Risk and Reward in the UK Continental Shelf: An Update Looking Into 2015
Tuesday, December 30, 2014

In November 2014, we published a three-part series (Nov. 6, Nov. 10, Nov. 12) outlining the UK Continental Shelf (UKCS) investment outlook and plans for much-needed reforms in the UKCS oil and gas industry. The update below provides an overview of key developments from December 2014 and considers what may lie ahead for the industry in 2015.

In December 2014, the price of Brent crude oil fell below $60 per barrel for the first time since 2009. As one of the most mature basins in the world, the impact of falling oil prices is felt profoundly by the UKCS oil and gas industry. Throughout December 2014, a series of studies and statements originating from a range of sources collectively produced a picture of the mounting pressures faced by the industry.

In an 18 December 2014 press release, Oil & Gas UK recognised that “the UK oil and gas industry is facing a serious challenge. The falling oil price is affecting activity across the UKCS and companies are having to take hard decisions in light of this challenging business environment.”

Robin Allen, chairman of the independent explorers’ association BRINDEX, expressed concerns that “almost no new projects in the North Sea are profitable with oil below $60 per barrel” and warned that the North Sea oil and gas industry is “close to collapse”.  Sir Ian Wood, who led a recent a review of UK offshore oil and gas recovery, reportedly considered that BRINDEX’s comments were “over the top for an industry which thinks and plans long term”. Nevertheless, Sir Wood conceded that the UKCS faces a “very difficult year to 18 months”.

Highlighting concerns over profitability in the UKCS, financial risk management group Company Watch published research on 29 December 2014 that out of the 126 oil exploration and production companies that are publicly quoted on the London Stock Exchange, 70% are currently loss-making and around a third are not producing any revenues.

Companies facing this level of financial uncertainty at the end of 2014 will likely be looking to become leaner in 2015 to secure their survival, at least until oil prices recover. As to how long this may take, Sir Wood has commented that there are “structural reasons” to believe that the price of oil should recover in 2015 or early 2016.  The credit rating agency Standard & Poor’s most recent price assumptions for Brent crude are $70 a barrel in 2015 and $75 a barrel in 2016. An increase in the price of Brent even to these estimated levels would represent a welcome (although relatively modest) recovery from the circa $60 per barrel level experienced in December 2014.

However, these estimates also indicate that the industry will face considerable challenges for the foreseeable future. What developments are likely in 2015 as companies adapt to the harsh current climate?

We have already seen companies active in the UKCS announcing job losses and pay freezes for contractors. This trend is likely to continue into 2015 as companies seek to lower their cost base and drive efficiency. An estimated 15,000 jobs could be lost in the next year to 18 months (out of a workforce of approximately 375,000). Looking further ahead, a December 2014 industry study by Ernst & Young predicts that the UKCS upstream workforce could be reduced by 35,000 jobs by 2019.

PwC expects 2015 to bring an increase in mergers and acquisitions in the UKCS oil and gas industry, including the possibility of the first hostile takeover in the sector as it faces “uncertain times”. High-profile deals have occurred worldwide in late 2014, with Repsol’s acquisition of Talisman Energy and Halliburton’s acquisition of Baker Hughes.

Oil & Gas UK has called for reforms to be accelerated in light of the falling oil prices, including: (1) urgent action to deliver fiscal change; and (2) swift implementation of the Wood Review recommendations (discussed in parts two and three of our UKCS risk and reward series).

HM Treasury’s Autumn Statement, December 2014 outlined the UK Government’s plans for “major reforms to the oil and gas fiscal regime”, intended to send “a strong signal that the UKCS is ‘open for business’”. However, these reforms have been described as modest, and the UK Government will likely face pressure to take further steps to facilitate recovery and incentivise investment in the UKCS in 2015.

With the industry facing another tough year ahead, the impact of the UK Government’s reforms and continuing developments in the price of oil will be closely monitored by UKCS stakeholders.

 

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