There was some good news for the North East offshore supply chain in last week’s Budget when the Chancellor unveiled a package of support for the beleaguered industry.
The introduction of a basin-wide Investment Allowance should mean that those companies investing in the North Sea will see their effective tax rate reduced to below 40%, say tax experts.
The 10% reduction in the supplementary charge has reduced the headline rate to 50% which is where it was five years ago.
And the petroleum revenue tax (PRT) change will make a difference to those older larger fields which support some of the North Sea’s key infrastructure.
These, and moves to support new seismic exploration which will cost £1.5bn, lead an additional £4bn of investment and boost oil production by 14%, says the Treasury.
But the low oil price – which means that many companies are currently losing money and will not be paying tax – and the high costs in the basin are draining investor confidence.
Dennis Clark helped to build one of the first rigs for the basin back on Tyneside in the early 1970s and went on to found North East-based supply chain powerhouse NOF Energy
Hartlepool-born Mr Clark returned to the region in 2008 to help launch OGN fabricators in Wallsend. He said: “At the current oil price of around $50 a barrel then the smaller oil companies are not profitable, and they will not be investing in the immediate future.
“The big companies such as Chevron and the BG Group have sanctioned projects and we’ll have to see if this Budget will be the signal for these to be moved forward.”
EnQuest, one of the North Sea’s largest independent producers, was one of the first operators to welcome the moves when it announced its annual results last week. It said it was pressing ahead with developments including in the £3.2bn heavy-oil Kraken field.
It said the tax cuts will have no immediate effect unless the oil price recovers. At current prices, EnQuest did not expect to pay tax until 2025, said chief financial officer Jonathan Swinney.
It is also benefiting from the renegotiation of contracts with its workers and suppliers, and is aiming to reduce the average operating cost per barrel produced from $42 to $38 this year.
The oil price slump has led to a renewed focus on costs which rose by almost 50% in the last three years – faster than any other basin.
As the oil price fell, majors including BP and ConocoPhillips cut more than 500 North Sea jobs and offshore staff have been asked to move to new, longer, shift patterns.
The impacts have been felt in the North East supply chain, with drilling company Archer closing its Blyth office and subsea contractors Deep Ocean, Flexlife and Reef Subsea all cutting headcount.
Last week one of the region’s leading offshore supply chain companies, the Newcastle-based British Engines Group – which operates BEL Valves – said it was looking at redundancies. Out of the 1,200 people it employs, it said fewer than 25 jobs were at risk, saying it expected the slump to last for up to two years.
Neil Kirkbride, managing director at BEL Valves, said: “The industry had become bloated before price started to drop.
“What we are now finding is that many contracts are being re-examined and reassessed and this is slowing projects down.
“In the North Sea, letters are flying around asking for re-workings to be done. Everything is in the mix. Project economics are being studied closely and contractor rates are being looked at. Some projects are being delayed for six to nine months, some even longer and some could be put back for an even longer time.
“We are hoping to see the oil price rally up to $80, but how quickly that will happen is anyone’s guess. It may be 12 to 18 months away. While some projects can still proceed at $60, a lot more projects are viable at the $80 price but at the current $50 price many more are not.”
Mr Kirkbride sits on the board of Oil & Gas UK which is looking at the mechanics of the supply chain and ways in which contracts can be simplified and costs taken out. One suggestion currently being considered is avoiding duplication in critical witness testing.
With Tier 1 and Tier 2 contractors under pressure to make price cuts in the region of 20%, this is placing greater pressure on those companies further down supply chain, like many in the North East.
He added: “The key thing for the North Sea right now is to see the oil price get back over $70.”
Mr Clark said: “There is a lot of current focus on standardisation and these are the same questions we were asking in the 1990s.
“Essentially each oil and gas field is different and it’s impractical to think you can offer a one-size-fits-all solution; some are working at depths which have not been tried before in new high-pressure and high-temperature environments.
“It’s a real task for the regulator and I am writing to him to highlight my concerns.
“He really needs to get the operators, big engineering and operating contractors together and examine exactly why it is costing so much, why is there so much overspending?
“They should really be looking more closely at introducing performance-related contracts with penalties. At the minute it’s a case of ‘more days, more dollars’ and this is a factor of the large number of day-rate contractors in the industry, who jump from project to project with no loyalty.
“I’ve been saying for years that we need to tackle this issue and now is the time for the Oil and Gas Authority (OGA) to see that it is done.”
The newly-established OGA begins its work in earnest next week and one of its first tasks will be to tackle costs.
Speaking after last week’s Budget, Andy Samuels, chief executive of the OGA, said: “Today’s new fiscal measures, together with the rapid creation of the OGA, demonstrate the Government’s support for the industry and its recognition that the UK must be in a position to compete effectively with other basins around the world.
“Industry must now move quickly to create a more competitive cost base and improve production efficiency in line with the goal of maximising economic recovery of the UK’s oil and gas resources. The OGA will actively support this work and monitor progress closely.”
The creation of the OGA signifies the emergence of a new era in relationships between the industry and government.
Industry protests following the 2011 Budget tax hike – reversed last week – led to an improved dialogue and a series of field allowances which prompted the recent record levels of investment.
Mr Clark said the Government had recovered and “we now have much more engagement and purpose than with previous regimes” with all parties working to the goal of ensuring all reserves are recovered and preventing early decommissioning.
He continued: “There was a lot in the Budget to encourage the industry. It certainly sends out positive signals to the people who can potentially invest in the North Sea but it’s not helping exploration and appraisal drilling.
“We could have done with something similar to Norway where drilling costs incurred can be written off against tax.”
Mr Clark also welcomed the £20m towards supporting seismic activity where, even after 50 years, not all areas have been surveyed. Many were also surveyed using outdated technology and it is hoped the money will be used to update this with 3D or 4D seismic monitoring of reservoirs.
Andrew Hodgson, chairman of Subsea North East and chief executive of Wallsend subsea remotely-operated vehicle-maker SMD, says the industry is experiencing a lull and using the opportunity to “catch its breath”, but has a healthy long-term future.
“In a slump the North Sea is affected more quickly with it being more of a commercial basin. In Mexico, Brazil and other places where the industry is run by state-owned companies, price is less important than things such as energy security and the balance of payments,” he said.
BEL Valves is still pressing ahead with a £10m research centre in Newcastle with Mr Kirkbride saying: “We are going through the cycle and it is taking longer than we would have liked but it will come back. There is a good future for oil and gas industry.”
Events over the past few years have seen the Government look at the industry in a different light. It is no longer viewed as a cash cow but more as a vital asset which employs half a million people, and supports the nation’s energy security.
Danny Alexander, Chief Secretary to the Treasury, acknowledged as much on Budget day when he said: “I would say that even beyond today, the direction of travel in the tax regime needs to continue to be downwards so I think that people can expect that in the years to come there can be further reductions both in the Petroleum Revenue Tax and the Supplementary Charge.”