Capital investment is key to UKCS recovery
31 March 2017
Recent musings in the UK Oil & Gas industry have suggested that there are some green shoots of a limited recovery popping up. Indeed Oil & Gas UK’s (OGUK) 2017 Business Outlook, released last month, certainly supports that view - large scale improvements in cost efficiency and productivity, largely enforced by a long period of reduced commodity prices, are now bearing fruit and this is being underpinned by the largest collection of discoveries in eight years.
However, the attractiveness of the UK continental shelf (UKCS) has to be measured in terms of something other than cost, production and reserves metrics. OGUK’s data suggests that investment in the basin continues to fall away with less than £500m of fresh capital invested last year and an overall reduction in investment of c£7bn. The development and eventual production of those 360m boe of new discoveries depends on that investment. Without it, they will be just numbers. Capital is needed to help those green shoots germinate.
Access to capital has been an issue for the sector since the banking crisis of 2008. Many traditional oil & gas lenders stepped away from the UKCS, focussing their efforts on basins deemed to have a longer term future, lower cost base and more attractive returns, such as West Africa. Some stepped away completely in search of safer bets. Moreover, Private Equity (PE) firms saw the UKCS as unattractive, with many choosing to have perhaps only one exploration company and one production company in their portfolios, often supported by a smattering of Oilfield Services firms (OFS). In fact, in recent times even this approach has been considered unusual as PE followed the banks in search of new horizons and return opportunity.
For the basin to prosper, investment is needed. However, it is expected, according to OGUK, to fall further over the next two years leading to a real and significant production decline post 2020 unless new sources enter the scene. Any delay to this investment could have a serious knock on impact on the supply chain, with the potential for more job losses in the future. Investment in exploration and appraisal drilling activity is vital in terms of maintaining the pipeline of opportunity for the sector and, ultimately, reserve replacement.
At the other end of the life cycle, investment in decommissioning is key to ensuring that as much of that activity as possible benefits the UK economy, whilst providing a springboard for growing that opportunity globally.
All of that may sound like doom and gloom, but the back end of 2016 leading into 2017 has perhaps seen a sea change, to coin a phrase, in appetite for the UKCS. Up and coming oil & gas companies have been at the forefront of some significant deals - Siccar Point acquired OMV’s North Sea assets in a deal worth $1bn, EnQuest acquired an interest in BP’s Magnus field and Sullom Voe Terminal for $85m and, perhaps most strikingly, PE backed Chrysaor announced a deal to acquire a portfolio of Shell’s North Sea assets for $3.8bn. The Siccar Point and Chrysaor deals represent a real step change in attitude of PE towards the North Sea and are real game changers for both companies. The EnQuest deal shows that their banking syndicate is highly supportive of their future aspirations. While no cash will change hands there would need to be approval from the lenders to proceed.
In addition, we’ve started to see foreign investment in the UKCS pick up - Delek is currently working on a deal to acquire Ithaca, not long after it acquired a 20% stake in Faroe Petroleum. And these deals came along at a time they were also looking to acquire a share in Kraken from EnQuest. A real demonstration of foreign interest in the North Sea.
And beyond the traditional sources of capital, newer ideas, and the return of some older ones too, are coming to the fore. Cairn Energy recently announced a $200m streaming deal with Flowstream for offtake from the Kraken and Catcher fields. Premier Oil signed a similar deal for Solan back in 2015. Interestingly, older financing models such as project finance are now being discussed again as a way of breathing new capital life into the basin.
These are just a few of the more prominent examples. Overall, there has already been more investment in the UKCS in 2017 than in the whole of 2016 but this trend needs to continue in order to sustain the near and medium term future of the basin.
From a banking perspective, while some of the traditional backers of the basin seem to have stepped away, new players are coming to the fore and banks, who might previously have been considered syndicate participants, are stepping up to lead and underwrite. And PE is once again awake to the opportunity of the UKCS, with asset deals to the fore, particularly where innovative agreements around decommissioning liabilities can be reached.
Harking back to the mantra post 2008, access to capital, while difficult to come by, is definitely there for the right company with the right deal and the right supporting portfolio. And 2017 may signal a turning point, or sea change, in direction for investment in the sector.
Time will tell, but the future of the industry in the UKCS will depend on an influx of investment to help encourage those green shoots.
Alan McCrae - UK Head of Energy Tax