Background

Grosvenor Clive & Stokes is a specialist international executive search and advisory services firm with a long heritage in the energy sector. For over fifty years we have worked across the Oil & Gas value chain and in the Power, Renewables and Nuclear sectors for developers, E&P companies, power generators and utilities. Our involvement across the development lifecycle, from initial fund raising to project development and operations, gives us a unique insight into the activities of the industry. This is complemented by a number of our partners who have spent significant parts of their careers in senior roles in the energy business, thereby bringing a wealth of knowledge and experience to the firm.

During the last two decades, we have undertaken many assignments in the North Sea working in the oil and gas upstream arena as well as the power and renewables sectors. Our clients range from multi-national and integrated energy companies to state power utilities and independent oil companies. Our work has included projects to find CEOs and their Leadership Teams as well as Heads and senior managers for all the technical, commercial and support functions.

Over the past few months, Grosvenor Clive & Stokes has sought the views of a broad cross-section of energy industry executives to gauge the impact of the current oil price volatility. This document distils those conversations into a review of the current thinking and takes into account data from other sources including statements from the OGA, industry bodies and commercial analysts.

The Author

Tim Shingler has worked in international Upstream Oil & Gas recruitment since 2003 specialising in senior subsurface and commercial appointments. His clients include a wide range of energy companies from global multinationals to the independent oil producers. He also has a strong relationship with the Oilfield Services industry and the Consulting sector, where he has a particular expertise in recruiting for specialist advisory firms operating in Exploration & Production.

Tim has a truly international network and client base, having worked successfully on assignments in Europe, the Middle East, Asia and Australia as well as in Africa and the FSU.

Prior to his career in executive recruitment, Tim spent many years working in the oil industry, firstly with Shell UK Exploration & Production, then as an oil analyst with James Capel & Co. and latterly as the Director leading the Petroleum Service Group at Arthur Andersen. Tim is a member of the Energy Institute (EI), the Petroleum Exploration Society of Great Britain (PESGB) and the SE Asia Petroleum Exploration Society (SEAPEX).

ths@grosvenorcliveandstokes.com
+44 (0) 7785 772649

Executive Summary

Over the past three months, we have met with and interviewed a number of companies which operate onshore and offshore in the UK, as well as service providers and contractors. The results of those interviews have ben distilled into this report.

Since the publication of our last report in February 2016, the industry has faced the continuing problems of a low oil price and a lack of investor confidence. This has resulted in the need to continue to reduce the cost of operations and overheads with the further loss of staff.

On a more positive note, oil production on the UKCS increased for the second year running. In the March budget, the UK Treasury offered the industry some help with changes to the tax regime. At the same time, the Oil & Gas Authority (OGA) has been encouraging activity with funding for new projects and announcing future licensing rounds.

The other great hope for the future of the highly experienced workforce is that the decommissioning industry comes into its own as platform and infrastructure reaches the end of economic life. This industry is expected to be a multi-billion dollar operation taking decades to complete.

This report not only reviews the issues that have faced the industry in 2016 but also looks ahead at the aspirations and hopes for 2017 and beyond.

Some key points:

• The 2016 Budget lowered taxes for the industry and the OGA believes that the Government take is now below 40% and the Internal Rate of Return (IRR) is 35%
• Exploration and appraisal drilling on UKCS was at its lowest for 50 years according to analysts Wood Mackenzie
• Production levels increased for a second year and should climb again in 2017
• UK efficiency levels improved and, in consequence, offered a more competitive business environment
• New onshore and offshore licencing rounds announced to encourage investment and increase activity
• OPEC production agreement deal settled oil prices in mid US$50s.
• A number of players see the oil price rising to over US$60 in 2017
• Oil price stability and confidence to invest will help the industry in 2017
• M&A market shows signs of significant increase as majors sell down assets and PE funds focus on new opportunities in the upstream sector
• Decommissioning will play an increasingly important role for the industry, offering a new and important segment for international growth

Overview

Since the publication of our last report, “UK Continental Shelf: A Time for Action” in February last year, the industry experienced another year of pain and job losses. The Brent crude price sank below US$28 per barrel before recovering to US$55 per barrel by December 2016. This was a swing of 100% in the year. The biggest problem facing the industry has been the volatility of the oil price and not just the low level. No one will deny that the low price has had a massive adverse impact on the levels of activity and staffing numbers in all companies. It has caused the demise of a number of companies in the region and the laying off of more teams and, in some cases, whole offices.

We believe that the North Sea will be seen as a place to invest by companies from around the world as long as the fiscal regime is kept competitive and the OGA maintains an open door policy for new players to grow.

