Oil to Play for As North Sea’s Future Looks Bright

AT first glance, the latest Royal Bank of Scotland oil and gas index makes for pretty grim reading. The monthly snapshot of the industry shows UK oil production fell by 11 per cent in April, while gas production was down by 16 per cent on the year.

But behind the headlines it is far from being all doom and gloom. Despite continuing falls in production over the last three to four years, the North Sea energy industry is attracting interest from big and small players alike.

Industry commentators believe there is still hope the oil fields can provide a positive outlook, on the back of consistently high oil prices and the success of the most recent round of offshore licensing.

“The continuing decline is surprising because of the high oil price,” notes Tony Wood, senior economist at RBS, as the cost of a barrel of crude hovers around the sensitive dollars 60 mark. And with some experts expecting to see a high of dollars 70 a barrel or more by the end of the year, the level of Mr Wood’s surprise could increase.

Yet there remains significant activity in the region with a number of high-profile mergers and acquisitions, as well as new finds, taking place – not just among the big boys of the industry, such as BP and Shell, but also smaller explorers and producers such as Aberdeen’s Dana Petroleum.

While the long-term trend remains one of declining output, the history of North Sea energy production suggests there could be some form of surge in production over the next few years.

This chimes with the findings of the Department of Trade and Industry, which, in 2002, suggested there was an untapped supply of oil under the North Sea of more than 42 billion barrels – ten billion barrels more than had already been pumped from below the seabed since production began in 1967.

The DTI’s announcement followed the discovery of 1.1 billion barrels of oil – the biggest North Sea discovery for 25 years – at the Buzzard Field, about 80 miles north-east of Aberdeen.

Mr Wood sees a number of reasons for the slowdown in production – not linked to supply but because companies are restrained by the number of skilled individuals and resources available.

“Everyone is competing for the same labour, the same oil rigs and the same technology,” RBS’s chief economist argues.

The latest licensing round was completed on June 9. This saw a 30- year high in the number of applications at 279, including frontier licences, which present opportunities in areas to the north and west of Shetland. The round saw applications from a wide range of companies from super-majors through to new entrants. In total, 104 companies applied for licences.

“This is a massive vote of confidence,” says Malcolm Webb, chief executive of the UK Offshore Operators Association.

Mr Wood is also encouraged. “The success of this and previous rounds is in large part down to the main forum,” he says. “It has led to a lot of smaller companies coming in to the industry.”

Formed in response to the collapse in oil prices in 1998, this initiative has worked hard to bring government and industry together. Both have demonstrated that significant potential remains in the UK continental shelf.

This injection of new blood augers well for the Scottish oil and gas industry, giving genuine cause for optimism, with the independents seemingly prepared to exploit assets that do not fit with the majors’ international portfolios.

The North Sea is now what is known as a mature region in terms of oil and gas exploration, with development taking place around the edges and in smaller fields. But if explorers and operators are to be successful, they will have to be prepared to focus on developing these smaller opportunities that exist in the mature North Sea basin.

THE optimism in the area has been increased by the opening of a number of new fields. Last month, Tullow Oil started production at the Horne & Wren North Sea gas field, which it co-owns with UK utility group Centrica.

And earlier this year, Dana Petroleum’s chairman, Colin Goodall, said seven more appraisal wells were planned in 2005, with a total of 17 – targeting 1.2 billion barrels of potential reserves – in the pipeline for the end of 2006.

Such results have encouraged the view that the stamina and productivity of the region have been invigorated through new technology and a focus on the North Sea by smaller operators. There are also a number of acquisitions that are passing through the system, backing the feeling that there is still life in the old oil field yet.

In April, Edinburgh Oil & Gas was snapped up for GBP 133m by Dyon UK in a deal that will give its new owner access to the Buzzard Field. And earlier this week, Capital-based Alba Resources announced it was to be purchased by London firm Nautical Petroleum for GBP 14.2m, in a deal that is expected to be completed early next month.

Mr Wood expects to see further consolidation, although he argues continuing high oil prices will hinder any further large-scale mergers. And he feels the main transactions that do go ahead will centre around company assets rather than the companies themselves.

“Service companies, for example, will be trying to gain scale through mergers and acquisitions,” he says. It is not just exploration companies that are making the news. Companies offering servicing and design help are also in a position to fill their boots from the increased activity in the oil field. Energy services firm Wood Group has landed an engineering and design contract worth up to GBP 8.5m from BP for the redevelopment of the oil major’s Valhall field in the North Sea.

Independent firms working in the North Sea must become more broadly focused if the region’s 25 to 30 billion barrels-worth of estimated reserves are to be tapped successfully. According to a study by venture capital group 3i, the North Sea’s oil and gas minnows need to evolve from traditional exploration and production groups into multi-faceted companies “with the resources to exploit market and technological developments”.

This is a view echoed by Mr Wood. “If you look at the proven models of the Gulf of Mexico and Alberta, which are mature areas, smaller companies are involved and getting absolutely the most out of the fields,” he says. “In reality, while it takes a long time to make decisions, they are using very robust technology to help them. Technology has an impact on what is economically viable.”

Changes in technology have continued to help the oil exploration industry. The pain of the late 90s has driven technological innovation and what companies learnt in the North Sea has been applied on a global basis for a long time.

Mr Wood uses the example of the Russian oil fields as a way that local expertise can help developing areas: “Not long ago, the field recovery rates were just 40 per cent. Using technology developed in the UK and the US, this is now pushing up to 80 per cent.”

Despite the falling output, a trend which, in the long term, is unlikely to be reversed, Mr Wood believes things are on the whole pretty encouraging.

“The next two to three years look like they will be an exciting time for the industry,” he enthuses.

* Timeline of ‘black gold’ in pipeline *

NORTH Sea oil was discovered in the early 1960s, with the first “black gold” coming on-line in 1971 and being piped ashore from 1975.

But the fields were not intensively exploited until rising oil prices during the 1980s made it economically feasible.

Inaccessibility and dangerous conditions on the floating offshore rigs require complex and expensive production methods.

The North Sea contains the majority of Europe’s oil reserves and is one of the largest non-OPEC producing regions in the world.

While most reserves lie beneath waters belonging to the UK and Norway, some fields belong to Denmark, the Netherlands and Germany.

Most major oil companies have investments in the North Sea. Peaking in 1999, production of North Sea oil reached nearly six million barrels per day.

The latest figures from the Royal Bank of Scotland oil and gas index show that production fell to 1.7 million barrels per day in April.

Natural gas production reached nearly ten trillion cubic feet in 2001 and continues to increase.

Petroleum has been produced in small quantities on the UK mainland for centuries. The first commercial discovery was made in 1918 in Nottinghamshire. In 1973, Wytch Farm in Dorset was the first major onshore oil field discovery in the UK and is now the largest onshore oil field in Western Europe.