Outlook for the UKCS in 2006

Expenditure: Exploration and Appraisal, Development and Operations

Rising Cost trends: The survey was taken at a time when development and operating costs are continuing to rise rapidly both in the UK and around the North Sea. The survey is based on the costs and availability of resource assumed at the time companies compiled their plans. However all the signs are that costs are continuing to rise despite the flatting in oil prices. This makes investments more costly and operating costs higher than anticipated when plans were compiled and has the potential to undermine the delivery of companies’ investment plans.

This is reflected in the unit technical costs of new developments where average costs are circa $17 per boe when capital and operating costs are included, discounted at 10%. When exploration and appraisal costs are included, total costs for new oil and gas are now in excess of $20 / boe which emphasises the poor competitive position of the basin if oil prices fall back below $40.

Total Spend: £350 billion has already been spent in the UKCS and, based on existing plans, it is projected that a further £42 billion will be spent before the start of the next decade. The survey shows that investment tails off with time; however capital investment plans tend to concentrate on the next 2-3 three years as companies address current developments.

The oil and gas upstream industry spent nearly 15% more in 2005 than 2004 with a total expenditure of £9.7 billion. This comprised £0.64 billion on exploring for and appraising new discoveries, £4.4 billion capital investment to bring new production on stream and £4.7 billion to enable recovery from existing fields.

Figure 31: UKCS Expenditure Forecasts 2003-10

The main driver of the increase in total spending was Capital Investment (Capex) of £4.4 billion. This represented a 30% increase in spending on wells (excluding E&A) and other field development activities, and due to the near term outlook in oil prices, Capex is expected to be maintained at this level in 2006. Current projections of capital investment fall off rapidly over the decade demonstrating the challenge if investment is to be sustained at current levels.

Figure 32: UKCS Capital Expenditure Forecasts 2003-08

Oil price hurdles used by many companies as a basis for investment decisions have risen over the last year, in part in response to current oil prices. This has increased the volume of reserves that are economically viable to develop; in response, the number of development wells drilled rose by 37% from 166 to 227 between 2004 and 2005. It is anticipated that a similar number of wells should be drilled in 2006, although this may be constrained by competition for the limited number of drilling rigs available in the North Sea.

Figure 33: UKCS Drilling: Development Wells 1999-2006

Also reflected in the increase in capital expenditure is the higher cost of development drilling; it is in direct competition with E&A activity to secure rig slots for which daily rates have soared – this will be explored further below. To alleviate the tightness of the UKCS rig market, there is evidence that platform rigs are being re-commissioned, a very expensive process in itself. Increasingly, companies are pursuing more marginal projects, in part responding to the forward oil curve. The recently increased tax rate could reverse this effect though as economically marginal projects become less viable, especially if the oil price falls from the level seen in 2005/6.

Exploration and appraisal activity has continued to increase over recent years with 78 E&A wells drilled in 2005, a 25% increase on the 63 drilled in 2004. Projections suggest that this upward trend will continue into 2006 and beyond, encouraged both by the PILOT initiatives as well as the current high oil price. In particular, the trend is that exploration wells will comprise a larger proportion of the total, implying that in future more appraising will take place which should yield greater reserves.

Figure 34: UKCS Drilling: Exploration and Appraisal Wells 1999-2006

Despite these encouraging projections, several factors are liable to constrain E&A activity in the coming years. Note should be taken that a fifth of exploration activity aspirations are accounted for by Promote licensees, many of whom have made commitments to drill but have yet to secure rig slots.

Figure 35: UKCS Reported Discoveries 1993-2005

Despite the increase in drilling activity in 2005/6 it should be remembered that previous experience has shown that higher levels of drilling have usually produced poorer success rates overall:

• Rising oil price has increased the proportion of finds which are commercially attractive to develop
• Only 4 wells have discovered over 100 million boe pools over the last decade
• Overall exploration has been showing a success rate of between 25% and 33%
• Against the better success rate this means exploration wells are recently delivering on average ~ 10 million boe per well or ~ 30 million boe/discovery
• It is clear that there is no “right” drilling rate. Even if the UK is to deliver 6+ billion boe from exploration, it could take 20 years or more.

The 23rd licensing round in 2005 saw a record 152 licenses awarded (76 Promote licenses, 6 Frontier and 70 Traditional). It attracted 24 new entrants to the UKCS and included 69 blocks previously released from earlier licenses under the DTI’s ‘fallow blocks and discoveries’ initiative.

The licensing activity was stimulated by recent high oil prices which have increased the potential rewards of successful exploration. Of particular note is licensing activity in areas previously less explored such as the Mid North Sea High, Moray Firth, East Shetland Platform and the Atlantic Margin as well as renewed focus on the extraction of heavy oil. Even with the potential rewards that exploration success might yield, these blocks are still regarded as high risk domains where there is heightened sensitivity to the cost, resource and investment environment.

E&A activity is competing for rig slots with development and production drilling; any projections of an upward trend of E&A wells in 2006/7 must reflect a measure of aspiration. Market capacity will only allow operators to drill a similar level of wells going forward as in 2004 and 2005, with rig utilisation already at 100% for jack-ups and 90% for semi-submersibles. There is potential for the rig market to become even tighter and act as a bigger constraint on activity if rigs are attracted away from the UKCS to other basins which offer a more attractive proposition.

Figure 36: UKCS Rig Utilisation 2003-06

While rig availability could prove to be a material constraint on E&A activity, the soaring rig rates may yet prove to have a bigger impact. Rig rates continue to rise. Semi-submersibles have shown the most dramatic increase, rising six-fold since the start of 2004, with jack-ups rig rates rising by three-to-four-fold over the same period.

Figure 37: UKCS Rig Day Rates 2003-06

Operating expenditure to enable recovery from existing fields remained flat at £4.7 billion but given the 8% production decline, unit operating costs (UOC) increased. In 2004 it cost £3.7 per barrel to produce a barrel of oil or gas equivalent (disregarding initial finding and development costs) but this rose to £4 per barrel in 2005, an increase of 8%.

Typically, the lowest unit operating costs have been in the Southern Gas Basin (together with lower revenue) but this advantage is being gradually eroded. This is worrying because a third of UKCS gas is still produced from the Southern Gas Basin and projects that are already marginal in economic and technical terms appear to be getting more expensive.

Figure 38: UKCS Unit Operating Cost 2003-10

Despite the more positive production outlook for 2006 and 2007, UOCs are projected to be higher than was thought in the 2004 Activity Survey, reflecting the increasing cost of maintaining ageing assets and recent decline in production.

To ensure the industry can take advantage of investment opportunities that continue to present themselves in the UKCS, there is continued investment in long-term asset integrity and maintenance. This is a significant cost in such a mature basin.