Oil Market Report February, 2016

In March 2015 we looked at the Canadian oil sands and the extent of that sector’s suffering as a result of low oil prices. Then in June we looked at how oil prices were damaging the biofuels industry,  as it struggled to keep competitive against super cheap fossil fuels. Almost a year later and nothing has fundamentally changed for these two industries – prices remain low and many players are operating at negative margins.

Despite this however, both the oil sands and the biofuel industry continue to show resilience in the face of adversity. The oil sands have successfully managed to keep the oil flowing, through innovative long-term contractual arrangements with US refineries and the bio-fuel producers have been enjoying high prices on their Renewable Transport Fuel Certificates. These RTFC’s (a trading scheme that encourages the sale of biofuels) have offset the commercial pain of selling relatively expensive biofuels (50 pence per litre), when compared to normal petrol / diesel, which are trading around the 20 pence per litre mark.

Unfortunately for another hard-hit sector – the UK offshore industry – such alleviating “good fortune” is in short-supply and the low oil price continues to generate unremitting doom and gloom. To some extent, the woes of the North Sea are purely part of the worldwide firestorm that is facing those involved in oil exploration. Consider some of the figures; Schlumberger and Haliburton – the 2 largest oil field service companies – have in the last 12 months laid off some 55,000 jobs globally and still further job cuts are expected. Investment by the oil majors is massively down; Exxon-Mobil has cut investment by $7.5bn for the coming 12 months, BP by $10bn, British Gas the same amount and Shell by $15bn. And the previous darling of the offshore industry, Brazil’s Petrobras (currently being battered by both falling prices and corruption scandals), has announced an enormous $32bn reduction in capital expenditure for 2016.

Sadly though, there is more to the problems of the North Sea than just being a victim of the worldwide slump in oil prices. Rapidly declining production from ageing oil fields and a skilled workforce that is increasingly jumping ship to other parts of the world (or even other industries) sum up the problems faced. Equally, where new fields are being discovered in the North Sea (Alvheim, Johan Svedrup), they tend to be located in Norwegian waters. The majority of British oil fields date back to the 1970’s, meaning that increasingly difficult and innovative (read costly) exploration techniques are required to maintain satisfactory production yields. No amount of innovation however, can hide the fact that production in the UK North Sea has been declining since the late 1990’s, so that today less than 1m barrels per day (bpd) is being produced (from a peak of 5m bpd in 1998). That is a big reduction in a relatively short period of time and, most tellingly, it is a decline in production that has largely taken place in a high-price oil environment, ie, the decline started long before the current crisis engulfing the industry. So arguably the current low prices are merely hastening the end of an already terminal patient.

The catastrophe facing the UK Offshore Industry is also a catastrophe for the UK Treasury. In certain years, this traditional economic stalwart of UK plc has accounted for almost 20% of all corporate tax raised and since the 1960’s, it has generated over £300bn for the Exchequer. Having been as high as £10bn in 2010, oil and gas tax revenue is expected to be only £150m in 2016 and a £9.85bn drop in income is pretty tough for a Government still chasing its dream of reducing the deficit. This massive drop in revenue by the way, would have also blasted a big hole in the spending plans of a newly created Scottish State, had they voted for independence in 2014 – particularly when you consider the current national budget of Scotland is circa $40bn. And then there are jobs. In 2014, the UK Oil & Gas industry directly and indirectly supported 450,000 jobs in the UK. Latest figures show a drop in employment of circa 75,000 across all offshore sectors – a figure much higher than the job losses being experienced in the UK steel industry, but news that has received considerably less fanfare.

These really are tough times for the UK’s upstream oil industry and with such low volumes when compared to the “big boys” (13m bpd in USA, 10m in Saudi, 9m in Russia and even 1.5m in Norway), North Sea oil production in Britain could genuinely slip off the oil producing map. This would be huge news domestically, but the emotional truth is that the loss of North Sea oil would make no odds to a world already drowning in over supply. Perhaps the only comfort we can take at the current juncture is that the industry has survived low prices before and come back stronger. Plus Aberdeen is now a world leader in so many more areas than simply oil extraction. Centres of technical excellence abound in all things offshore, be they in wind-power, cabling, geological surveys, transportation and the grandest paradox of all – in rig decommissioning! In fact, if this is to be the beginning of the end for North Sea oil production, then the greatest projects arguably lie ahead, because decommissioning of oil rigs will require billions of pounds and years of work. As the first developed economic country to deal with multiple rig decommissioning on a grand-scale, it would be entirely logical for this expertise to be successfully exported around the world in the future. So best not write off the granite men and women of Aberdeen just yet…