The Onshore sector is hoping to demonstrate that shale gas is a viable option that can provide long-term security of supply for the nation at sensible rates. The industry is hoping that it can move forward after demonstrating in Court that the objections and dangers of shale gas were false. It is keen to show that this can be done safely and in an environmentally sensitive manner to produce gas for power generation.

Offshore there are a number of projects ready to move forward and provide new sources of oil and gas to assist the economy of the nation as well as maintain the high levels of skilled professionals. The decommissioning of older fields and infrastructure will continue to develop as more and more facilities need removing, thus opening up new opportunities for the creation and development of a new industry.

The current optimism relies upon the global crude price remaining above US$50 per barrel and the confidence of investors and players remaining high. Three specific factors have to be maintained for the oil price to remain at a commercial level:

• Global demand continues to grow
• OPEC maintains its restricted production levels
• North American shale oil does not flood the market

During the last three months, we have interviewed over 20 companies including contractors, service companies, operators and non-operators from the offshore and onshore sectors. It would appear that 2017 is expected to be a better and more productive year. Optimism is certainly on the rise as oil price holds and activity at all levels appears to be increasing. The main issue facing the industry is access to funding. Private Equity funds are looking more favourably on the upstream sector as can be seen from the recent acquisitions funded by them; the banks are expected to follow.

Oil Price

It was another year of misery for the industry as the oil price remained low throughout most of 2016. The Brent crude marker ‘bounced around’ all year on uncertainty and rumour. It was not until late in the year when OPEC and other major producers agreed to cut production that crude oil price began to recover (see Figure 1).

The year started badly with the price dropping to US$27.10 per barrel, a 12 year low, and many saw a catastrophic time ahead. Some pundits predicted that the price would fall below US$20 per barrel. However, by the end of the first quarter the price was hovering around US$40 per barrel. Brent crude then stayed above US$40 for the remainder of the year. In late November, after several false starts, OPEC members agreed to cut production with Saudi Arabia taking most of the reduction. This, combined with an agreement from Russia to keep production at a lower level, pushed the price above US$50 where it remained for the whole of December, recording a high of US$57.99 per barrel.

As the New Year dawned, the market fell again on the fear that North American shale oil producers were increasing production which was nullifying the OPEC cut backs. For the first two months of the year, the oil price has remained between US$54 and US$56 per barrel. This has been the main reason for the rise in confidence in the sector. By late February, some of the banks were suggesting that oil could rise to US$70 per barrel.

From the interviews that we conducted, the oil price was anticipated to be more stable and higher throughout 2017 with many suggesting that US$60 per barrel would be the norm. Platt’s, in a presentation before the OPEC announcement, was predicting a US$65 per barrel by end 2017. The majority of those interviewed believed that the bottom of the cycle had been reached in 2016 and that the future held more promise.

In its annual budget in March, the UK Government announced that Petroleum Revenue Tax (PRT) and Supplementary Duty were being cut, with the new rates being backdated to January 1st. This move would save the industry GBP1 billion over five years according to the Chancellor. The OGA stated that the Government take (after the 2016 budget) had fallen to below 40% and that the Internal Rate of Return (IRR) had risen to 35%. This is considerably better than a number of established competitor nations in NW Europe and internationally according to the OGA.

During our interviews, much was mentioned about the need for incentives for exploration drilling to stimulate activity. Very few saw the Norwegian model as a great success as it funded the drilling of many dry holes. However, if there is a better way to help companies, we believe it should be explored.

Figure 1 – Brent Crude Oil Prices 2016

Due to the de-bundling of oil and gas prices, gas producers have not suffered as much as those reliant on crude sales. Gas prices have also seen a rise throughout 2016 from the lows in April to the highs in December and early 2017. These higher prices were not seen in the winter of 2015/16, see Figure 2 below.

Figure 2 – UK Natural Gas Price Futures 2013 – 2016

Source: www.quandle.com/CHRIS/ICE_M1-UK-UK-Natural-Gas-Tutures-Continyours-Contracts -1-M1-Front-Month

The industry in 2016

Globally, contractors continued to lay-off considerable numbers of staff during the year and typically achieved over 30% cost reductions. This prompted fears about the ability in future to meet the demands of the industry and maintain the core workforce. One senior HR professional stated “…unless lay-offs stop, we will lose the experience and skills needed for the up-turn”. Staffing was also a major issue for the operators and large numbers were let go with some companies losing 40% of the payroll. This had a major adverse impact on the recruitment levels for the next generation. From past experience, we have seen that when graduates are not hired this results in a skills gap for the future.

