Even before the price of Brent crude plunged from $115 in June last year to under $50 in January the UK oil and gas industry was facing a crisis.

Over the previous five years the production cost of a barrel of oil had risen faster than anywhere else on the globe, doubling to $30.

Even before the price of Brent crude plunged from $115 in June last year to under $50 in January the UK oil and gas industry was facing a crisis.

Over the previous five years the production cost of a barrel of oil had risen faster than anywhere else on the globe, doubling to $30.

Production efficiency was at a record low and declining and you had to go back to 1965 to find less exploration drilling.

The focus on the importance of the sector and its key role in the UK economy and security of energy supply sharpened during the independence referendum debate and now the battle is under way on several fronts to sustain the industry as long as possible and produce every viable barrel.

However, confidence within the industry is at a record low according to recent research.

Grant Allan, deputy director of the Fraser of Allander Institute at the University of Strathclyde, says: “We know oil and gas is a vital industry for both Scotland and the UK, and, in particular, the north-east of Scotland, which demonstrated its resilience during the last sharp fall in the oil price through the Great Recession.

“Our most recent survey reveals, however, that optimism in the industry in the UK is at its lowest level since the survey started in 2004.

“Firms of all sizes have re-evaluated their activities significantly as a result of the sustained and significant fall in the oil price since summer 2014.

“Two thirds of operators have cancelled projects, while contractors – faced with an increasingly challenging cost environment in the UK – are exploring opportunities around the globe.

“We also found evidence of many firms reducing their staff training budgets, with larger firms more likely to do so, which is more pronounced than that seen during the Great Recession.

“This short-term focus on reducing costs is understandable; however, this may damage its resilience over the medium term.

“For the sector as a whole, there remains clear benefits from reducing costs – even if, as the market suggests, the price of oil remains below $70 a barrel for the next two years – and finding the appropriate technological and economic solutions so that the sector can continue to deliver its economic contribution to the Scottish and UK economies.”

Deirdre Michie is the new chief executive of Oil & Gas UK and, while under no illusion about the enormity of the task the industry faces, she says the prize is significant and worth the effort.

However, she warns the UK offshore oil and gas industry must become sustainable at $60 dollars a barrel.

“At $60 oil, 10 per cent of our production is struggling to make money and there is a shortage of capital and a shortage of investors willing to place their money here,” she says.

“While demand for our products remains strong, critical for our transport and heating our homes and giving us a whole host of everyday products, our productivity as an industry has fallen – and fallen rapidly.

“We know that as an industry we have been part of the problem, now we need to be part of the solution.

“Over the last 20 years the price has averaged $62 per barrel and the forward curve is between $65 and $75.

“Therefore it is not unreasonable for the North Sea to set out its stall at being sustainable in a $60 world.”

She says it will require a change in mindset and the industry has to avoid doing the same things in the same way and expecting different outcomes.

Neil Gordon, chief executive of Subsea UK, echoes this message and says following this slump the industry cannot simply go back to what it was, as it has following previous cyclical dips.

“This crisis presents an opportunity for us to rebalance or recalibrate, and the industry in this situation is likely to be more receptive to things like new technology and smarter ways of working.

“There is a real need for a step change in behaviour across the industry in how people work together.

“The word collaboration is used a lot but I think we need to talk about co-operation, which for me means giving a lot more – you have to put something in for the greater good of the industry.

“The government has to co-operate with the industry and operators and contractors, and the supply chain needs to co-operate a lot more and a lot earlier to look at efficiencies throughout the operation. It is time for real change.”

That change must involve everyone because the Oil and Gas Authority doesn’t have all the answers, according to chief executive Andy Samuel.

“We have moved quickly to establish the Oil and Gas Authority (OGA) and welcomed the strong support of industry and government.

“We have recruited an experienced leadership team and are now beginning the next wave of recruitment to build capacity.

“The £1.3bn package of measures announced in the 2015 Budget provided a welcome boost to the industry and was well received by investors.

“It is now essential the industry redoubles its efforts to create a more competitive cost base and increase efficiency.

