Business Outlook 2018

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BUSINESS OUTLOOK 2018

Contents

1. 2. 3.

Foreword

5 6 8 9

Key Performance Indicators

Market Outlook

3.1 3.2 3.3 4.1 4.2 4.3 4.4 4.5 5.1 5.2 5.3 5.4

Oil Markets Gas Markets

12 14 16 17 21 22 24 25 26 27 29 35 36

Mergers and Acquisitions

Supply Chain Outlook

Financial Performance

Insolvencies 2018 Outlook

Share Price Performance

Employment

Exploration and Production Outlook

Production Expenditure Profitability

Drilling Activity

BUSINESS OUTLOOK 2018

The UK Oil and Gas Industry Association Limited (trading as Oil & Gas UK) 2018 Oil & Gas UK uses reasonable efforts to ensure that the materials and information contained in the report are current and accurate. Oil & Gas UK offers the materials and information in good faith and believes that the information is correct at the date of publication. The materials and information are supplied to you on the condition that you or any other person receiving them will make their own determination as to their suitability and appropriateness for any proposed purpose prior to their use. Neither Oil & Gas UK nor any of its members assume liability for any use made thereof.

1. Foreword W elcome to Oil & Gas UK’s 2018 Business Outlook , which draws on market intelligence from across the sector to present industry performance and highlight future expectations for the UK Continental Shelf. As I reflect on the findings in this year’s report, it is evident that this industry is adapting effectively to a very demanding business environment and is now in a more competitive position as a result. The sector continues to show remarkable resilience. It is fitter and leaner than many could have imagined four years ago. This is testament to the ingenuity and innovation of our people that such progress has been achieved so rapidly and with such commitment. Our report shows the statistics that reflect this change. It is impressive to see that unit operating costs have halved and that production is 16 per cent higher than 2014. However, for me, it is the change in culture and mindset now gaining momentum that is compelling. This shift is key to the long-term health of the industry that is dependent on the whole supply chain – operators, contractors and suppliers – working together to maximise value from the basin, generating a healthy return for all stakeholders in the process. However, it’s important that we do not underestimate that many areas of the supply chain are still dealing with the consequences of the downturn and have yet to benefit from any upturn in activity. Although I believe that the underlying oil and gas services sector we have here in the UK is one of the best in the world, the resilience of the wider supply chain remains a concern and will be an important focus for Oil & Gas UK in 2018. A reinvigorated supply chain, competitive and eager for new business both in the domestic market and overseas, is a key part of our vision for this industry, but to realise its potential there is of course more work to be done. There are positive signs of capital investment returning to the UKCS. This report highlights 12-16 greenfield or major brownfield projects up for sanction this year. These could lead to development spend of around £5 billion yielding more than 450 million boe over time. While encouraging, it is important to recognise that the reserves within these projects are equivalent to less than one year of production from the UKCS. It is therefore essential that we find ways to sustain this level of investment year-on-year to avoid further downward pressure on production. Working closely with HM Treasury and the Oil and Gas Authority, we have delivered a much more globally competitive fiscal and regulatory environment that complements the excellent work of companies and of the industry-led Efficiency Task Force. Together, these factors have made the UK a very attractive basin. The $8 billion worth of merger and acquisition activity last year did not come as a surprise to me and underlines that the UKCS is attracting interest from investors from all over the world. The next generation of development projects must come from a mix of both new exploration success and the continued reassessment of opportunities we are already aware of. Increasing recovery from existing assets is a part of the business where the deployment of innovative technology has a vital role to play, for example, the enhanced oil recovery project at Chevron’s Captain field. Long-term production decline is not inevitable, as the basin has already shown by reversing a previous trend of 14 consecutive years of falling output. However, a fresh mindset is essential if the industry is to unlock some of the more challenging opportunities. Oil and gas remain a vital part of the UK economy and will form the majority of our primary energy needs for many years to come under any credible scenario. As we move to a lower-carbon economy, the UK needs to meet as much of its domestic demand for oil and gas from indigenous resources as possible. This will ensure security of supply, revenue for the Exchequer, the sustaining of hundreds of thousands of highly-skilled jobs and the deepening of the base from which to increase export opportunities for the supply chain. These factors are all at the heart of our industry’s Vision 2035 that sets out a great future for this sector and how it can benefit the UK and support its energy transition. The energy market moves quickly, but if we are ambitious in what we want to achieve, we will remain relevant and successful for many decades to come.

