Can UK oil and gas regulator save N. Sea ‘Jurassic Park’ industry from extinction in $60-barrel climate?

Jurassic-rig2By PETER STRACHAN

and ALEX RUSSELL

The recent loss of thousands of North Sea oil jobs has sent an icy chill down the spine of an oil industry whose fortunes were amassed with ease when oil prices were over $100-barrel but whose future now looks as grey as a North Sea swell now that oil stands at around $60-barrel.

Indeed, Brent crude oil prices fell more than 8% on Wall Street to $56.54-barrel on 6 July, albeit mostly in response to market fears about the risk of contagion from Greece voting ‘No’ to the proposed EU bail-out for its sovereign debt.

The loss of confidence in the future of the North Sea oil industry is not surprising. A gloom laden report published in 2014 had forecast that there would be up to 35,000 job losses in the industry by 2019.

Unfortunately this prediction is now well and truly on the way to realisation and in due course may be seen as having been an optimistic view of the dire state of the industry.  

The industry’s decline and possible demise has been brought about, inter alia, through crass neglect by Westminster in its failure to assist engineering aspects of the oil industry, the result of which has been the loss of thousands of jobs to competitor nations such as Korea.

The problem has also been exacerbated by the long term prevalence of poor work practices across the industry, the consequences of which were masked by the high bottom line windfall profits that resulted from high oil prices.

These Jurassic practices were given prominence in 2012 when Oil and Gas UK, PILOT and the Department of Energy and Climate Change (DECC) established a Production Efficiency Task Force (PETF) to address the issues. Indeed, PILOT itself had been established to try to iron out inefficiencies in the industry’s practices.

Everyone is aware that the North Sea oil industry has struggled for years due to an ageing infrastructure, rising costs and little prospect of new large scale field discoveries. Indeed, the creation of PILOT and PETF could be viewed as a rearguard effort to keep the industry alive.

ALEX RUSSELL is Professor of Petroleum Accounting, Robert Gordon University. PETER STRACHAN is Professor of Energy Policy, Robert Gordon University.
ALEX RUSSELL (right)  is Professor of Petroleum Accounting, Robert Gordon University. PETER STRACHAN is Professor of Energy Policy, Robert Gordon University.

There was a brief period of optimism when the Wood Review was published on 14 February 2014 as its Maximising Economic Recovery (MER) recommendations appeared to be a way of generating a spirit of camaraderie throughout the industry and were applauded by Oil and Gas UK.

Wood’s most significant recommendation was that a new Regulator should be established for the industry and industry veteran Andy Samuel has been appointed to lead the newly established Oil and Gas Authority (OGA).

The intention behind the creation of the OGA is that it will be a proactive catalyst in helping to maximise economic recovery (MER) from the rapidly depleting North Sea oil reserves. The OGA’s proactive capabilities stem from the radical powers that are vested in the post of Regulator.

For example, the OGA can compel North Sea Operators to reveal details of their future activities so that the Regulator can assess how these plans might impact on adjacent oil plays.

In light of that analysis the Regulator can force Operators to act in a way that maximises economic outcomes across the whole sector rather than just in their own area of interest. Under certain conditions drilling licences can be withdrawn from operators.  

This all sounds nice in theory but in practice it is at odds with basic free market principles where companies have the right to act in the interests of their own shareholders. Perhaps that is why compulsion is at the heart of the new idea, but compulsion seldom leads to fruitful outcomes.

The idea of N Sea operators sacrificing some of their profits for the good of others is an oil pipe dream divorced from reality.

Some more substantial mechanism needs to be put in place to safeguard the industry. The flaws in the current rationale for setting up the OGA are not hard to find.   

First, the Wood Review’s recommendations were pertinent to the situation that existed when the price of a barrel of Brent Crude was $114; no one envisaged oil falling to around $65 a barrel so soon after the publication of the Wood Review. Further, the forecast data that assisted the analysis were provided by Oil and Gas UK and DECC dating back to 2012, and are now only of historical relevance in assessing the inadequacy of such data.

Fatally, in assessing the views of parties on the way forward, no lawyers that represent Operators were consulted on the legal implications of the Regulator having the right to intervene in the commercial decision-making of those Operators.

Is there a case for revisiting the Wood Review’s recommendations? Such a review would start by defining what is meant by maximising economic recovery as that was a material omission from the original review.

Second, the North Sea oil industry is an industry historically characterised by a desire to conceal information of any commercial value.

In an end-game situation – such as the final rounds of a world heavy weight boxing bout, rather than revealing the final telling tactics – the boxers will at first do their utmost to mislead his opponent and only in the final round strive for a knockout punch.

In the case of the North Sea oil industry, the knockout punch could be a takeover of a competitor with better assets, or the sale of assets to that competitor at an inflated price.

Co-operation amongst operators is as likely as the boxers hugging each other in the final round and raising their chins to give the opponent a better target.

Thirdly, one of the game changing tactics that the UK Government could have employed has been, unbelievingly, thrown away in a moment of madness.

There are enormous costs to be incurred when the North Sea oil industry tries to clear away the debris that litters the North Sea. A modest estimate of those costs would be £70 billion.

In order to encourage Operators to stay the course in the North Sea before entering the final decommissioning phase it was indeed sound tactics to offer assistance from the Government to help with those costs.

But it beggars belief that Westminster have agreed that the UK taxpayers should pay 50% of those costs without first contractually tying down the operators to a requirement to extract a specified percentage of the viable reserves in their licence areas.

The decommissioning ace up the Westminster sleeve has been used to trump a deuce and is no longer available to be played by the effete OGA.  

Fourth, the delay in getting the OGA up and running has weakened its hand. The industry is focused on retrenching and minimising future losses. The outside view is that the time for seeking the efficiencies necessary to save the industry has passed. That view can and should be challenged but is the OGA really the answer to the industry’s problems?

Finally, the remit of the OGA is to seek efficiencies throughout the industry. Offshore workers’ salaries have been slashed and their working conditions changed which means they work longer for less pay. Yet, the salaries paid to the directors of the OGA are high by anyone’s standards.

Is the message to operators from the paymasters of the OGA: “Do as I say but not as I pay”?

Some of the work previously done by the Department of Energy (DECC) is now being done by the OGA. Indeed, OGA is sponsored by DECC.  Those directors who currently chair committees in the OGA would, in all probability, now be chairing similar committees in DECC in the absence of the OGA. Has the OGA simply been an expensive exercise in rearranging the DECC Chairs in a titanic effort to try to save the North Sea oil industry?

There is a viable alternative to Wood and OGA.

Over 90% of remaining reserves of oil and gas in the North Sea lie in Scottish waters.

The Smith Commission’s recommendations relating to devolution of powers to Holyrood are derisible and a million miles removed from the promises made by Clegg, Brown and Cameron (the main UK political party leaders) prior to Scotland’s Independence referendum.

It may well have been better for Holyrood to stick with the powers they already possessed and to play a waiting game but the political reality of situation left little alternative other than accept those powers.

But it would have been so much better for Smith to have delivered real power to Holyrood by recommending devolution of full fiscal control of all economic activity in Scottish land and offshore territory.

Holyrood is far better positioned to make the right decisions that affect Scottish economic activity than Westminster. Such devolution has the real potential to save the North Sea Oil Industry.

The tax scaremongering from unionists should not be allowed to lead to the early demise of North Sea oil.

ALEX RUSSELL is Professor of Petroleum Accounting, Robert Gordon University and Chairman of the Oil Industry Finance Association. PETER STRACHAN is Professor of Energy Policy, Robert Gordon University.

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