At the same time as resources were cut back in 2015 and 2016, new well activity suffered a similar fate. A very small number of wells were drilled. According to Wood Mackenzie only 15 Exploration and 7 Appraisal wells were spudded in 2016, this compares to a total of 26 in 2015. The analysts went on to say that this was the lowest level of activity on the UKCS for 50 years. However, 00the OGA predicated an increase in exploration activity in 2017 and 2018.

Companies had been drilling, mainly, commitment wells as obligated by the licence terms. Exploration budgets were savagely cut post 2014 as companies conserved the cash they held. Discretionary spending was at an all time low. The lower oil price had been with us for over two years – “lower for longer” – resulting in the dramatic fall in all aspects of the industry’s activities.

However, the operating costs were brought down to meet the demands of the market. During the year, a number of operators announced that they had been working hard to reduce costs of their operations. This combined with the efforts of the contracting companies meant that the UKCS was a more efficient and cost effective region. This comment is borne out in the OGA’s latest report.

It is believed that costs were reduced by 40% since 2014 with one commentator stating that average cost per barrel on the UKCS was US$16.50 per barrel. This point alone is encouragement for the future. However, there are still fields that are operating at higher costs.

The OGA and the Government were, and still are, trying to support the industry with tax cuts, spending on new projects for industry use and opening up neglected areas for re-examination. There will be new Licensing Rounds in the UK onshore and offshore sectors for mature areas and frontier acreage.

The OGA was established in 2015 and on 1 October 2016 it was converted into a Government company under the ownership of the Secretary of State for Business, Energy, Industry and Strategy (BEIS). The 2016 Energy Act provided the OGA with all the powers it needs to legislate, influence and promote oil and gas in the UK. It is seen by some as coming too late for the North Sea and was a way of privatising the former Department of Energy & Climate Change (DECC) through a levy.

The OGA continues to work hard to help companies by providing advice and reducing the decision timelines. It will also be willing to use its new powers to persuade and encourage operators to meet their licence commitments or penalise them for failure.

However, the problem for some companies was that they had no cash or access to cash to meet these commitments: Some operators were ready to drill but their JV partners were delaying activity due to limited funds, a problem voiced by several operators in the offshore sector. Overall our correspondents thought that the OGA was doing a good job albeit at a higher cost. The hope is that the OGA will grow in stature and salvage a longer life for the UKCS.

In a recent report, Wood Mackenzie demonstrated that the budget changes to the fiscal regime had increased the global appeal of the UK.

It reported that the government’s take had fallen to below 40% whilst the Internal Rate of Return (IRR) had increased to some 35%. Figure 3 below shows a comparison with six other oil producing regions.

Figure 3 – Comparison of UKCS Fiscal Regime with other producing countries

On a further optimistic note, oil production from the UKCS had risen for a second year. And, the OGA predicted that production will rise for the next couple of years due to increased efficiency (some 30% according to OGA) and new fields coming on-stream.

The OGA reported that there was considerably more oil and gas yet to be found (YTF), estimated at around six billion barrels of oil equivalent (boe) in the mature area of the UKCS. Existing oil fields tend to recover only around 50-60% of in-place reserves, thus improved production technology and enhanced oil recovery (EOR) processes could extend the lives of the older fields. The MER UK Forum was set up to bring together the government, the industry and the OGA and deliver a programme of work to maximise economic recovery from the UK Continental Shelf. It has identified EOR as one of the major strategies for the industry going forward.

The Years Ahead

Offshore

One of the encouraging consequences of the price rise towards the end of 2016 is that M&A activity appears to be on the increase. The announcement of the sale of a package of Shell’s North Sea assets to Chrysaor and the purchase of OMV’s UK assets by Siccar Point, are just two of the recent announcements. These acquisitions were both funded by Private Equity companies. This underscores the belief that the UK North Sea continues to have significant value. This is a view echoed by the British oil lobby group in its latest annual report.

Recent press statements, speculate that the assets of French gas utility, Engie UK, and of Danish utility, DONG UK, are both in various stages of negotiation. Additionally, a recommended bid has been made to acquire the whole of Ithaca Energy by the Israeli company, Delek Energy. This is a cash bid and comes just as Ithaca’s Stella field starts production.

Funding is coming from the PE firms which have been waiting for signs of a price increase to help push E&P companies into positive cashflow. Funding has been a major issue for the last couple of years as banks and PE firms have held back from the upstream sector, waiting for a more optimistic market. Wood Mackenzie recently stated that “2017 will be a record year for M&A activity for the UKCS”.