Deirdre Michie, Chief Executive, Oil & Gas UK

BUSINESS OUTLOOK 2018

2. Key Performance Indicators

Forecast ‘18 Our outlook explained

‘14 ‘15 ‘16 ‘17

Year-On-Year % Change

Positive - A combination of production efficiency

517 571 598 598 620-640

Total Production (million barrels of oil equivalent)

improvements and new fields are driving production increases after 14 consecutive years of decline.

0% +11% +5% 0% +5%

Positive - All 12 of the new field start-ups in 2017 have a majority oil composition, which

311

352

371

368

395-405

Liquids Production (million barrels of oil equivalent)

is expected to support production growth over the next two years.

-1%

+13%

+5%

-1%

+9%

Positive - The start-up of Cygnus in late 2016 and depletion of cushion gas from the Rough storage facility are helping to maintain flat gas production in 2018.

206 220 228 230 225-235

Net Gas Production (million barrels of oil equivalent)

+1% +7% +4% +1% 0%

Positive - More than £5 billion of new capital projects could be approved this year, providing much needed new business for the supply chain.

2 12-16

New Field Approvals

-20% -38% -60% 0% +600%

Neutral - Fresh investment in 2018 could see capital expenditure increase for the first time in four years, despite the recent completion of a number of major projects and capital efficiency gains. Neutral - After a trend of poor project execution, operators have improved efficiency and are now routinely delivering projects on time and under budget. Neutral - A small increase in operating costs is likely this year as exploration and production companies look to carry out previously deferred activities and maximise opportunities to improve recovery rates. Neutral - Unit operating costs are set to remain flat in sterling terms this year, although a weaker dollar may result in a slight increase in dollar terms.

15 11.7 8.3 5.6

5.5-6.0

Capital Expenditure (£ billion) a

+3% -22% -29% -33% +3%

23.8 15.1 12.6 c

11.8 c

13-15

Unit Development Costs ($/barrel of oil equivalent) a,b

-22% -36% -16% -7% +19%

9.8 8.3

7-7.5

Operating Expenditure (£ billion) a

+7% -15%

-16%

0% +4%

29.6 21.0 15.2 15.2 15.8- 16.4 -1% +13% -29% -27% +6%

Unit Operating Costs ($/barrel of oil equivalent) a

a. All data shown in 2017 money. b. Refers to the average unit development costs of projects approved within year. c. 2016 and 2017 may not fully represent the long-term outlook due to the nature and low number of field approvals. d. Including geological sidetracks but not mechanical sidetracks or respuds.

Forecast ‘14 ‘15 ‘16 ‘17 ‘18 Our outlook explained

Neutral - Decommissioning expenditure is expected to remain within £1.7-2 billion per year through to 2020.

1.1

1.2

1.8

1.7-1.9

Decommissioning Spend (£ billion) a

-6% +2% +11% +48% 0%

Although the spot price briefly surpassed $70/bbl in January 2018, futures contracts for 2020 delivery are still sub-$60/bbl. new capital and operational spend in 2018, although a lack of cash flow remains a major concern for many companies. Challenging - After one of its toughest periods, the UK supply chain is well placed to maximise Challenging - Development drilling has fallen sharply, partly due to the deployment of technologies enhancing drilling efficiency, but also because only the most profitable wells are being drilled. Challenging - Exploration wells are expected to fall in 2018 due to intense international competition for capital, although there is a healthy mix of wildcat and infrastructure-led opportunities. Challenging - Limited exploration success in recent years has been the primary factor behind the fall in appraisal activity. Challenging - Although start-ups are set to fall this year, Clair Ridge and Mariner are two of the largest in the last decade and are expected to provide more than 160,000 barrels per day of oil at peak production rates.

