The Wood Review: Welcome Step Forward But Is It Enough?

The Wood Review: Welcome Step Forward But Is It Enough?

2nd December 2014

On 10th July 2013, Edward Davey MP, UK Secretary of State for Energy and Climate Change, announced a review of UK offshore oil and gas recovery and its regulation.  The review was led by Sir Ian Wood.  The final report was published on 24th February 2014 with its findings being largely welcomed by the industry and enthusiastically adopted by government.

Based on the Wood Review, and upon information published by DECC, industry experience and observations of recent trends and developments within the industry, GCA has reviewed the prognosis for the UK North Sea.  

From this review GCA has concluded that, despite the warm welcome, there is a significant risk that the major focus on the new Regulator will distract attention from the more fundamental and urgent needs and as a result, the Wood Review alone may not be sufficient.  

An analysis of the current state of UK North Sea production from DECC published figures as at the end of 2013 indicates that the proportion of fields that are reaching the end of economic life is growing. 

Extending this analysis using a rate vs cumulative production basis for the producing oilfields indicates the likely trajectory of oil production in a “no investment” case. 

Aggregating the forecast at a production-hub level also indicates that many of the 48 hubs will be reaching unsustainable levels of production in the next 4 to 5 years even at US$ 100 per Bbl.  

At present the average unit Opex cost is around US$29/bbl, according to Oil and Gas UK, and GCA analysis indicates that this will rapidly increase to an unsustainable level in the face of declining production.  Some rationalisation of infrastructure is inevitable, and if done correctly would allow unit Opex costs to be stabilised in the region of US$30 to 35 per Bbl.

In attempting to assess what the future may hold, GCA has reviewed current developments and considered DECC expectations on the potential for EOR and IOR, which identifies up to 6 billion Bbl of incremental oil that could be produced by a variety of techniques.  The sheer scale of the investment for such incremental oil is huge, at a time when costs have been increasing and oil prices dropping. 

Even ignoring the cost and capability to construct and install such incremental infrastructure, there are numerous underlying macro-challenges to overcome.

The large number of changes to the UK fiscal regime since 2002, and the perceived punitive nature of many of these, has meant that the UK is no longer regarded as an attractive environment for investment dollars, affecting both exploration as well as development decisions.  All of this comes with little benefit in tax income: currently RFCT, SC, PRT contribute less than 1% of total UK tax take.

The fiscal system has a great deal of complexity and while recent changes have been aimed at allowances which reduce the burden of tax for certain types of fields this has been against a background of increases in the Supplementary Charge, increasing the marginal tax rates to 81% for production systems subject to PRT and 62% for non-PRT fields.  Overall, the recent history has been one of increasing taxation and fiscal complexity which limits the appeal of the UK to investors.

As to the Wood Review itself, the report contains much relevant analysis and a number of strategies and specific actions.  The thrust of the report is to create a new regulator with a brief which far exceeds that of that held by DECC, and with powers to drive cooperation between industry and the Treasury.  There are some important aspects which many observers have identified.

Although mentioned in the report there are two aspects that GCA considers has not received enough attention.

The first element is that the UK is competing for investment worldwide.  Even a regulator with enhanced powers is unlikely to be able to force investment if it is not in the interests of the investor. 

Secondly, the report seems to assume that the oil companies will be responsible for the maintenance on existing infrastructure.  Other beneficial approaches taken, such as in the Gulf of Mexico, offshore Norway and the Netherlands, whereby other parties (e.g. utility companies) can enter the market as infrastructure operators, has not been considered.

The fundamental issue with opening up infrastructure ownership to service companies is handling of abandonment liability.  The present regime limits tax relief to the operating oil companies who pay PRT, Ring-Fenced Corporation tax and the Supplementary Charge. In addition, liabilities would extend to any such service companies involved in operations.

While the government response to the Wood Review has been swift and the regulator is being put in place at present, the timescale for assembling a new regulator with wider powers is such that significant action is unlikely before 2016/7, and the impact is unlikely to be felt before 2018 at the earliest.  

Furthermore, the uniting concept in the report “Maximising Economic Recovery UK” is an ill-defined concept and masks many conflicting interpretations from different parties.

In light of all these comments, GCA has laid out certain suggestions for achieving a progressive investment environment for the UKCS:

  • Simplify the tax structure.  In this declining phase of production there is little justification for additional taxation when it is hampering exploration and development. 

  • Address allowances that make the system complex and opaque.

  • Introduce a field-level Abandonment Fund that accumulates over time from pre-tax contributions which can be traded between infrastructure operators.  The fund should be audited and cost estimates updated annually.  At present DECC recognises the existence of the sinking fund concept, but taxation rules mean that it is not used.  This would have the effect of removing the shadow of uncovered abandonment costs.

  • Allow tax relief to be crystallised in instruments such as the Decommissioning Relief Deeds, but as tradable instruments that can be included in the Abandonment Fund.  This will allow utility operators to enter the market.

GCA’s opinion is that these actions are the most urgent given the forecast fall in production rates.  It is also the case that such a proposed progressive fiscal regime is not within the remit of either DECC or the new regulator to grant.  The responsibility lies with the Treasury and in that sense the Wood Review alone is not sufficient. 

There is a risk that the focus on the new Regulator will distract attention from the more fundamental and urgent needs.

This paper was presented in November 2014 in London by Charles Goedhals at an SPE evening programme seminar.  The full presentation can be found here.

If you are interested in following up on the contents of this article, or would like to discuss how it might be applied to affect  your company, please contact your local GCA office, or in the UK call +44 (0)1420 526700 and ask to speak to Charles Goedhals.  

Authors

The Wood Review: Welcome Step Forward But Is It Enough?

Charles Goedhals

Principal Consultant: Development Planning - charles.goedhals@gaffney-cline.com

Signup to receive our latest articles

We're here to help