Listen: Does the UK need the North Sea for its energy future?

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Nick Coleman:

Hello and welcome to Commodities Focus Podcast by S&P Global Commodity Insights. Today's episode is the first of a series of podcasts where we'll be exploring energy security in the context of the UK's upcoming election. A chance for us to dig into what we mean by the notion of energy security and the debates playing out across the UK and Europe.

I'm Nick Coleman. I'm a senior editor for Oil News in the S&P Global Commodity Insights news team. I aim to bring together experts from across S&P Global Commodity Insights to talk about themes ranging from power to oil refining to renewables. And starting today with the North Sea, the sector once seen as a backbone of the economy, able to provide resilience in the event of geopolitical upsets in the Middle East, for example. A sector that shored up the country in the fraught years of the miners' strike in the 1980s but now viewed as low in the tooth, struggling for direction perhaps in the face of emissions reduction goals and seemingly prey to cash-strapped politicians looking for windfall finance.

I'm joined by my colleagues, Stuart Elliott, a journalist focused on the UK and European gas market. And Gethin Baker, senior technical research analyst, also at S&P Global Commodity Insights, who provides clients with deep subsurface insights into the North Sea and its potential. We are recording this as the UK heads for an election widely expected to be won by the opposition Labour Party, who would be returning to government for the first time since 2010. And the relevant points here is that Ed Miliband, Labour's presumed energy minister, is one of the few opposition figures with experience of government office. And he thus brings a certain amount of authority and ability to get his way. So, Gerthin, let's start with you. What does the North Sea provides in terms of energy security, and should we be worried about its future? There is talk by the Labour of a moratorium on new licenses in the North Sea. So what do you make of all this?

Gethin Baker:

So the UK has been a net importer since 2005, and the UK has had no option but to diversify its imports through countries such as Norway, the US, and Qatar, with US and Qatar supplying LNG. And as natural gas makes up 40% in the UK's energy demand, we are heavily rely on these countries for a consistent supply. But the North Sea brings another layer of diversification to the UK's energy mix, and without it, we're probably only going to ever see a more and more dependence on those countries I've just mentioned. And I think with the North Sea, something also to factor in is the emission intensity with it. So, as I said, we are very dependent on LNG imports, but they've got a four-times higher emission intensity associated with them when compared to our homegrown indigenous supply, sorry, oil and gas. So, from a climate element, it's also very important.

So moving on to the ban on licensing, now this would have an impact on energy security, in my opinion, because we'd see a reduction in exploration drilling, we'd see a decrease in field development, and therefore less production coming online. And basically, accelerating the decline in production from the North Sea. And just to kind of expand on that more, we look at the most recent 33rd licensing round that was just awarded at the end of last year. We'll see another tranche this year as well of awards. And essentially, one of the key themes in that was that we saw a very high number of straight-to-second-term licenses awarded. And this basically allows the operator to move straight into the field development phase of the license. So you can accelerate bringing a field onto production, and we've seen some success stories already with that. So Equinor's barnacle discovery is basically forced onto production 14 months after award.

And then we look at some recent examples in Harbour's Talbot and BP's Murdock discovery, so they were both awarded as the straight-to-second-term licenses in 2022 and then due on stream in '24 and '25. So the point we're trying to make here is that without licensing, those assets would've been less stranded and not bought onto production, and therefore helping stem the decline of production from the North Sea and bolstering our energy security. And just the last point on those recent awards, over 200 million barrels of oil equivalent was awarded on those straight-to-second-term licenses. So all of that big, significant resource could be developed in the next three to five years in both those stream, bolstering our supply and therefore becoming more energy secure.