4-6

New Field Start-Ups

-69% +100% +13% +33% -58%

14 10-12

Exploration Well Count d

-13% 0% +8% 0% -21%

7-10

Appraisal Well Count d

-38% -28% -38% +13% -6%

126 129 88

71 70-80

Development Well Count d

+5% +2% -32% -19% +6%

40.9 35.7 30.2 27.4 25-30

Supply Chain Revenues (£ billion)

+4% -13% -15% -9% 0%

99 52.5 43.7 54.2 55-65

Brent Oil Price ($/barrel)

-9% -47% -17% +24% +11%

Volatility and seasonal swing have returned to the NBP gas market in 2017-18, driven by a cold winter, lack of domestic storage and unplanned outages across Europe.

50 42.6 34.6 45 40-50

National Balancing Point Day-Ahead Gas Price (pence/therm)

-26% -15% -19% +30% 0%

BUSINESS OUTLOOK 2018

3. Market Outlook

In Summary I t was a tale of two halves for oil markets in 2017. The first half of the year saw the Brent spot price settle in the $45-55 per barrel (bbl) range, with the relative stability and increased confidence in the basin being the catalysts in unlocking a wave of mergers and acquisitions (M&A). The second half of the year, and particularly the last quarter, was characterised by rising prices that eventually saw Brent surpass $70/bbl in early 2018 for the first time in three years. This will have provided a welcome short-term boost to margins for exploration and production (E&P) companies on the UK Continental Shelf (UKCS), although the oil price has since fallen back to $65/bbl. The National Balancing Point (NBP) gas market gave gas producers a similar boost last year. The average day-ahead price finished at 45 pence per therm (p/th), around 30 per cent higher than in 2016. With some European gas contracts still linked to oil prices, it was the second half of the year where the gains were made as rising oil prices fed through to the NBP gas market. This was heightened by local factors such as a cold winter, a reduction in the UK gas storage capacity and unplanned outages across Europe, which drove the gas price up beyond expectations during the 2017-18 winter months. The question moving forward is will the recent price increases hold over the next couple of years? Growing US production, the threat of falling OPEC quota compliance and fears that global economic growth may slow are currently limiting contracts for future delivery of Brent to sub-$60/bbl in 2020. Although caution remains over longer-term price expectations, it is encouraging that a new mix of investors in the UKCS have already shown a willingness to deploy capital as they look to generate maximum value from their newly acquired assets. 3. Market Outlook are expected to stabilise in 2018 Brent oil price averaged $54.2/bbl in 2017 25% up on 2016 £ although free cash flow remains a major concern 3. Market Outlook Brent oil price averaged $54.2/bbl in 2017 25% up on 2016 Although the Brent spot price briefly surpassed $70/bbl in January 2018, future co tracts for deliv ry b yond 2019 remain at sub-$60/bbl

Brent oil price averaged $54.2/bbl in 2017

25% up on 2016

4. Supply Chain Outl Although the Brent spot price briefly surpassed $70/bbl in Ja uary 2018, futur contracts for

Supply chain revenues are expected to stabilise in 2018 £ although free cash flow remains a major concern delivery b yond 2019 remain at sub-$60/bbl

4. Supply Chain Outlook Supply chain revenues

The NBP day-ahead gas price averaged 45 p/th in 2017

5. Exploration &Prod The average share price of supply chain

Around companies active on the UKCS increased by 30% higher than 2016 of post-tax cash flow was generated on the UKCS in 2017, more than in any year since 2011 8% in 2017

