Leaner times ahead as oil prices fall

There are already some worrying signs of the damage low oil prices are likely to inflict on the UK economy this year. Shell and BP Amoco, the two biggest investors in Britain’s offshore industry, have both announced drastic cuts in their worldwide capital expenditure. Between them they will spend $8bn less in exploration and development […]

There are already some worrying signs of the damage low oil prices are likely to inflict on the UK economy this year. Shell and BP Amoco, the two biggest investors in Britain’s offshore industry, have both announced drastic cuts in their worldwide capital expenditure. Between them they will spend $8bn less in exploration and development this year than in 1998.

While neither was specific on what this meant for the North Sea, the omens are not good for what remains a relatively high-cost region for producing oil and gas.

BP Amoco has slashed its exploration budget from $1.65bn last year to $900m for 1999. But it has said it will spend more than half this figure in four ‘target’ areas elsewhere.

‘It’s almost certain that no wells will be drilled in the North Sea this year,’ says a company executive.

The offshore supply industry is already feeling the impact of this decline in investment. The Offshore Contractors’ Association says big engineering companies had made large staff cutbacks over the past few months in the absence of new projects. It warned that thousands of jobs will disappear at fabrication yards in the coming months as existing contracts come to an end.

The knock-on effect on equipment suppliers was seen this month, when Alstom Electrical Machines said a drop in orders from the offshore industry was largely responsible for 220 redundancies at its Rugby site.

While the UK offshore industry has always been cyclical in nature and is used to downturns in activity, there is reason to believe it is entering a period of more lasting change.

Sir John Browne, chief executive of BP Amoco, said last week that whereas oil prices over the past decade had fluctuated between $15 and $21 a barrel, ‘now it seems that we’ve experienced a real shift to a lower band, which in broad terms runs from $10 to $17’.

In such an environment, it is not viable to produce oil at an average cost of $13 a barrel the present North Sea norm.

Browne said the Government could provide some short-term relief by adjusting a taxation regime that was no longer appropriate: ‘We need to be absolutely clear that at these prices there is no excess economic rent and there are no windfall profits.

‘That means that at these prices the continued existence of a separate tax regime for oil and gas in areas like the North Sea above and beyond a standard corporation tax charge on profits is a barrier to new activity and is therefore a tax on investment and employment. I think it’s important to make that case, as clearly as possible.’

The joint taskforce set up by former Trade and Industry minister Peter Mandelson last year to address the impact of low oil prices on the UK will recommend a number of further tax concessions to stimulate new developments when it reports to the Government in the coming weeks.

In the longer term, the development of cost-reducing technology and commercial arrangements will be the key to sustaining the UK’s oil and gas production.

The Crine Network, the industry project to reduce costs in the North Sea, says technologies that would allow large cuts in the costs of offshore operations notably on oil wells and the simplification of production facilities already exist, but further investment is needed if they are to be exploited commercially. Several of these will be presented at the organisation’s conference on 10 March.

Crine also argues that the industry is capable of producing oil at $8 a barrel. It arrives at this figure by taking the ‘best in class’ across the range of North Sea activities exploration, development, facility maintenance to produce a composite. If companies were more willing to share information on how these efficiencies were achieved, this could become the norm, it says.

There is also further scope to cut costs through closer relationships between oil companies and their core contractors and suppliers. The deal BP Amoco signed this year with Sumitomo of Japan to meet its pipeline requirements for the next five years was an example. The oil company said if the arrangement had been in force during the previous five years, it would have saved £100m of the £500m it invested in pipeline projects over the period.