UK North Sea Oil and Gas Output

Source: DECC, via UK Office of Budget Responsibility, “Fiscal Sustainability Report 2014”, EIA, Prienga (author’s) estimates

The UK’s Department of Energy and Climate Change (DECC) sees a plateau at recent production levels, followed by renewed decline after 2020. This is pure nonsense. DECC made this same prediction in 2013; DECC now expects 2014 output 11% lower than its prediction last year, and 25% below its forecast of 2011.

Despite DECC’s hopes for the future, there has never been a plateau in North Sea oil production even remotely resembling DECC’s forecast, and there is no reason to believe we will see one now. Indeed, if recent trends continue, UK oil production could fall from an anticipated 1.5 mmboe / day in 2014 to 1 mmboe / day by 2016, and below 500 kbpd by 2022. That is, on current trends, UK oil production could fall by a third in the next 2-3 years, and by two-thirds in the next eight or nine.

How likely is this bleak scenario? Consider: The great Prudhoe Bay field in Alaska is declining by 6% per year, despite ministrations to maintain production there. On the other hand, the decline rates for mature offshore platforms in the US Gulf of Mexico and Brazilian offshore are typically in the 12% range. Thus, UK production is declining at the rate of a mature offshore field with no significant production additions. It doesn’t get much worse than that. Norway, by contrast, has seen an average decline rate of 3.6% since 2010, albeit with perhaps better prospects than those of UK waters. Given that Norway's oil company, Statoil, is cutting capex and focusing its incremental efforts outside Norway, we might expect declines there to accelerate.

Thus, the UK North Sea might expect to see a decline rate between that of Prudhoe Bay and a mature offshore field, perhaps 8-9%. Using 8%, UK oil production would fall be 1 mmboe / day in 2019, and below 500 kboe / day in 2027, as the graph above shows.

What are the economic implications?

Oil and gas receipts to the UK are a function principally of three factors: oil and gas production; oil and gas prices; and the costs of extraction for the oil companies. Having considered the oil and gas production outlook, let us consider prices. The UK’s Brent oil price stood at $111 / barrel in 2011 and 2012. It has plummeted to $96 / barrel in the last few days, and the futures markets expects it to stay there through the end of the decade. Thus, oil prices have declined and are not expected—at least by the futures market—to recover.

At the same time, revenues to oil companies—and the cost of exploration and production—have been rising at the pace of 8% per annum in the North Sea over the last decade or so. Operating costs increased by 15.5% in 2013 alone, according to UK trade group, Oil and Gas UK. If an 8% pace continues, and the futures price holds, then government take, oil and gas revenues to the government, would fall to effectively zero by 2018. Of course, some receipts will flow in. While there is production, the government should see revenues. However, to maintain production, the government in the UK (as elsewhere) will find itself forced to progressively offer increasingly generous incentives to producers, and within a very few years, will effectively be willing to accept nothing as long as production, and related jobs, are maintained.

Oil prices may well come in above the futures curve. To an extent, rising costs should be mitigated by rising oil prices. North American unconventional production growth has been spectacular and is now sufficient to depress global oil prices. Notwithstanding, about one-third of the world oil supply is subject to cost and price pressures similar to that seen in the UK. Therefore, within the finite future, at recent prices, we will begin to see significant deterioration in the conventional oil supply. This will affect supply growth and ultimately lift Brent prices, despite formidable shale oil production. North Sea production economics will benefit. On the other hand, oil prices are unlikely to exceed the global carrying capacity, currently calculated at around $115 Brent on a sustained basis in the near term. Although there is upside in the oil price, it is by no means unlimited.

Therefore, a better case forecast sees Brent oil prices edging back to those seen in the last few years, around $106 / barrel, and gradually increasing to $120 / barrel in 2020, and $175 / barrel in 2030. Meanwhile, operator costs are anticipated to rise at their recent rate of 8.9%. If we combine all these in a single forecast, UK government take for 2017 would come in at £2.3 bn, 1/3 below the most recent projections of the Office for Budget Responsibility (OBR). Government take would be half the OBR's forecast level by 2020 and converge with zero after 2025.