Predicting oil price movements is as risky as exploring for oil itself. The average price for crude fell 10.3% from the start of 2014 to the date of the Scottish independence referendum on September 18. It fluctuated over this period – but few, if any, were predicting any major move in either direction in the months to follow.
Yet during the past three months we have seen another 48.4% fall. Geopolitical factors involving OPEC, the US, Russia and Iran, as well as the economic decline of China and the Eurozone, have been touted as contributory causes. Whatever the reason, the trend looks set to continue well into 2015, with Saudi Arabia prepared to run a substantial budget deficit and let the price fall to $20 a barrel to win back its market share.
Oil keeps tumbling
The North Sea situation
The sharp price drop has inevitably had implications for the UK. While the chancellor of the exchequer, George Osborne, has led calls for industries from airlines to utilities to pass on cheaper fuel costs to consumers, politicians of all hues have been raising concerns about the oil industry. Industry association Oil and Gas UK/Ernst & Young is predicting that 35,000 jobs could be lost over the next five years out of a total of 375,000 or 450,000 – depending on whose figures you believe.
Even before the oil price crashed, the UK industry was at a crossroads. Its future was the subject of a series of proposals laid down last February in a report by industry veteran Sir Ian Wood, the UKCS [UK continental shelf] Maximising Recovery Review, which was commissioned by the UK government.
The report was a blueprint for maximising the level of petroleum that can be extracted from the region. Its recommendations included setting up a new oil and gas regulator, closer collaboration between government and industry, developing fields in groups rather than individually to maximise their value and investing to prolong the life of existing infrastructure.
The report stated: “The review believes that urgent and full implementation of the recommendations will have the potential to deliver, at the low end, an additional 3-4bn boe [barrels of oil equivalent] over the next 20 years, worth approximately £200bn to the UK’s economy at today’s prices.”
Presumably this £200bn boost might now be revised drastically downwards, as that was based on an oil price of $109.76 per barrel and not a price around the current $50 mark. As for the 35,000 jobs that OGUK/E&Y predicted were at risk last month, the forecasts were based on interviews and questionnaires that must have taken several months to complete. Would the 35,000 prediction be the same if these interviews were to be conducted now? Or even remotely the same?
Our point is that when oil prices change dramatically, reports on the industry lose their mojo. They are still useful as a starting point but recommendations for saving the industry when oil prices are riding high need to be revised as a matter of urgency when prices fall.
Wood moves to date
The present situation is that the government intends to implement Wood in full. It appointed the head of a new Oil and Gas Authority in November and intends to have the regulator fully operational later this year. Ex-BG executive Andy Samuel duly took up the post on Monday January 5.
Osborne and Danny Alexander, the chief secretary to the Treasury, also announced various measures around December’s Autumn Statement that were mainly aimed at implementing other parts of Wood. These included introducing a new “cluster area” allowance to encourage companies to explore areas surrounding individual fields and grants to fund seismic exploration in under-explored areas. The supplementary tax on profits that oil companies pay on top of corporation tax was meanwhile cut from 32% to 30%.
With the oil price falling so sharply, these plans simply do not go far enough. In addition to fully implementing Wood, the chancellor needs to be seen to act decisively and not merely tinker at the edges of the tax system. It is worth bearing in mind that at the 2011 budget, Osborne raised the supplementary tax rate from 20% to 32%, using the justification that oil prices had almost doubled.
Now that oil prices have halved in the past six months, this logic indicates that that 12-point hike now needs to be reversed immediately and not only reduced by a paltry two percentage points. Indeed, arguably the oil industry should be put on an equal footing with other industries and the supplementary tax should be removed as a whole.
Then there is petroleum revenue tax. It is an additional 50% tax on petroleum extraction profits that is levied on fields given development consent before March 1993. It should be scrapped as its revenue-raising power is now minimal, presumably because oil companies have cut back on their activities in fields that incur PRT.
Backslappers no more
There are also issues around implementing the rest of Wood’s recommendations. It appears that it will take the Department of Energy until well into 2016 to fully set up the infrastructure necessary to bring about the efficiency gains that the review envisages. That delay is potentially a death blow to the success of the new initiative.
Then there is the question of the industry sharing technology and working co-operatively in the way that the review suggested. The industry’s appetite for this may have been genuine a year ago, but the 50% fall in oil prices may make the predatory nature of oil companies more evident than the backslapping scout-jamboree gathering that we saw before.
The world has changed in a way that ensures that it is a fallacy to argue that the industry has seen it all before and that we just need to ride out the storm. The 45% increase in North Sea operating costs over the past three years plus the decline in easily accessible reserves makes the North Sea less attractive to invest in than other areas of the world.
The industry unquestionably needs to look at its cost structure. Should it only be contractors who should bear the pain of salary cuts? Can the North Sea oil industry afford the high salaries it has been paying? But equally the oil price drop is a signal that the government needs to redouble its efforts at reform and go much further than Wood. We cannot see why the industry would continue to invest in the North Sea without additional incentives. The future of the industry is on a precipice. The good old days have gone, and they won’t be coming back.