Nick Coleman:

Thank you. Now I've got to play devil's advocate here for a moment, so I'm going to turn actually to Stuart. So, I hear what you're saying, Gethin, about these new projects, which are still coming through the pipeline as it were. Nonetheless, the ones that you mentioned there are quite small, little add-ons rather than any massive new projects. What we've actually seen recently is the United States bailing out Europe with shale gas and shale oil. I think that's a reasonable assertion. If I was perhaps a young person leaving school now wondering what to do with myself with my career, would I really want to go into the North Sea oil and gas industry, which might be seen as a sort of a 20th century industry that can be left behind? Now, what do you make of these arguments, Stuart?

Stuart Elliott:

Yes, it's definitely fair to say that the reputation of oil and gas in the UK, well, everywhere really, is certainly in question. And whether or not people leaving university would want to join, what you could say is a declining industry is probably a fair argument. That said, I think we've learned from the major risk curtailments in Russian pipeline gas to Europe in 2021, 2022. And through last year and into this year, that energy security is critical, and fossil fuels make up obviously a large part of what makes us energy secure in this country. So there's certainly two sides to it. And I think one side is that we are now looking at energy security with a much closer, sharper letters than perhaps we used to, or at least what the trend was towards some more climate concerns. And I think the North Sea is really critical still to how we view energy security in this country.

I mean, gas production in the UK last year it was down 10% year-on-year, and we've had some data from the National Gas Grid Operator predicting another decline this summer in gas production from the UK continental shelf down to about 16 BCM, which is down from about 16.6 last summer. So we're seeing a declining gas production sector for sure, but alongside that, we're also seeing demand falling. So with foreign demand, production is still making up about half of what we consume. And as Gethin was saying, we do have to depend then on imports for the rest from Norway, in particular, and LNG, as Gethin said, from the US and Qatar. But production is declining. And if you think back to the mid-2000s, production was still about 800 terawatt hours per year, and now we're down at about 350, which is a significant decline. So what comes next? That's a big factor, and I think it's something that Nick, you've been looking at closely, is what Labour has been proposing in terms of the tax regime and the tax burden on upstream operations. It would be higher under Labour, is that right?

Nick Coleman:

I think Gethin might be able to talk about that. My impressions of the industry is not pleased either with Labour policy or, frankly, the current conservative policy. Nonetheless, I think the line that the current government has been taking recently is that we certainly need the gas for our energy security, but they seem a little bit less certain about why we need the oil, especially when a lot of our oil is exported anyway, frankly. And I think some governments around Europe have tried or entertained the idea of a moratorium on oil exploration, but they want to keep the gas going because that's what goes into our homes and our factories. So actually, one thing I'm curious about to hear a bit more from you, Gethin, about is that something that could work to target the remaining gas in the North Sea, which after all is meant to be a bit cleaner in terms of emissions compared with the crude oil, and then leave the crude oil in the ground. Is that a sort of a realistic idea, Gethin?

Gethin Baker:

It's an interesting approach, but I couldn't see it really going. I don't think it in the UK. I mean, ultimately, oil is a slightly more profitable venture. I think companies would still look at the oil from that point of view and the economics associated with it. I also think with gas, if you did just focused on gas production in the UK, I think the biggest problem is where would you store it, particularly in the summer. If we increase gas production due to having very, very low storage capacities, the lowest in Europe, in fact, I think we could end up having to actually export a lot of the gas in the summer into Europe for storage. So I'm not sure it would be a suitable idea just to focus on the gas and the power very much intertwined when you look at the production of the Central Sea, for example, you get a lot of solution gas coming out of the oil as you produce it. So they kind of go hand in hand.

And when we look more towards our gas basin in the Southern North Sea, it's very, very mature, expiration first fields to be bought on stream all started down in the Southern gas basin back in the '60s, '70s. So it's a very mature region. So you would have to kind of encourage expiration to go back into the gas basin. I would not be confident that we'd be getting large discoveries being found. Pensacola, in fact, was a significant one that we saw last year from Shell, and that's targeting a new Zechstein play. So there is still potential, I'm not ruling it out, but I think if you wanted to move just to developing gas, I don't think it could be done in the UK.

