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Opinion: The North Sea isn’t dying, just having a midlife crisis

Mark Routh, chief executive of Independent Oil and Gas
Mark Routh, chief executive of Independent Oil and Gas

Next year will mark 50 years since first gas at West Sole, the UK North Sea’s first producing field. Since oil prices crashed in 2014, however, pessimism has descended upon the industry like a thick North Sea fog, obscuring five decades of achievement. The 2004-14 boom decade left a legacy of unsustainably high costs, followed by painful restructurings and even outright bankruptcies. UK production levels have fallen over 60% since the peak, investment levels and tax receipts even further, and 120,000 jobs have been lost. 2016 will be the fourth consecutive cash flow negative year, severely curtailing new exploration and development activity. Little wonder the North Sea is widely seen as a busted flush, condemned to a grim future of costly decommissioning.

But the pendulum of pessimism may have swung too far. Beneath the gloomy surface, new approaches and progressive ideas are pointing the way forward. Here are the eight key characteristics of this new North Sea:

Leaner management: Key pitfalls for North Sea companies included financial overleveraging, cost control, partner misalignment, corporate over-complexity and slow decision-making. Nonetheless, the industry has been profitable before at these prices and there’s no reason why it can’t be again. Overheads and operating costs have already fallen hard. Average lifting costs are on course to drop by 45% to $16 per barrel of oil equivalent since 2014, reducing exposure to oil market fluctuations. This is already giving many assets another lease of life. At larger firms, digitisation, automation and standardisation learnings are also being adopted from other industries to drive down costs.

Collaborative partnerships: Traditionally, upstream operators sat across the negotiating table from the service sector – the oilfield service and management companies, drilling contractors and equipment providers. This zero-sum game ultimately reduced returns on capital and exacerbated cyclicality. Now, new commercial structures are emerging that create partnership and alignment, helping to reduce and spread out capital burdens. This more even distribution of risk and return across project participants fosters a collective focus on operational and financial success. Collaboration is also increasing between operators themselves. Whether operating shared assets or adjacent clusters, this is clearly beneficial – for example sharing vessel capacity or helicopter flights, or co-investing in mutual infrastructure.

Financial innovation: Funding models are evolving similarly. Typically, companies rely on equity raises, farm-outs and reserve-based bank lending. Pre-crash, bonds became fashionable, layering them over existing bank debt brought increased vulnerability and sometimes fatal consequences for smaller, less diversified operators. Looking ahead however, offtaker, receivables and contractor financings may well become more common. When these other participants in the value chain step into the financing role, taking more direct risk, this further encourages co-operation, improves the likelihood of successful operations, and reduces excessive dependence on banks and capital markets.

Efficiency strategies: There is renewed focus on optimising existing production: uptime at offshore installations has rebounded above 70%, from only 60% in 2012. Meanwhile, over 350 undeveloped North Sea discoveries still remain. Extracting these discoveries successfully will generally require the hub strategy, which leverages common infrastructure to turn stranded or marginal assets into cost-efficient clusters. This creates a unique opportunity for companies which are focused and successfully executing on the hub strategy. Capturing these economies of scale can then de-risk nearby activity, increasing overall production. Hubs can be also be vertical, i.e. targeting different horizons in a productive location. This is ideal for mature basins where technological progress can unlock overlooked discoveries and undrilled prospects. It’s also more reliable than expensive exploration in high-risk areas.

Recycling & recommissioning: Used assets and infrastructure can remain potentially very valuable. There are over 200 platforms and 3000 pipelines in the North Sea. If they can be refurbished to the required integrity and safety standards, these can be cost-effective for new projects particularly in cash-strapped times.

Regulatory engagement: The relatively new UK Oil & Gas Authority is changing the culture of industry oversight. Regulation is being defined not as mere rule enforcement, but proactive stewardship and creative enablement. The OGA is playing the important role of joining the dots between discrete operators. Its founding principle of Maximising Economic Recovery should breathe new life into mature areas and create new opportunities for agile companies.

Gas focus: Among the 20 billion barrels of oil equivalent potentially left in the North Sea there are up to nine trillion cubic feet of gas resources. Gas has a strong future – the UK will continue to be very reliant on it for power, heating and industry. While oil prices have flatlined, UK gas prices have rebounded recently. A 50% decline in domestic gas production since 2005 has steadily increased the share of imported gas, which comes by pipeline or LNG from Qatar, Russia, Norway and now even the US. These imports cost more, bring no tax revenue and have a greater environmental footprint. The national debate on Hinkley has highlighted serious cost and reliability issues with nuclear, while coal is being phased out and onshore shale gas faces enormous popular resistance. For UK energy security, then, maximising North Sea gas resources makes overwhelming sense, reducing imports and relieving the current account burden. Environmentally, to ignore domestic gas would simply make perfect the enemy of good. Alongside growing renewable investments, replacing dirty coal with much cleaner gas helps reduce emissions, as seen in the US.

Portfolio optimisation: To stimulate investment and maximise output, it’s vital to get assets in the right hands. Big developments need major company budgets, while smaller independents are best suited to manage declining fields. The two main hurdles to asset transfers have been buyer-seller valuation differences and decommissioning liabilities. Recent deals have often seen distressed sellers or opportunistic buyers. Oil prices stabilising around $45-55/barrel should align price expectations and bolster deal flow.

They say you should never waste a good downturn. And indeed, a recovery of sorts is now emerging, reoriented towards lower costs, clearer goals, greater efficiency and closer collaboration. The past two years may yet be merely the North Sea’s midlife crisis. Based on these eight principles, there could still be many fruitful years ahead.

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