WoodMac: Disappointing exploration success dampens long term outlook for UK upstream investors

Wood Mackenzie

Wood Mackenzie’s annual UK upstream review concludes that continued high oil prices and fiscal engagement between the UK Government and industry have given companies the confidence to invest in the UK. However optimism generated by high levels of capital investment and M&A activity has been dampened by poor exploration and production performance in 2012. Wood Mackenzie warns that while there is a lot of development activity expected out to 2015, low exploration success rates raise concerns about the longer term project pipeline.

Lindsay Wexelstein, UK Upstream Lead Analyst for Wood Mackenzie, explains; “Based on our review of 2012, the outlook in the next few years for the UK is encouraging and we expect the trend of high levels of capital investment to continue. The process of engagement by the UK Government with industry has contributed to a return of some investor confidence and we expect high levels of development activity out to 2015, however the disappointing exploration results in 2012 raise concerns about levels of activity beyond that point.”

Wexelstein expands: “Over US$60 billion (£39 million) of capital investment is expected to be spent in the UK between 2012 and 2015, largely due to new field developments and incremental projects on existing fields. 2012 spend was at levels last experienced in the mid-1970s, in 2012 real terms. This was partly driven by spend on more technically challenging projects and cost inflation.” 

However, without an improvement in Exploration & Appraisal success, there are concerns over the long-term pipeline of development projects. Wexelstein qualifies: “2012 was another disappointing year for exploration: Although 66 E&A wells were spudded in 2012, a 40% increase on 2011, only two discoveries were made – Carnaby and Cormorant East - with combined reserves of 20 mmboe. The exploration success rate stands at an all-time low.”

“The frontier West of Shetlands region is still expected to provide the best opportunity for material discoveries and although there was no announced exploration success in 2012, interest in the area remains high. However, the challenging and high cost environment means that only those with the expertise and sufficient funding are able to drill. There are four prospects to watch which have results expected in 2013: North Uist, Spinnaker, Glenrothes and Cragganmore,” Wexelstein continues.

The UK government introduced a range of fiscal incentives throughout 2012 to target commercially marginal fields, as well as making a commitment to create certainty around the rate of tax relief that will be available for future abandonment spend.  Wood Mackenzie says this process of engagement has helped some investor confidence return following the surprise supplementary charge tax increase in 2011.

The review also notes the high levels of M&A: “The US$9.3 billion traded in UK focused deals during 2012 was the highest level since 2002.  Early signs are that the promise of certainty on tax relief available for decommissioning spend is having a positive impact on the late life asset market.” 

Turning to development activity, the report says nine new fields were brought onstream in 2012, with total recoverable reserves of 153 million barrels of oil equivalent (mmboe): a fourfold increase on the low volumes brought onstream the previous year.  Wood Mackenzie expects the upturn to continue in 2013, forecasting 21 fields with combined reserves of 638 mmboe to come onstream this year. Larger gas projects, including Breagh and Jasmine, are expected to start producing in 2013. However, with high levels of activity in the UK there is a risk that some of these projects may be delayed due to demand for services in a tight market.

Wexelstein offers in closing: “Despite poor E&A performance, the success of the 27th Licensing Round demonstrates the continued attractiveness of the UK as a place to explore. If all offered blocks are awarded, the round would be as successful as the 26th round. But, with only 18 firm wells committed within the next four years, the round is not expected to significantly boost E&A drilling in the medium term.”

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