Foreword

The UK ranks high in the global league of oil and gas producers. In 2004, we produced 1.3 billion barrels of oil and gas from the UK Continental Shelf, sufficient to provide over 80% of the nation’s total energy needs. This year the industry will spend over £9 billion to explore, develop and produce our oil and gas resources and will provide employment for over a quarter of a million people in the UK. In 2004 we paid over £5 billion in direct taxation. This will rise to around £7 billion in 2005 as a result of the increase in oil and gas prices and the changes announced in the budget in April 2005.

The offshore oil and gas sector is the largest single industrial investor in the UK economy and accounted for 2.5% of total Gross Value Added in the whole economy. Investment is seen to be rising sharply, drilling rigs are fully committed and the production outlook has improved for the first time in several years.

Against this positive picture, operating costs continue to rise as production is declining. Operating costs per barrel of oil or gas rose by 13% in 2004 and UKOOA surveys show a step increase in operating costs which are around £500 million per year higher over the next few years than previously forecast. In part this arises from the need to extend the life of ageing assets and infrastructure, which will enhance the longevity of the UKCS. However, environmental and regulatory costs are increasing and there are signs that this could reduce the rate of new developments.

Oil price rose substantially during 2004 with average crude prices of $38, some 30% higher than in the previous year. Brent crude rose to over $50 by October 2004 and has remained highly volatile since then. Sterling oil prices saw a similar rise last year; however the 25% decline in the value of the dollar over the last 5 years has shielded the UK from the full impact of the rise in oil prices. Indeed, when inflation is taken into account, average Sterling oil price in 2004 was less than 5% higher than in 2000.

UK gas consumption has risen by 50% in the last 10 years and gas is now used to generate 40% of the nation’s electricity. This rapid switch to gas has been good for the environment and will enable the UK to meet its Kyoto commitment to reduce greenhouse gas emissions by 12.5% by 2010 from 1990.

For the first time in a decade, gas imports marginally exceeded gas exports in 2004. Whilst UK gas production has continued to decline in line with previous projections it will meet much of the UK’s gas needs for many years to come. In 2010 we will still provide 60% of total UK gas demand. Gas prices in the UK have continued to rise, driven up on the back of higher oil prices and a tighter supply-demand picture. To meet the growing demand for imported gas, massive new investment, measured in the tens of billions of pounds, is currently being made to bring new gas supplies to the UK both via pipeline and via tankers as LNG (Liquid Natural Gas).

The Tale of Two Possible Futures

To date, 34 billion barrels of oil and gas (boe) have been produced from the UKCS and it is estimated that there is future potential of up to 28 billion boe. Meanwhile oil and gas demand continues to grow. Annual investment of £4 billion per year in exploration, incremental projects and new field developments is halving the rate of production decline in the UKCS, from what it would otherwise be, to around 7% per annum. However, it is getting harder to find and more costly to produce these new reserves. The challenge is to maintain the attractiveness of the UK as an oil and gas province in the face of global competition.

Figure 1: A Tale of Two Possible Futures - Future production from the UKCS

Our industry has two possible futures in the UK. One is bright. A period of fiscal stability and good regulation results in sustained investment to 2020 and beyond. The new fields and improved infrastructure create wealth and support the UK economy, the balance of trade, tax revenues and many thousands of jobs for decades to come. The other future is bleak. International competitiveness and investor confidence are destroyed by more tax hits, poor regulation and escalating costs. By 2020 the industry is a spent force; much of the infrastructure is decommissioned resulting in billions of barrels of reserves remaining in the ground, never to be recovered.

If we continue to build on current success, the UK could still be a significant producer in 2020, producing 1.5 – 2 million barrels of oil and gas per day. Decommissioning could be delayed 10 years and we could still be supplying nearly half of the total UK oil and gas needs in 2020. If we fail to attract the investment then, by 2020 the UK will be producing less than 0.5 million barrels of oil and gas per day, around 40% of our offshore platforms and infrastructure will be decommissioned and we will be importing 90% of our oil and gas requirements at a cost of £30 billion in imports.

Which future is realised depends on the stewardship of these resources. The oil and gas industry, government and the workforce have a shared responsibility for this. If the UK remains competitive, oil and gas companies will continue to deliver sustained investment on a huge scale. UKOOA members, together with their contractors and the workforce, must continue to apply new technology and ever safer, more efficient and environmentally sensitive ways of working.

Equally importantly, government, both UK and European, must avoid the temptation to impose extra taxes on its oil and gas producers. Tax shocks will result in less inward investment, less production and a smaller overall tax take. Government also needs to regulate for good and enlightened stewardship. UK oil and gas producers do not seek subsidies or handouts. Sustainable development is in the best interest of society. We need light and well founded regulation to achieve that end. We benefit from an engaged, skilled and dedicated workforce. If we each properly discharge our stewardship responsibilities, there will be thousands of good jobs for generations to come, and the UK will be strengthened as a global centre of expertise.

To extend the productive life of the UKCS we must now address the costs of decommissioning, currently estimated at £15 – 19 billion and confront the technical, commercial and fiscal uncertainties. The industry is preparing a standard decommissioning agreement to facilitate sale and purchase of oil and gas fields to encourage asset trading and is working with the supply chain and government to reduce the technical costs and ensure clarity on the environmental obligations. We also need to ensure there is certainty on the future fiscal treatment of decommissioning costs to continue to attract new investment. If we are successful we will delay the onset of decommissioning by ten years or more for many fields.

Together we can achieve the bright future. Industry enjoys a good and open dialogue with government. In that regard, it was encouraging to hear the then Economic Secretary to the Treasury in March reject the argument for windfall taxes on our industry. Ground-breaking PILOT projects are changing the way we do business. There is now improved access to exploration data; quicker and easier entry to pipelines; faster release of acreage and discoveries to those wishing to work on them; less bureaucracy and sharper focus on the stewardship of assets to support investment in and around mature fields. These initiatives help those who are ready to invest to get on with the job. There are many companies, both established players and new entrants, willing to do just that. Over 120 companies are now active in the UK, almost double the number in 1990. More than 30 new entrants have invested in UK production since 2000. New entrants since 1999, accounted for more than 25 percent of total capital expenditure in 2004. 2005 began with 20 new exploration and appraisal wells in the first quarter and last year saw 63 such wells drilled, the highest number for six years.

Signs of hope are certainly present, but the future must not be taken for granted. The UK is a mature oil province. It needs careful, far-sighted stewardship for the long term. Loss of investment, rising costs or the wrong fiscal or regulatory moves could each stop this industry dead in its tracks. History will not judge us well if that happens. This Economic Report demonstrates the size of the opportunity and UKOOA urges all stakeholders to work together as good stewards for the better future.

Malcolm Webb
Chief Executive
UK Offshore Operators Association