Across the North Sea, upstream projects have been rocked by the one-two punch of the oil price crash and coronavirus. Brent fell below US$20/bbl in April, its lowest since 2001. Operators are scrambling to respond, slashing budgets and 2020 production outlooks.
Most North Sea production is ‘in the money’ in 2020
At a Brent price of US$35/bbl, only 130 000 boe/d – or 2% of North Sea production – does not cover operating costs and government share. This rises to 290 000 boe/d (5%) at US$30/bbl, and to 6%, or 370 000 boe/d, at US$25/bbl.
For the North Sea, the major concern here is not volumes. Cost reductions achieved during the last downturn mean 95% of the North Sea’s onstream production is ‘in the money’ at US$30/bbl. But close to a quarter of fields will run at a loss in this price environment. Equally, an early shut-in of the nearly 100 fields (mostly in the UK) running at a loss at US$30/bbl would speed up a staggering US$20 billion in decommissioning spend.
Could decommissioning be a lifeline for the service sector? Not quite yet.
Operators can ill-afford to jump into costly abandonment programmes. EnQuest has decided to permanently shut-in its Heather and Thistle fields in the UK, but they were both offline and would have required further CAPEX to bring back onstream. Most fields are likely to continue producing at a loss, as they have in the past, in the hope the price will rebound.
Exploration and production (E&P) companies will instead look to apply downward pressure on operating costs. But even in the absence of a significant reduction, with a weighted-average short run marginal cost (SRMC – operating costs plus taxes) of US$12/bbl, the North Sea is amongst the most competitive of the traditionally higher-cost regions. Most production is safe for now, but longer-term investment is required to increase production and reduce unit costs.
Investment cuts expected
While cuts in 2020 will not be quite as severe as in other parts of the world – most sanctioned projects are on contract and likely to proceed as planned – Wood Mackenzie still expects a 20% drop in North Sea investment compared to its pre-downturn estimate.
And the traditional North Sea players may not be willing investors. The majors are likely to defer capital investment and the sector’s independents will struggle financially, particularly if banks look to decarbonise their portfolios.
In addition, it is not certain whether private equity will step in. With several unmonetised vehicles already on the shelf, a new wave of money is not certain. What was already looking like a difficult exit story just became much harder.
Mid- to long-term investment in the North Sea is under real threat. Pre-final investment decision (FID) projects account for approximately half of Wood Mackenzie’s investment outlook between now and 2025 at the start of the year. Annual investment in the UK could fall below US$1 billion as early as 2024. To combat this threat, Norway passed a landmark tax reform in June. The agreed terms include immediate capital allowance against Special Tax for all existing investment in 2020 and 2021 and, for projects sanctioned before 2022, all CAPEX up to first production.
While the North Sea industry continued to sanction projects during the previous downturn, the lack of world-class opportunities will see it follow a similar pattern to the global story. Wood Mackenzie identified over 20 projects that had a chance of being sanctioned this year. Securing project financing was already a concern for many and now less than a handful are expected to get the green light.
Major cost cuts from the service sector are unlikely. The supply chain bore the brunt of the previous crash and has yet to fully recover. Coming into 2020, the service sector had been struggling with low margins, over-supply and weak investor sentiment. E&P companies will need to revisit development plans to achieve material reductions.
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