A tale of two countries

Author Konstantin Rozhnov

In the run-up to the referendum on the UK's membership of the EU in June, Norway will undoubtedly be mentioned again and again by both sides as an example of a prosperous European country outside the EU. The two countries, while quite different in many respects, have at least one thing in common — the task of recovering still-vast offshore oil and gas reserves.

In the run-up to the referendum on the UK's membership of the EU in June, Norway will undoubtedly be mentioned again and again by both sides as an example of a prosperous European country outside the EU. The two countries, while quite different in many respects, have at least one thing in common — the task of recovering still-vast offshore oil and gas reserves.

The UK has introduced a string of incentives to attract investment to its offshore oil and gas industry since the end of 2014. The moves, which include tax cuts and an investment allowance for the North Sea, were a response to high operating costs in the basin even before oil prices started to slide in the middle of 2014. And while the incentives softened the blow of sharply lower prices for oil and gas producers operating offshore the UK — with the government earning praise from BP chief executive Bob Dudley this month for being among the first to adjust its tax system to match the new price environment — they could be too little, too late.

Things look quite rosy for now — production offshore the UK increased last year for the first time in 15 years and is expected to increase further in 2016 and at least for the next couple of years on planned start-ups and improved efficiency, industry lobby group OGUK says in its annual Activity Survey.

But only 26 exploration and appraisal wells were drilled in 2015 — the lowest in 45 years — and, this year, no more than 19 wells are expected to be drilled, OGUK says. Furthermore, the UK oil and gas industry is likely to approve less than £1bn ($1.4bn) of investment in new development projects this year, compared with the average £8bn/yr over the past five years, it forecasts.

“This reflects a scarcity of capital globally across the oil and gas industry, primarily due to the price fall, but also the lack of attractive investment opportunities on the UK continental shelf, which is of serious concern,” the group says, warning that output could halve by 2025. “The basin risks another production collapse at the start of the next decade if new development opportunities do not begin to be delivered now.”

And this is where Norway comes into the picture. For about 10 years, the Norwegian government has been refunding up to 78pc of exploration expenses, meaning that exploration firms see little reason not to try their luck and drill a well. In the Norwegian North Sea alone, 21 exploration wells were drilled last year, compared with a peak of 30 in 2009. For the whole of Norway’s continental shelf, 40 exploration wells were drilled last year. In comparison, 13 exploration wells were drilled offshore the UK last year, compared with over 40 in 2008.

Norway-focused Swedish independent Lundin Petroleum was one of the early movers that benefited from Norway’s exploration tax incentive. Ashley Heppenstall, who was chief executive of Lundin until last year, said in 2014: “We were the ones who were in Utsira High first, when everyone told us that we were crazy.” Lundin’s very first well drilled in the area of the North Sea resulted in the Edvard Grieg discovery, and more followed, including the giant Johan Sverdrup project. Johan Sverdrup, which is due on stream at the end of 2019, is expected to be profitable even at oil prices below $30/bl. Its peak production will be equivalent to a quarter of all Norwegian petroleum output.

OGUK and the Scottish government have been among those urging the UK government to introduce exploration incentives similar to Norway’s for companies operating offshore the UK.

London could well decide that it has nothing to lose by providing further incentives to the oil and gas industry — the government expects oil and gas revenues to drop to just £100mn/yr in the current financial year to early April and over the next three years, down from over £2bn in the 2014-15 financial year. That’s a 95pc drop in tax revenues in the space of a year.

Some answers could be given on 16 March, when finance minister George Osborne makes the government’s annual financial statement. For now, the government — which keeps oil and gas taxes under review just like any other taxes — reiterates that it expects companies to capitalise on its already-introduced incentives.

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