In a similar fashion, many operators will be looking at the UKCS for a last time to see if there are ways to defer the costly decommissioning and abandonment of their offshore infrastructure. Can more hydrocarbons be extracted efficiently and cheaply enough to leave the platforms in place for a longer period? Are there enough new fields coming on-stream in the near future to provide tariff income to delay the inevitable abandonment? UK Oil & Gas believe this to be true and predict some 14 new fields should be confirmed before the end of 2018.

Technology will play an important role in this area as finds get smaller and extraction costs rise again. The GBP180 million funded Oil & Gas Technology Centre in Aberdeen, will play an important role alongside industry to answer some of these questions. The centre was opened in September 2016 as part of the recommendations of the 2014 Wood report and will take on projects to improve drilling, development and decommissioning.

Decommissioning is the sword hanging over the heads of both the operators and the Government. The costs of removing the platforms and infrastructure from the North Sea is estimated by Wood Mackenzie at some GBP53 billion; the government’s share is estimated to be GBP24 billion from Petroleum Revenue tax (PRT). This figure is some 50% higher than the government’s own calculation. Decommissioning is a difficult and costly process but as the final decision on how much has to be removed is still unclear, these figures may change. These costs are said to remove any further tax income to the Government from the UKCS.

As a result of this huge operation, the UK could develop a new global industry offering expertise and skills to decommission infrastructure locally and around the world. The North Sea has some of the largest man-made steel and concrete structures in the world. Removing them will take many years.

The industry will require large numbers of skilled people to safely deconstruct these massive structures in an environmentally sensitive manner.

On the new activity front, exploration drilling is scheduled to rise as the oil price creeps towards US$60 per barrel, providing a boost to optimism and confidence. Operators need to replace the reserves that have been produced and drilling activity is therefore necessary to keep the reserves base growing. New fields, some deferred as prices fell, will be re-evaluated in the lower cost environment. The danger is that the industry allows costs to increase without constantly checking for overruns and delays. This latter area of concern is the subject of the latest OGA report on ‘lessons learnt’.

In our last report, we stressed the need for co-operation and collaboration between parties. There have been incidents of operators working closely together but, alas, little evidence of the operators working closely with contractors. This is one area that came up time and again during our interviews. Bringing contractors on board early to work on projects together can have long-lasting mutually beneficial effects. This is still an area of concern which requires the engagement of management at all levels.

Due to the competitive nature of the business, some believe that a culture change will be required from both the operators and contractors. For the industry to succeed in planning and developing new projects at reduced costs, a real change in working practices will be required.

Onshore

The onshore sector is different from offshore with many more hurdles that have to be overcome before operations can commence. The number of different agencies involved in the onshore sector demand more evidential paperwork and Operators continue to be frustrated by delays in the approval process. These delays have significantly increased the costs of operations, most of which have little to do with the drilling of wells.

Those with onshore assets believe that there needs to be a more realistic approach to the whole process, ensuring that once a licence has been awarded, activity can proceed within a reasonable time and with the necessary regulatory approvals. The costs to onshore companies have risen due to continued enquiries and false accusations about the implications of the ‘fracking’ of wells. This was highlighted in a recent court case against protesters by Third Energy which proved that much of the propaganda being circulated was untrue. The protesters hoped that the longer operations were delayed the greater was the chance that investors would withdraw due to increased costs and cause companies involved in onshore shale gas to cease the search for more gas.

Onshore operators need the opportunity to demonstrate that shale gas is a commercial option to importing gas. This would secure resources for many years ahead. A number of authoritative reports suggest that the UK has decades of production. It has been suggested that rather than invest GBP 1 billion in ‘turning on’ old power stations to keep the lights on, the investment should be in assisting and supporting onshore gas which will be more environmentally friendly for the future of power generation.

In Conclusion

The industry has spent two years coming to terms with lower oil prices as well as the lower rates of increase in world demand for fossil fuels. Many jobs have been lost and companies have reduced costs to meet the demands of the changed business model. At the same time, the government has reduced the tax burden on the industry and improved the fiscal regime. It has also been demonstrated that there are still significant quantities of hydrocarbons remaining to be recovered. And finally, new investment has been forthcoming from PE led teams, as evidenced by the recent acquisitions of large asset bases.

These factors should be enough to revive and sustain a ‘smarter’ industry to develop more of the resources of the UKCS and defer further imports. The decommissioning of some of the UKCS infrastructure may also be delayed by additional discoveries. However, the decommissioning arena will develop and should establish a vibrant new business for the skilled North Sea workforce and be a revenue generator for many years to come.