“To help revitalise exploration, we’re moving ahead with a £20m government-funded seismic project to acquire new high-quality 2D data from the Rockall and Mid-North Sea High, which will be made freely available.

“The Energy Bill will provide new regulatory powers for the OGA, including the ability to participate in meetings with operators, have access to data, provide dispute resolution and issue sanctions such as improvement notices and fines of up to £1m.

“These new powers will enable the OGA to work proactively with industry to facilitate action and encourage greater collaboration to maximise economic recovery.

“Now, more than ever, is the time to remove behavioural barriers, set clearer expectations between organisations involved in the North Sea and secure leadership commitment to cultural change.

“I have high expectations of industry and am encouraged by what I see but there remains a lot to be done.

“The OGA will do everything we can but we don’t have all the answers. We need everyone to lead the change.”

Ian Phillips, chief executive of the Oil & Gas Innovation Centre (OGIC), says: “Technology is going to play a key role in maximising economic recovery in the North Sea – both by enhancing recovery from existing fields and by accessing the as yet untapped reserves through exploration and production activity.

“Innovation is now a strategic priority across the industry but to deliver real value we need to see a shift in how innovation is deployed.

“Oil and gas has traditionally been slow to adopt new technologies and new methods of working. “It’s an industry where no-one wants to be the first to trial innovation and where procurement processes can be a major stumbling block to deploying new technology in the field.

“However, in the current climate there is a financial imperative to explore new ways of working, spanning processes, technologies and collaboration across industry.

“We hope this will accelerate the speed at which near to market technologies can be deployed in the field and OGIC’s work to fast-track R&D in conjunction with Scotland’s world-class academic resource is part of this process.”

Jill Reid, partner and head of the oil and gas team in Aberdeen for Maclay Murray & Spens, wonders whether existing and potential investors in the North Sea will be prepared to buy into the collaboration proposals, although she points out joint ventures in which co-venturers contribute a share of the cost and the operator conducts the business on behalf of the whole joint venture is already very well entrenched into the UK Continental Shelf (UKCS).

“It is just going to be developed a little bit further and what is interesting for me is how, in a low oil price, you marry up the two ideas that on the one side you have closer collaboration as stated by the Oil & Gas Authority while on the other there is pressure on individual oil companies from their boards to maximise returns to investors.

“I think potentially we are going to go through an interim period when you might see some litigation as companies revisit their contracts or terminate them and these actions are met with some resistance.

“Looking ahead, I think things will settle because in the UKCS we are accustomed to this spirit of collaboration.

“The amount of litigation that has taken place is not significant because there is almost this unwritten code that people collaborate and work on an ethical and fair basis.

“What is proposed is nothing brand new.

“What is new, however, is how rigorously it will be enforced by the OGA.

“We are going to have to work on how individual companies advise their respective boards and particular shareholders about the impact this is going to have.

“There are many companies looking to invest in the UK for the first time because it is seen, from the regulatory point of view, to be a safe and known area.

“I hope they will also readily accept the expectation of even greater co-operation and collaboration in the UKCS.”

Bill Fowler, partner, corporate, with Maclay Murray & Spens, says that over the past few months the industry has been taking stock of the potential impact of a number of significant developments including the Wood Review, the Infrastructure Act and the new Oil & Gas Authority.

“People have been trying to get their heads around a whole host of factors and what they might actually mean and I don’t think there is a conclusion yet,” he says.

He believes in recent months the industry has been sharply focused on internal cost reduction, a process which is ongoing, and until it is complete companies may not concentrate on the longer term strategic view.

“The challenge for people is making sure they still have a great resource and the expertise in the business when activity levels kick back off again.”

He says companies are also starting to look at decommissioning more seriously.

“I suspect the wave which has been forecast for the last five or so years may now be about to come through.

“You will then have the conflict between the oil companies wanting to decommission inefficient fields in the current cost environment and the UK Government’s MER UK [Maximising Economic Recovery in the UK strategy].”