Nick Coleman:

I think it's a really interesting point, Gethin, that a lot of times a field contains both oil and gas, and the two things you can't really have the two... One thing without the other. I noticed that a company just the other day is saying that it wants to tap into some gas in a heavy oil field and it only wants to use the gas to power some other facilities nearby. That was the Bressay heavy oil field. But they're not going to touch the oil at the moment. They're only going to touch the gas, which is much cleaner and probably easier to get approved by the regulator.

Gethin Baker:

Yes, it's an interesting one. So that's EnQuest up in the Northern North Sea. And that's Bressay. So, Bressay is, I think, the fifth-largest undeveloped discovery in the North Sea. So it's a significant find, and essentially, what they're looking to do is they've got the Kraken FPSO in relative to close proximity. And they're going to look to produce the gas only from Bressay and then use that on the Kraken FPSO to decarbonize the operations there and to use the gas rather than reliant on diesel. So it's a bit of a decarbonization play. And then once that's up and running, the plan would then be to go back and, like you say, go for the oil later on. So it's a play on using the gas to decarbonize and then looking to exploit the oil afterwards.

Nick Coleman:

Yeah, I think a lot of people don't really realize that there's actually a lot of oil and gas consumed on oil and gas platforms by burning things like diesel, which is perhaps not the cleanest way of going about things, but it's how the industry got going originally. Moving on, however, just perhaps as we draw to a close now, is it fair to say that it's now the North Sea is about a sort of managed decline or are there still any big projects out there? We did have this Rosebank project, which you might... That seems to be bucking the decline trend. Could we actually see a long life with a few more of these bigger oil projects coming in the next decades or so?

Gethin Baker:

Yeah, I mean, Rosebank will make a difference, but overall, I think we are in a managed decline in the North Sea. We do have Cambo as well, which is also in the west of Shetlands and other significant discovery that Ithaca are looking to develop. Currently farming it out looking for a partner. So we do have some large finds, but if you look from a historical perspective, these are relatively small. So I think we will be managing decline going forward.

Nick Coleman:

And the tax rate, which Stuart mentioned just now, 75%, is the sort of headline rate in a very complicated tax system that's probably not helping matters, is it?

Gethin Baker:

No. So yes, the Labour suggesting lots of changes. So tax rate will potentially go up under labor from 75% to 78% and that would mark the fifth fiscal rate change if it does go ahead within sort of two to three years, which is destroying the investor confidence across the basin. So we're getting more and more companies stalling plans now, kind of waiting to see what happens with these Labour proposals. And I think what's key in these proposals is their potential removal of the incentives that were put in. So the Tory government puts in what's called an investment allowance and that gives operators 91% tax relief on reinvestment into assets. So that's where we've seen... We see a lot deal activity around this as well. So an example, Jersey Oil and Gas in the Central North Sea they picked up the book and field back in 2019 have been farming out ever since with not a lot of success.

And now we see Neo Energy, a big player and Serica Energy both farm into this asset citing the investment allowance as kind of a driver because they'll get a 91% tax relief on the investment and bringing that field onto production, which is due on stream in 2026. So what I'm trying to say is this investment allowances has kind of generated deals, which I don't think would've happened under a pre-EPL condition, and Labour are looking to pull that away now. So essentially would just need the industry being taxed at 78% with no incentives, which I think would seriously impact the decline of production in the North Sea.

Stuart Elliott:

Yeah. And there's another company isn't there called Hartshead who are an Australian company and they've been very vocal about what Labour are proposing and the impact that could have on their North Sea gas development, which is to try to bring online the earning in some of their fields. But they've said quite openly with Labour currently well ahead in polls for the next election that these new changes that Gethin is just talking about, that the increase in the headline tax rates and the removal of the incentives could really damage the prospects of their project. And they had hoped to go to FID last year and then first gas in 2025, but they flagged delays now to that. And the CEO said something about that this could cause a flight of capital to other markets, decimate the skills and supply chain in the UK and lead to lots of job losses. He said tens if not hundreds of thousands of jobs. So it sounds to me like under a Labour government, the industry would face certainly more headwinds than under the Tory government.