8 4. Supply Chain Outlook Supply chain revenues

3.1 Oil Markets After starting 2017 at little over $50/bbl, the Brent spot price showed solid gains through the second half of the year surpassing $70/bbl in January 2018 for the first time in over three years, though it has since fallen back to $65/bbl. This has resulted in an average annual price of $54.2/bbl in 2017. Oil producers have benefitted from the upturn and any additional cash generation from existing operations will increase the likelihood of new capital projects proceeding on the UKCS. While new activity should be good news for the domestic supply chain, it must be acknowledged that the paydown of debt – prioritising returns to investors and overseas projects – will provide stiff competition for capital allocation within E&P companies.

Figure 1: Average Monthly Nominal Brent Spot Price

140

120

100

Average Monthly Nominal Brent Spot Price ($/bbl)

2010

2011

2012

2013

2014

2015

2016

2017

2018

Source: EIA

The recent rise in price has been driven by both supply and demand. On the supply-side, high compliance with OPEC production quotas and the gradual drawdown of oil inventories have had an impact. Oil demand grew by 1.6 million barrels per day last year, driven by strong real GDP growth of 3.6 per cent for 2017 1 as most of the world’s biggest economies outperformed start-of-year expectations. This has been complemented with a weaker US dollar increasing the purchasing power of global consumers of oil.

1 Source: IMF Data Mapper

BUSINESS OUTLOOK 2018

While the USD/GBP exchange rate averaged 1.29 during 2017, it reached an annual high of 1.35 in December and surpassed 1.40 in January 2018. Although a weaker dollar tends to have a positive impact on oil prices, there are downsides for the domestic industry. UK producers with a local cost base will find their revenues are worth less in sterling terms and supply chain companies with a propensity to export will be less internationally competitive as the pound strengthens, albeit many companies will hedge against currency fluctuations.

Figure 2: Exchange Rate

1.8

1.7

1.6

)PBG ot DSU( etaR egnahcxE

1.5

1.4

1.3

1.2

1.1

Source: Bank of England

Despite short-term growth, the futures market has moved into backwardation, whereby contracts for future delivery of Brent are trading at a discount to the current spot price, as shown by Figure 3 opposite.

Figure 3: Monthly Brent Crude Futures

Monthly Brent Crude Futures ($/bbl)

2018

2019

2020

2021

2022

2023

2024

2025

2026

Source: CME Group

There are three primary factors behind this trend that may limit oil price growth over the rest of the decade and into the 2020s:

• North-American supply – prices in excess of $60/bbl encourage the activation of more rigs and therefore greater production from the shale plays across the US. This could effectively act as a price ceiling, with low fixed costs allowing operators control over whether they increase or slow supply in accordance with price.

• OPEC behaviour – the incentive for countries to comply with their production quotas becomes less appealing at higher prices, which in turn increases supply to the market.

• Global economic growth – there is uncertainty over whether the exceptional economic performance of 2017 can be maintained. Growth in major economies, including China and the US, may slow in 2018 and 2019, therefore reducing oil demand growth.

BUSINESS OUTLOOK 2018

Looking at the longer-term outlook, there are wide-ranging views on how the energy market will evolve and what this means for oil demand. Figure 4 shows a range of future oil demand scenarios, showing growth continuing well into the 2030s. Even in the fastest transition scenario, whereby the two-degree global climate change target is met, oil demand continues to grow until the late 2020s, highlighting the key role oil must play in the energy mix, even in a lower-carbon economy.

Figure 4: Oil Demand Scenarios

120

100

Evolving Transition Scenario

Fastest Transition Scenario (where climate change targets are met)

Oil Demand (Million barrels per day)

Supply With No Further Investment

1970

1980

1990

2000

2010

2020

2030

2040

Source: BP Energy Outlook 2018

The longer-term viability of alternatives to fossil fuels will gradually have a bigger impact on oil markets and depend primarily on political decision making, infrastructure requirements, the provision of subsidies, the cost of supply and the impact of energy efficiency gains on demand.