Nigel Jenkins, chief executive of Decom North Sea, says despite challenging times, decommissioning is a developing sector which presents new opportunities and key to that is the chance to develop cost effective solutions through collaboration and innovation.

“Crucially, and more pertinent than ever, this all needs to take place within the context of MER UK. Just 10 major decommissioning projects in the UKCS have taken place over the past 20 years.

“However, an estimated 5,500 wells, 400 facilities and 10,000km of pipelines are forecast to be decommissioned over the next 35 years.

“We are set to experience an exponential increase of decommissioning activity, on a previously unseen scale, so at the beginning of this market, collaboration and knowledge sharing really are the fundamental keys to achieving the cost efficiencies and benefits we’re aiming for.

“Decommissioning used to be seen as the beginning of the end. Now it’s seen as the beginning.”

Alan Kennedy, Aberdeen-based oilfield services UK lead partner with KPMG, says: “Cost control and reduction measures have been the priority for industry since Q4 of 2014 following the collapse in the price of crude.

“The operators’ reaction to the shift in commodity price has rippled out through the supply chain.

“However, basic cost-cutting itself is not going to solve the challenges faced by the industry, particularly in a mature basin like the UKCS.

“For the North Sea this is a watershed moment and all those with a stake in the industry are grappling with significant strategic issues as well as their operational concerns, spanning people, infrastructure, working methods and technology.

“There is no silver bullet solution to these but there is an opportunity now to take a serious look at how the industry works and how things could be done differently.”

Ewan MacKinnon, investment director for Maven Capital Partners UK, says: “We have looked at a lot of studies over the last few months and if you actually correlate the price of oil to the price it has cost to take it out of the ground it is pretty much linear.

“As the oil price has increased so has cost base so no-one has made any more money during these times – efficiency has just got worse.

“Everything had to be bespoke and gold plated and even before the oil price dropped the economics were unsustainable.

“Following the Wood Review and reports from Oil & Gas UK everyone is saying ‘we need to do things differently, we need to work together, everything cannot be bespoke because it is just not sustainable’.

“People are certainly saying they are going to adjust but whether that happens, who knows?

“However, we are still seeing opportunities and we typically invest in owner-managed SMEs which are a bit more fleet of foot and can react and change more quickly.”

According to Graham Cunning, Campbell Dallas corporate finance partner, most felt 2014 oil prices were unsustainable and the real surprise was the speed and ferocity of the fall.

“Boards have clearly looked hard at costs, focusing on reviewing capex spend and any operating cost savings.

“The rest of 2015 is expected to remain challenging but having held discussions with key industry decision makers I know there is a buoyant, determined mood.

“There is an opportunity for stronger corporates to seek opportunities to accelerate any acquisition programmes as some producers struggle to cope with the new world order; while consolidation may be necessary to take out costs and realise the benefits of economies of scale.

“Many are already making unsolicited approaches to select targets.

“Larger corporates will seek to divest non-core divisions to free up capital, which will also prompt deal activity.

“Inevitably there will be an element of forced M&A for corporates with high gearing on their balance sheets.

“UK private equity houses are continually scouring the country for investment opportunities in growth firms with international ambitions, and oil and gas companies with operations overseas fit the bill.”

Colin Welsh, chief executive officer, Simmons & Company International, says the oilfield services M&A market has been turned on its head and the days of business owners expecting a queue of potential buyers prepared to pay seven or eight times historic EBITDA are gone.

“The slump in the price of crude and uncertainty over future price mean determining future earnings in the industry is very difficult and this has spooked a lot of potential buyers, resulting in a dramatic slowdown in M&A activity compared to recent years.

“Our advisory teams are busier than ever but the difference today is that the lead-in times for deals completing are much, much longer in order to afford businesses the best opportunities to achieve their goals.

“Despite the challenges in the oil and gas industry, there is no doubt this is a time of significant opportunity. If you are at, or near, the bottom it is a good time to invest.

“It is certainly not a time for complacency but it is also true that strong businesses with good management teams are holding their own and, in many cases, actually managing to grow.”

Source: www.dailyrecord.co.uk

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