The high oil price has a double impact in Europe because gas prices are for the most part index-linked to the oil price.

In addition, most of the world’s oil reserves are now known and in the hands of national oil companies, leaving the Western oil companies to explore ever-more problematic resources either in terms of their remote and difficult conditions (such as the Arctic), technically challenging (such as Brazil’s pre-salt reserves, Kazakhstan’s Kashagan project, or even shale gas and oil) or politically volatile (Iraq). This means that finding and exploiting new reserves is becoming more challenging and more expensive.

At the same time, the industry faces a new challenge in the form of the increasingly certain evidence that fossil fuels are a major contributor to climate change, meaning that companies are coming under pressure from investors, governments and consumers to be aware of and reduce the environmental impacts of their operations, which is also challenging and expensive.

The upstream oil and gas supply chain remains a £35-billion industry with a strong export capability that employs 200,000 people

Closer to home, the North Sea is a mature resource and output is falling significantly from year to year. Mirroring the global trend, much of the oil and gas that is left is remoter and more technologically challenging to exploit, particularly ultra-high pressure high-temperature clusters.

Nonetheless, a study for Oil and Gas UK shows the upstream oil and gas supply chain remains a £35-billion industry with a strong export capability that employs 200,000 people, and that there remains around 24 billion barrels of oil still to be extracted from the North Sea basin. And indeed, there has been significant investment in the UK Continental Shelf in recent years, with inflows increasing from £11.4 billion in 2012 to £14.4 billion in 2013 and a further £13 billion foreseen this year, according to Oil & Gas UK’s Activity Survey 2014.

But as well as identifying the significant opportunities for the UK industry – the UK is a recognised world leader in offshore oil and gas developments, with the expertise developed providing a competitive advantage for UK companies competing internationally, the survey says – it also identifies a number of threats, notably the difficulty of attracting and retaining skilled workers, and a lack of policy consistency that has seen the Chancellor of the Exchequer impose windfall taxes one year followed by tax breaks a year later.

Malcolm Webb, chief executive of Oil & Gas UK, says: “It is increasingly obvious that the offshore oil and gas fiscal regime has become overly complex, burdensome and uncompetitive. The industry faces marginal tax rates of 62 per cent – 81 per cent on oil and gas production – which are unsustainable in a mature basin.” The industry needs “a simpler regime more attuned to the industry’s challenges and better able to secure international investment in the many, varied opportunities that remain”.

According to Alex Milward, oil and gas advisory partner at EY, there are significant opportunities facing the UK oilfield services industry, but also barriers that must be overcome if growth is to be sustained in the sector. “Crucially, the attractiveness of the UK as a place to do business must be maximised. Steps must also be taken to realise domestic and international demand for oilfield services, and to promote the industry to new talent,” he says.

Another mirror of global trends is the climate of political uncertainty. In the UK’s case this is created by the forthcoming Scottish independence referendum, which has raised concerns for some in the sector, although any upheaval would be relatively minor compared to the risks that pertain in other markets.

Meanwhile, the industry has welcomed publication of the Wood Review of the future of the North Sea oil and gas industry, and the government’s acceptance of its recommendations, which include plans for a new allowance to encourage investment in ultra-high-pressure high-temperature (u-HPHT) oil and gas field clusters, that it is estimated could attract an extra £5 billion to £6 billion of investment to the North Sea.

Sir Ian Wood, the review’s author, says: “The UK offshore oil and gas industry has made an immeasurable and vastly under-estimated contribution to the UK economy over the past 50 years. This review provides the opportunity for it to face its next 30 years and beyond.”