Join our community of smart investors

From rigs to riches

North Sea oil and gas production is in a long decline. Might the multi-billion pound clean up of the region's infrastructure give hope to investors - and even a new generation of producers? Alex Newman assesses the risks and opportunities of decommissioning
April 12, 2017

Oil executives don’t like to talk about “clean-up operations”. The phrase tends to conjure images of 10-mile spillages, crude-slicked gulls and outraged fishing communities. Yet for the UK hydrocarbon industry in 2017, cleaning up is fast becoming the only subject on the agenda. This isn’t about crude tankers that have run aground, but involves a clean up of unprecedented proportions: the decommissioning of the fields that heralded the dawn of production from the UK Continental Shelf.

These North Sea oil and gas rigs, some of which have been in operation for four decades, represent an enormous if somewhat hidden part of the UK’s modern history. At their peak, they helped the country avoid the worst pits of recession. Their evolution has also spurred the growth of a world-class industry and the creation of hundreds of thousands of jobs. The London Stock Exchange’s reputation as a hub for burgeoning and major – oil stocks owes much to the region. Yet as many investors who follow the sector will know, the North Sea has been in decline for nearly two decades, as oil fields have reached their economic limit and investment has all but dried up. Now much of the infrastructure that allowed the sector to function – and at one point supported the production of more than 4m barrels of oil equivalent a day – has to be dismantled.

The scale of the challenge is immense. Decom North Sea, the non-profit body encouraging industry best practice in decommissioning, predicts that £17.6bn will need to be spent in the next decade to remove 100 platforms, plug 1,800 wells and retire 7,500 kilometres of pipeline. This is just a portion of what needs to be done. Beyond the next decade, thousands more wells and hundreds more platforms will need to be taken apart.

Some companies – including listed oil and gas services firms – will do this. This is potentially lucrative work for the likes of Petrofac (PFC) and Wood Group (WG.), which this year acquired Amec Foster Wheeler, a company whose recent fortunes have been detrimentally impacted by declining North Sea activity. Other listed groups – from waste disposal firm Augean (AUG) to marine specialists James Fisher & Sons (FSJ) and engineering outfit Costain (COST) – are positioning themselves and building teams in preparation for what many predict will be a flood of work. For investors, there is opportunity. There is also a huge trade-off for the companies involved in production; quite simply, they will have to face up to liabilities long ignored on balance sheets.

However, little is set in stone, and much of the industry is still locked in a stand-off between producers and service companies, with either side unable or unwilling to agree on costs. Some even argue that uncertainty around the full scale of the liabilities have stuck a pin in oil majors’ appetite to recover any of the 20bn barrels industry lobby group Oil & Gas UK believes still sit beneath the seabed.

A number of recent developments have ratcheted up the focus. The first came last October, with the establishment of the Oil and Gas Authority (OGA), an independent UK government company charged with maximising the economic recovery from the North Sea. The body was borne out of a review carried out by Wood Group founder John Wood, one of whose recommendations was the promotion of cost-effective and collaborative decommissioning. As we will discuss later on, those terms of engagement remain contentious, and could have huge ramifications for the future of the industry and UK energy tax contributions.

 

Brent, past and present

The second development arrived in February, when Royal Dutch Shell (RDSB) launched a long-awaited plan to take apart the four rigs that make up the Brent oil and gas field, an operation that will take up to a decade to complete at a cost of billions of pounds. Although the Brent field comprises four rigs, just one, Charlie, is still producing. Next month, Shell plans to remove the topside of the Delta platform, in what is set to be the heaviest ever single lift attempted. Preparation has involved 1,500 people working to reinforce the platform with steel, a lot of logistical planning, and the involvement of myriad UK and international contractors, including Wood Group, Allseas Group and even NASA. The feat could also set the ground for future decommissioning projects, as typically, platforms have in the past been dismantled in several stages.

The lift won’t be the only precedent Shell is hoping to set with the Brent decommissioning. Part of the company’s plan for the rigs is to leave the concrete legs that have propped up the platforms for more than four decades. This will require exemption from international rules governing the protection of the North-East Atlantic, which state that offshore rigs must be completely removed. Shell says that abandoning the concrete structures will have a negligible environmental impact, even accounting for the oil that will be left behind in the rigs’ cells.

Duncan Manning, the Shell manager leading Brent decommissioning, points to independent studies, and a decade of consultation with communities, scientists and environmental interest groups, to justify the proposals to abandon a structure that was never designed to be removed. “We are not making up the science to suit our own needs,” says Mr Manning. “We are required to make our proposals based on a holistic view of the least environmental impact and what is technically achievable, although cost is the other factor to weigh up.” Asked whether the industry might seek to avoid such a lengthy process in the future, under a modified OSPAR Convention (the legislative framework to which the UK and the European Union are signatories), Mr Manning is effusive. “The guidelines are clear and well understood; it’s up to the operators to follow.”

In fact, one of Shell’s previous decommissioning plans played a large role in setting the current rules in motion, and partly explains the entire rationale for the rigorous expectations for dismantling fading North Sea fields. In 1995, and with backing from the UK government, the company suggested dumping the unused Brent Spar oil storage and loading buoy in the Atlantic Ridge. The international backlash which ensued – including a petrol boycott in Germany and a high-profile Greenpeace-led campaign– forced the major to seek a different approach. “A lot of things have happened since Brent Spar days,” adds Mr Manning “[One of the] key lessons we are applying to this project has been scrupulous engagement with stakeholders in what is technically a very complex project.”