3.2 Gas Markets

The average day-ahead gas price for 2017 was 45 p/th, a 30 per cent increase on the 34.6 p/th average gas price of 2016.

2017 started off with high gas prices, with exports to France reaching capacity to meet extra demand due to the country’s reduced nuclear capacity. The first quarter also saw the outage extended at Rough, the UK’s largest gas storage facility. This eventually led to Centrica Storage announcing the permanent closure of the facility later in the year.

After a summer dip in prices, the NBP day-ahead and month-ahead markets both entered a winter upturn that appears to be more pronounced in 2017-18 than in recent years. Traditionally, higher winter gas demand resulted in the UK becoming a much larger producer from the UKCS and net-importer from the continent than it is during the summer months, therefore driving up prices. However, the UKCS now meets a smaller proportion of domestic gas demand than it once did, and diverse sources of gas are more widely available through liquefied natural gas cargoes, interconnectors with Europe and domestic gas storage. This has led to the price differential between summer and winter months narrowing over the last decade until this year. Reduced storage capacity and a colder winter appear to be the leading structural causes for the return to seasonal swing in traded gas prices. In addition, there were some unexpected outages, most notably the explosion at Austria’s Baumgarten gas hub, which is a key distributor of gas across Europe, and the closure of the Forties Pipeline System in December, which led to around 20 per cent of UKCS gas production being shut-in. A combination of all these factors drove the average NBP day-ahead gas price to almost 60 p/th during December 2017. The cold snap, combined with unexpected supply disruptions, led to within-day prices exceeding 300 p/th in February 2018 – the highest in 12 years.

Figure 5: Average Monthly Day-Ahead NBP Nominal Gas Prices

100

Average Monthly Day-Ahead NBP Gas Prices (p/th)

2010

2011

2012

2013

2014

2015

2016

2017

2018

Source: ICIS Heren

BUSINESS OUTLOOK 2018

3.3 Mergers and Acquisitions

As confidence in the UKCS increased and the futures market stabilised, valuations between prospective buyers and sellers began to converge, enabling a wave of M&A activity.

The value of UK upstream M&A deals announced last year surpassed $8 billion (total UK traded value only) as counterparts reached innovative commercial deals to overcome potential barriers such as decommissioning liabilities.

Figure 6: Mergers, Acquisitions and Asset Deals involving UKCS Companies 2

Corporate Acquisition

Corporate Merger

Corporate Acquisition

Asset Deal (Bruce, Keith, Rhum)

Asset Deal (Wytch Farm)

Corporate Merger

Asset Deal (Magnus, Sullom Voe Terminal)

2 Figure 6 shows UK upstream M&A deals with an estimated UK traded value of at least $100 million. Please note that some of these deals are yet to be formally completed.

Although there has been a trend towards divestment from majors and investment from smaller independent companies through private equity finance, there were a variety of deal types and sizes last year that offer a real sign of confidence in the UKCS. While the majors have often been the sellers in recent M&A deals (with the exception of the Total takeover of Maersk Oil), they have retained their stake in assets they consider core to their portfolios. They are not seeking to exit the UKCS and still view it as a basin of strategic importance. Meanwhile, on the purchasing side, private equity vehicles and independently backed companies are increasingly investing in the UKCS with a view to creating value by driving efficiencies within producing assets and enhancing their portfolios through the appraisal and progression of future development prospects. This has added to activity levels at a time when the domestic supply chain needs it most. The world-class domestic supply chain is one of several factors that makes the UKCS an attractive destination for potential investors, along with a competitive fiscal regime, a more co-operative business culture, straightforward access to markets, relative geopolitical stability and an exceptional geological understanding that shows up to 20 billion barrels of oil equivalent (boe) are yet to be recovered from the basin.

Oil & Gas UK expects M&A to continue during this year, albeit on a lesser scale than in 2017, as many new owners work hard to maximise value from their newly acquired portfolios.

