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    Low Prices Hammer UK Offshore Projects


The UK upstream is vulnerable to the low oil and gas price environment: investors will have little choice but to defer or cancel contracts.

by: William Powell

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Low Prices Hammer UK Offshore Projects

This year's crash in oil and gas prices – the most dramatic in almost 30 years, with Brent crude trading below $27/barrel March 18 – has dealt a serious blow to the UK’s exploration and production sector.

The industry group Oil & Gas UK (OGUK) said March 19 that some offshore jobs have already been cut as operators rein in spending, and it is contemplating a return to the dismal drilling figures of 2015.

Its latest Economic Outlook warns of discretionary spending cuts, contract cancellations, and further bankruptcies among companies operating on the UK Continental Shelf (UKCS). The supply chain has already done what it can to keep operating unit costs down, following the last crash in 2014. So it is now "paper-thin," says OGUK CEO Deirdre Michie. The report says that the investments of almost £5.5 ($6.2)bn in the last three years would struggle to reach £4.5bn this year. Inevitably there will be many redundancies.

OGUK had expected the number of wells drilled to be in a similar range as in 2019; however based on recent experience, it is conceivable that this could be down more than a third, repeating the cuts seen in 2015-16 when activity slumped to a record low. This drilling reduction will also impact future production and revenue growth in the short term as projects are allowed to stagnate.

OGUK has called for government support with a sector deal so that the sector can continue to provide security of supply. The body also said it was working with industry, regulators and government to understand how it can protect supply chain companies, and jobs. In each of the last two years the upstream has paid £1.1 ($1.26)bn in taxes which might provide some leverage in talks.

Michie said: “The offshore oil and gas sector is part of the UK’s critical infrastructure, providing the secure and affordable energy the country needs and is a key contributor to the economy in terms of supporting hundreds of thousands of skilled jobs, businesses and our wider economic contribution.” 

The UK produced almost 1.7mn barrels of oil equivalent/day last year, a fifth more than in 2014. This was 51% of gas demand and 74% of demand for oil products. But OGUK estimates that UKCS production revenue, which exceeded £28bn in 2018, could be half that this year for the same output. 

OGUK market intelligence manager Ross Dornan said the UKCS could operate at a loss this year; for revenues to equal expenditures, oil would have to cost at least $40/barrel and gas 25 p/therm. But that is unlikely.

“The UKCS has seen significant improvement in its competitiveness, efficiency and productivity in recent years. These improvements will help performance; however in this harsh environment we expect companies to take significant steps to preserve cash flow and ensure business continuity. This will have a very negative impact on the supply chain, which has not yet seen much recovery from the previous downturn and doesn’t have the capacity to absorb much more pain,” the report says.

Large companies could possibly hedge their exposure to oil and gas by moving into other energy sectors but the smaller ones will need to find innovative solutions if they are to survive. “Partnerships and meaningful collaboration will be required to help as many as possible to weather the storm,” he said.

Serious questions

The government has an interest in supporting the upstream, as it represents a vital part of the UK’s security of supply. It will also be critical as the UK moves towards a net-zero carbon future, the report says. The upstream has a role to play in facilitating the hydrogen economy through carbon capture and storage and gas production, for example. Any loss of capabilities will make it harder to provide the solutions that the UK and the world will need, it said. 

There is still significant resource opportunity to unlock, with 6.6bn boe in company plans through to 2035, as well as further additions through recent exploration successes. However, in the current environment very few projects will receive investment approval, until companies have a clearer understanding of the longer term market dynamics. There are more than 2bn boe in company plans without committed investment.

Norwegian consultancy Rystad Energy estimates that, at a global level, total oilfield services revenues could fall by 8% if Brent averages $40/b, or 15% if prices fall to an average of $30/b. A longer period of lower prices will also cause a negative impact on revenues in 2021. 

The upstream has improved its competitiveness, efficiency and productivity in recent years but the industry remains significantly challenged on a number of fronts. Across the UKCS overall, unit operating costs (UOCs) averaged $15.2/boe (£12.50) in 2019. This compares with 2014 when average UOCs were $32/boe (£20/boe). OGUK estimates that around 85% of assets which produced at least 1mn boe last year have UOCs under $40/boe, compared with two-thirds in 2014.

The highest-cost asset in this group is now around $64/boe, compared with more than $100/boe in 2014. The improved cost profile has been achieved through reductions in operating expenditure and increased production: last year the UK industry produced 20% more, and at a 30% lower cost than in 2014.