That engagement has failed to persuade everyone. This week, WWF, Greenpeace, RSPB Scotland and Friends of the Earth rejected Shell’s plan for Brent, citing “insufficient information and a failure to adhere to clear internationally agreed criteria and procedures”. The oil major could have another public relations war on its hands.

Tax battle

Another change has been the scale of the decommissioning challenge, and its increasingly political and economic ramifications. Primarily, this is gearing up to be a battle over liabilities and tax, as operators are allowed to claim up to 75 per cent of decommissioning costs against previous tax paid by any particular field. As a result, analysts at Wood Mackenzie think taxpayers could ultimately end up footing a £24bn bill to clean up the entire North Sea. Then again, the industry has always had a poor track record of forecasting budgets. Other estimates are far higher; the GMB Union believes the true cost of North Sea decommissioning will pass £100bn. Ultimately, the true amount will be a political compromise to suit visions for future energy policy, as well as the age of indefinite fiscal austerity.

The industry can of course point to the £330bn of tax revenues generated by the North Sea in the last half a century, and the incubation of expertise which allowed the likes of BP (BP.) and Wood Group to become global leaders in offshore exploration, production and infrastructure maintenance.

From a political perspective, those historical contributions will matter less than the contemporary context. According to Carbon Brief, the North Sea oil and gas sector became a net drain on the UK public purse in 2016, as subsidies and low oil prices resulted in a £396m net payment to the industry, the first year that the North Sea industry has cost the exchequer more than it has contributed.

Of course, taxpayers and producers are in chorus in wanting to minimise the cost of decommissioning. But a failure to properly budget for these liabilities could turn the whole subject into a vexed issue, in which this or a future government turns on the industry. On this matter, Mr Manning is sanguine: “It’s important to understand that [relief] is on tax already paid, and a legitimate business expense. Clearly there’s a focus on costs and the OGA is charged with ensuring this is being done in a cost-effective manner.” The former Royal Marine also points to the Brent supply chain, which will provide additional revenue to the exchequer whilst gaining valuable experience that can be exported around the world.

 

UKCS Expenditure Estimates 2016-2025
Owners' costs£3.4bn
Well P&A£8.3bn
Removal£3.4bn
Other associated activity£2.6bn

 

Oil services opportunity

Ask any North Sea operator in the North Sea, and they will invariably round on one adjective to describe the current state of the market for decommissioning services: “immature”. This isn’t about ability, per se. “The skill set is similar,” commented Win Thornton, BP’s vice president for decommissioning at a recent industry event. “It’s about moving staff from operating mode to decom mode; we want a good, well-heeled contractor with their own supplies and equipment.” Many others feel paralysed by cost pressures. “The supply chain is not there yet,” argue INEOS decommissioning director Dougie Scott. “We need appropriate cost estimates, but the supply chain hasn’t decoupled from the production model.”

The same contention could be levelled at operators reluctant to set aside huge capital costs for projects that offer no prospect of return. The government could push the envelope, too: according to Mr Scott, the OGA has to date provided “limited” schedule pressure on decommissioning.

One solution to all of this has been repeatedly cited, however, and it seems all too possible that whoever can perfect it stands to lead the sector. The answer involves the so-called “stringing” together of multiple wells, thereby splitting the costs of plugging and abandoning fields between several operators over the course of one vessel trip. For UK companies such as Petrofac and Cape (CIU), there will be intense competition for this work, particularly from service providers operating in the Gulf of Mexico, where several pioneering solutions have been demonstrated. In 2005, when Hurricane Katrina destroyed seven of BP’s platforms in the Grand Isle and West Delta fields, Wild Well Control successfully managed to remediate and recover the rigs in one process. Five years later, Shell transferred ownership of the late-life Bullwinkle field to Super Energy Services (US:SPN), and the operating licence to Dynamic Offshore Resources. When the field reaches its economic life, Superior Energy will plug and abandon Bullwinkle’s 29 wells, remove the platform and pay the oil major a pre-agreed undisclosed amount.

Getting the plug and abandon (P&A) costs right is widely seen as the area where the greatest savings can be made. “If you can string, you can save 30 to 50 per cent on P&A costs, which would be very good not only for operators, but for taxpayers,” says David Sinclair, of Maersk Oil. “Heavy lift vessels are currently cheap, so now is the time to do it.” With offshore costs the chief focus of operators, companies such as Augean, which can treat waste materials from the decommissioning process, might be better placed to benefit from tender opportunities.

 

Horse-trading

If a formal supply chain fails to materialise, it seems likely that operators will continue to trade producing assets with huge liabilities – or caveats – attached. BP’s sale of its Magnus field was a case in point, and contained much wrangling about the scale of the decommissioning liabilities. As part of the deal, EnQuest (ENQ) was given the option to receive $50m in cash to manage the decommissioning of the Thistle and Deveron fields, in which BP retains a 1 per cent stake (and together with ConocoPhillips, all of the abandonment liabilities) after selling out to EnQuest in 2010.

A similar deal was struck when Premier Oil (PMO) agreed to acquire E.ON’s UK North Sea assets in 2016. Although the deal was signed for $120m, it also gave the indebted group access to £250m of historical taxes paid on the fields, which can be offset against future decommissioning costs, as well as joint cost-sharing with E.ON on the abandonment of the Ravenspurn North and Johnston fields, expected between 2019 and 2021.