Scotland's Independent Expert Commission on Oil and Gas: report

1. Introduction

1. The history of Oil and Gas in the UKCS has been one of considerable success.

2. The industry has succeeded in producing over 42 Bboe to date from a relatively inhospitable environment, generating a domestic support industry that is competitive, recognised for capability and technology and is succeeding in global markets.

3. The success of the industry is illustrated by;

• buoyant employment levels across the sector and supply chain;
• improved workforce demographics;
• record interest in recent licensing rounds;
• world leading expertise in supply chain sub-sectors ( e.g. sub-sea technology);
• unique experience of technically challenging fields such as High Pressure-High Temperature ( HP-HT) developments; and
• record levels of international activity and exports by the supply chain.

4. Notwithstanding these achievements, the province is now facing a range of challenges as a mature basin, including:

• falling production levels and production efficiency;
• development and operating costs at record high levels;
• exploration activity at a near 50 year low;
• average salaries continuing to rise (increasing by 35-40% since 2006) putting pressure on companies' wage bills; and
• the number of people needed to produce a barrel of oil has risen from 18 in 2006 to 45 in 2012.

5. As a result, the costs of production are rising, with a diminishing return. This unsustainable commercial environment must be understood and addressed through an effective policy framework and stewardship model.

A Crossroads

6. It is the Commission's view that the oil and gas industry has reached a critical crossroads: while significant opportunities exist, the scale and imminence of the challenge has not been fully appreciated.

7. With complex interdependencies influencing investment decisions in the UKCS, there is some urgency needed to ensure potential investment opportunities are not lost or stranded. Government and industry must act now if they are to overcome this challenge and secure a long-term and sustainable future for the UKCS

8. There is much emphasis placed on the current reported record levels of investment. In the short term, there are a number of existing fields receiving record levels of investment. However this is masking reduced investment in exploration and production, diverting attention away from the challenges which must be overcome.

9. A paper published by the UK Government in April 2014 estimated remaining potential production from 2014 to 2050 to be 10.2 Bboe ^[6] . This level of recovery would represent a substantial failure for the UKCS as a whole, resulting in a great loss of economic value, and runs contrary to the MER strategy.

10. This estimate for the next 35 years is less than half the estimate of 24 Bboe potentially recoverable overall, which has been used in previous Department of Energy and Climate Change ^[7] ( DECC) and recent Oil & Gas UK ( OGUK) forecasts ^[8] . It follows that if production between now and 2050 is as low as 10.2 Bboe, this will inevitably jeopardise the basin's ability to achieve its maximum potential overall.

11. The Commission is therefore of the view that Government should provide a policy framework consistent with recovering 24 Bboe, though recognising that the development of new capabilities and technologies could result in an increase to this figure. This policy framework must build on the understanding that:

I. strengthened incentives for further investment in infrastructure will stimulate and accelerate production, and in turn, enhance the economics of marginal fields;

II. the supply chain must be challenged and incentivised to develop the technologies and skills to enable the economic and rapid development of smaller fields, and to improve recovery from existing fields; and

III. further opportunity exists to develop indigenous technologies, capabilities and skills to build production and service provision, reducing the dependence on imports.

12. A policy framework with these principles at its core would generate substantial value from additional production and supply chain activity.

The Opportunity

13. The UKCS will remain an important offshore oil and gas province for many years to come, with a potential 24 Bboe or more still to be recovered. However, given the maturity of the province, a sizeable proportion of those remaining resources will be technically difficult to reach, and more expensive to recover than the 42 Bboe already extracted. This presents a range of challenges.

14. The current policy framework needs to swiftly evolve and reflect the changing dynamics of the UKCS. The Commission believes that with appropriate and well-targeted Government intervention the UKCS could be transformed into a global leader amongst the many mature oil and gas provinces worldwide.

15. Government must focus real effort on innovative policies and practice, which support the development of technologies and capabilities to achieve the target of recovering the remaining 24 Bboe. As well as maximising oil and gas production, the result would also be improved energy security, and the continued growth of an indigenous, high value, global supply chain.

16. Government and all parts of the industry must work closely together if they are to realise the significant opportunity that the potential remaining 24 Bboe represents. Only through a more collaborative approach can the barriers to investment in exploration and production be addressed.

The Challenge

17. The corporate landscape and investment dynamics in the UKCS are continually evolving. The basin was once dominated by international super-majors with financial capacity to fund the exploration and development of major field discoveries. These companies were the architects of the major arterial export routes that underpin the current UKCS infrastructure.

18. However, today's oil and gas business is more diverse. It harnesses the skills of independent oil and gas companies that come in many different shapes and sizes. This varied range of business models has emerged in direct response to the challenges and opportunities of the market.

19. The main challenge is:

To adapt quickly to the transition of the UKCS from a province where prospectivity attracted high levels of investment, to one where investment in late-life fields and more technically challenging resources is rewarded by a reasonable rate of return for industry and for the nation ('the Challenge').

20. The Commission has focussed on the two key components of this challenge:

I. ensuring the continuing success of the UKCS, through overcoming current challenges and Maximising Economic Recovery; and

II. ensuring that the broader opportunities and additional value from oil and gas activity are realised for the wider economy and society.

Maximising Economic Recovery (' MER')

21. The Commission welcomes Sir Ian Wood's Maximising Recovery in the UKCS Review and its assessment of the governance model applying in the UKCS. It fully supports the proposed solution: the creation of a new arm's length Regulator for the UKCS with increased powers to enable effective high quality, proactive stewardship for the delivery of the MER strategy.

22. The changes brought about by this approach will address many of the regulatory failings in order to successfully achieve the first component of the Challenge. The Commission believes that an innovative approach to stewardship and regulation in the UKCS is needed in order to guarantee the transition to a new paradigm of oil and gas activity in the UKCS.

23. The new Regulator must have the ability and power to evaluate all of the remaining assets of the UKCS and develop a clear strategy for their development.

24. As long as this new approach is implemented swiftly, cost effectively, with minimal bureaucracy and with the full cooperation of the industry, this could enable the UKCS to capture some of the benefits that a National Oil Company can generate, without the need to form one ^[9] .

Maximising the Total Value Added (' TVA')

25. To address the second component of the Challenge, the Commission is of the view that there needs to be a stronger emphasis from Government on maximising the overall contribution of the sector to the economy: the Total Value Added.

Box 1: Total Value Added

Total Value Added is the sum of 3 components namely;

1. that derived directly from the UKCS in the wages, profits and related taxes from production activity;

2. the indirect contribution from wages, profits and taxes of the supply chain; and

3. the extra induced activity of the supply chain, in export markets and other non-oil sectors, from UKCS activity in the form of further wages, profits and taxes.

TVA is therefore a measure of the maximum value added by the whole industry to the economy. ^[10]

26. A greater focus on maximising TVA will result in a broader governmental, and wider societal, understanding of what the oil and gas sector contributes, and as such, what opportunities remain. This will in turn enable an assessment of the degree to which factors considered to be impeding or encouraging exploration, investment and production, also have an impact on the wider economy.

27. The Commission strongly believes that the domestic supply chain must be presented with the opportunity to be innovative, developing the technology and capabilities necessary to produce the potential remaining 24 Bboe.

28. Maximum value to the economy can be achieved directly from that additional production, but also through developing the strength and capability of the domestic supply chain, ensuring its competitiveness in every oil and gas province worldwide, while building the indigenous skills base and enhancing future employment.

29. At this critical crossroads, the Commission intends to provide advice to Government, the new Regulator and to industry on how to maximise the opportunity and TVA from the UKCS.