Oil prices: scraping the barrel?

As the cost of Brent crude plummets to a four-year low, the North Sea industry is at a crossroads, writes Kristy Dorsey

Although oil prices rose slightly on Friday, 86 dollars a barrel represents a decline of more than 20 per cent since June. Picture: AP
Although oil prices rose slightly on Friday, 86 dollars a barrel represents a decline of more than 20 per cent since June. Picture: AP

DOGGED by slowing demand and oversupply, oil prices have fallen to lows not seen in four years, sending economic and political shock waves around the world.

Brent crude closed out its fourth weekly loss in a row on Friday, having tumbled by nearly four dollars on Tuesday alone.

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That decline – brought about by suggestions that production giant Saudi Arabia will not step in to defend prices at $100 per barrel – left the benchmark at less than $86, a decline of more than 20 per cent since June.

All of this came just days after a report warning of a substantial decline in investment in the North Sea, the primary financial battleground in last month’s vote on independence. Accountancy firm Deloitte found that just four offshore UK deals were announced during the three months to September, down from 14 in the same period a year earlier.

“Uncertainty” was cast as the culprit, with firms said to be biding their time until further details on regulation and taxation in the North Sea are clarified. But with disruption and further possible ructions throughout the wider market, surety remains on the distant horizon.

Alex Kemp, professor of petroleum economics at the University of Aberdeen, says there is “no doubt” that mature regions such as the North Sea are highly sensitive to the price of oil. Activity in the field is funded by cash flow, and when that gets squeezed, everything slows down.

This comes on top of the fact that North Sea operators have already shifted down several gears in advance of the implementation of the Wood Review, part of which includes setting up a new regulator for the sector. The industry is also awaiting what it hopes will be favourable tax changes when Chancellor George Osborne delivers his Autumn Statement on 3 December.

“There is no doubt about it, the industry is at a crossroads, and with the price fall it is that much more dramatic,” Kemp says.

Mike Tholen, economics and commercial director at Oil & Gas UK, says the recent fall in prices has “put things into sharp and clear focus” for the industry. Companies are cutting costs, but without a reduction in the minimum headline tax rate of 62 per cent, he warns that much of the extraction in the North Sea will become unviable.

“At the start of the year, when no one anticipated the current price dynamic, there were already signs that investment was falling away,” Tholen says.

“This is an industry that is under some pressures that have not gotten any easier as prices have fallen, because costs are continuing to go up even as production declines. There are some newer developments in the North Sea that would withstand lower oil prices for some time, but for the most part, by the time you get to $80 and below, we have got some parts of the North Sea that are starting to feel very uncomfortable.”

Should low prices continue, the Chancellor will come under increasing pressure to give the industry what it says it needs. And looking at the global picture, there seems little if anything that will prop up prices in the short to medium-term.

The price of oil has been fairly stable for the past four years, averaging about $110 per barrel. While the Arab Spring disrupted supplies from exporters such as Nigeria, Syria and Yemen, production from other parts of the world – led by the shale revolution in the United States – helped fill those shortfalls.

This balance has been upended by a weak global economy, with the likes of Japan and Germany both suffering a fall in gross domestic product during the second quarter of this year. Slower growth in China, a comparatively weak recovery in the US and similar situations elsewhere have forced the International Monetary Fund to cut its global growth projection three times this year, the last one being a drop to 3.3 per cent earlier this month.

Weaker growth means less demand for energy. According to projections last week from the International Energy Agency, global demand for oil is likely to rise by just 700,000 barrels per day (bpd) this year, 200,000 bpd fewer than it was predicting only last month.

While weak demand has come as a surprise, the glut of supply has not. The world’s total output of oil has been rising strongly since April last year as US shale production has surged and countries such as Libya have come back on stream.

This is historically a juncture where the Organisation of the Petroleum Exporting Countries (Opec) would cut shipments to bolster prices, but here again the portents are ambiguous.

Kemp notes reports that Saudi Arabia, the largest producer within the Opec oil exporters’ club, seems happy for the moment to let prices fall. The kingdom has even cut its charges on shipments to Asia in what the professor says is a bid to protect its market share in that part of the world.

This move will eat into Saudi Arabia’s revenues, but the kingdom has reserves to withstand this for a while. However, other Opec members who have hiked their domestic budgets in the wake of the Arab Spring will be pressing to cut production when the cartel meets again next month.

“It is a very dangerous strategy, because it could lead to at least the temporary dissolution of Opec,” Kemp says. “In that situation, the oil price could fall even further.”

Black gold: The story so far

» Natural gas was discovered in the North Sea in 1965, when BP drilled in the West Sole prospect.

» Oil was uncovered in the North Sea in 1970 when BP’s semi-submersible rig Sea Quest discovered the 50 square mile reservoir now known as the Forties field.

» To date, about 42 billion barrels of oil have been extracted from the North Sea.

» Perhaps as many as 24 billion barrels remain untapped, though much of this is in locations where drilling is increasingly difficult and expensive.

» The industry employs roughly 440,000 people across the UK, about half of whom are in Scotland.

» Since the 1970s, 11,000 wells have been drilled in UK waters including those for exploration, appraisal and production.

» There are 281 North Sea platforms, which either float or are fixed to the seabed on legs. About half of these are normally unmanned.