Gethin Baker:

Yeah. Just to jump in there as well, we were also seeing Hartshead with issues and companies like Total as well. So they're looking to FID on a project Glendronach in the west of Shetlands and the Teal West as well. But they've been delaying this kind of waiting for a more predictable fiscal regime to come around. So we're seeing companies all across the North Sea now stalling and almost waiting to see what happens post-election. And that's not great for activity at all in the North Sea. So just to put that into perspective, last year we saw no field development plans submitted for approval. And this year we've got a few maybe booking, but as we've already seen and just spoken about now, companies are now delaying their plans. We could see another year of no field development plans submitted, which is only going to impact production in the long term as well.

Nick Coleman:

So it's just to probably sum up here, I think the North Sea oil and gas industry is very much characterizes in the public as quite a dirty industry, and the opposition comes from organizations like Just Oil. What do you think this decline of the North Sea industry actually means for Britain's environmental ambitions?

Gethin Baker:

Yeah, so I think we've got to tread carefully here because a lot of the companies involved in the CCS industry at the moment are oil and gas players because they have that subsurface experience and knowledge.

Nick Coleman:

CCS being carbon capture and storage. So this is where you capture emissions from an industrial facility and you pump them under the North Sea into basically a disused field, right?

Gethin Baker:

Yeah, that's... Yeah, that's pretty much it in a nutshell. So a lot of the EEP players are involved in those and the industry is at its infancy. So they're very key in how that industry is going to unfold and play in the future. And the worser off the investment scenario is we're going to drive investment away, we're going to drive these companies out of the basins. And potentially that could have an impact then on the carbon capture storage industry as these players leave the basin.

Nick Coleman:

Stuart, any final thoughts on that theme?

Stuart Elliott:

Some of the IOCs that we've been talking about, some of the big companies in the North Sea are looking to join the energy transition in some ways. There's investment in wind by BP, for example, in Germany and others as well, Total. So I think they understand that there's a need also to push the energy transition and to invest in renewables. And then, of course, you've got a lot of pure player renewables companies as well that are looking to use what we have to offer in terms of wind power, offshore wind in particular, given how much wind there is offshore in the UK. And that industry will thrive, I think, regardless of what happens to oil and gas because that is the future. But I think for now, perhaps I don't see an argument against why you can't have both working together in tandem during this transition period.

So we continue to produce oil and gas from the North Sea while we invest more especially in offshore wind and come 2040, 2050, then I'm sure things will look very different. But for now, I agree with Gethin that the attractiveness of the UK as a market to invest upstream is definitely waning. And that's a shame. And I think there's certainly... If you look at Norway and they're continued upstream activity with a lot of exploration, still has definitely worked their benefit, especially with gas and the gas exports to Europe now being the single biggest supply source for Europe after Russian deliveries were cut. So there's definitely, I think the scope to continue to produce from the North Sea, but in tandem with a build out of renewables, especially offshore wind.

Nick Coleman:

I think it's a really interesting dynamic that some of the companies we've talked about, BP and Shell, they are the target of demands for more tax payments because they're so big, because their profits on paper seems so big, but in reality a lot of them don't actually have a huge presence in the North Sea anymore. They've moved aside to some extent to make way for some of the smaller players, but they are nonetheless really significant for this country and for jobs and for generating the expertise that can be exported around the world. And some of them, of course, might be thinking about even moving their offices to more favorable locations elsewhere. So they are part of the story here and it's definitely one that's going to be continued and that we'll be watching.

Thanks very much Stuart and Gethin for joining me to illuminate these topics. This Commodities Focus episode was produced by Felix Fernandez in London. And for more insights related to energy security, check out our interactive digital report, the Energy Security Sentinel, follow the link in the description. Thanks again for listening.