BUSINESS OUTLOOK 2018

25% up on 2016

4. Supply Chain Outlook

3. Market Outlook

4. Supply Chain Outl

In Summary T he UK oil and gas services sector has faced some of its toughest times as revenues fell by more than £10 billion from 2014-16. However, latest data show that EBITDA (Earnings Before Interest, Taxation, Depreciation and Amortisation) fell by a comparatively modest £1.7 billion on average over the same period. This highlights the excellent, but very challenging, work by companies to adapt to the difficult environment by managing their cost base. Innovations in digital and technology, diversification into other related sectors, increased activity through M&A, and other structural and organisational changes have been vital in helping supply chain companies sustain their businesses in the difficult climate. Despite these improvements, free cash flow for supply chain companies remains a major concern, with longer payment terms regularly imposed by their customers and some of the costs of restructure reported as exceptional capital items (therefore not captured within EBITDA). As expenditure and activity levels on the UKCS are now expected to pick up, share price data indicate that confidence is returning to the supply chain. The average share price of a representative group of listed oil and gas service companies has been on an upward trend since mid-2016 and has now almost recovered back to 2013 levels. The decline in the number of jobs supported by the industry slowed last year reaching 4 per cent, which compares with a total drop of 35 per cent since the downturn. This suggests that the largest workforce reductions might be behind us, although some companies are still reducing their headcount. The challenge of replacing lost skills and competencies is beginning to feature again in companies’ risk profiles, particularly those with expertise in new project development, subsea activity, rig and well services, and maintenance and turnaround work. Supply chain revenues are expected to stabilise in 2018 Around Brent oil price averaged $54.2/bbl in 2017 25% up on 2016 £ although free cash flow remains a major concern 3. Market Outlook 4. Supply Chain Outlook Supply chain revenues are expected to stabilise in 2018 The average share price of supply chain companies active on t e UKCS increased by Brent oil price averaged $54.2/bbl in 2017 25% up on 2016 Although the Brent spot price briefly surpassed $70/bbl in January 2018, future contracts for delivery beyond 2019 remain at sub-$60/bbl 8% in 2017 £ although free cash flow remains a major concern

Supply chain revenues are expected to stabilise in 2018 £ although free cash flow remains a major concern Although the Brent spot price briefly surpassed $70/bbl in January 2018, future contracts for delivery beyond 2019 remain at sub-$60/bbl

4. Supply Chain Outlook

5. Exploration &Prod The NBP day-ahead gas price averaged 45 p/th in 2017

Around The average share price of supply chain companies active on the UKCS increased by 30% higher than 2016 of post-tax cash flow was generated on the UKCS in 2017, more than in any year since 2011 8% in 2017 At least 12 new developments – worth around £5 billion of capital investment – are expected to be sanctioned in 2018 62% of supply chain companies surveyed by Oil & Gas UK have a more positive outlook for 2018

5. Exploration &Production Outlook

of post-tax cash flow was generated on the UKCS in 2017, more than in any year since 2011

4.1 Financial Performance

Figure 7 shows how revenues fell across each sector of the supply chain in 2016 – the most recent year for which firm data is available – by a total of 15 per cent to £30.2 billion.

Although 2017 was viewed by many as the beginning of the recovery for the upstream sector, there is a lag in this translating into revenues across the supply chain. While a survey of Oil & Gas UK members indicates that around one-third of companies reported an increase, total revenues are likely to have fallen again in 2017, albeit to a lesser extent than in previous years.

Figure 7: Supply Chain Revenue by Sector

Potential Upside on Forecast Total Forecast Reservoirs Support and Services Wells Services Marine and Subsea Facilities

Turnover (£ Billion - 2017 Money)

2010

2011

2012

2013

2014

2015

2016

2017

2018

Source: EY

BUSINESS OUTLOOK 2018

With cost-effectiveness the primary focus for many operators during 2015 and 2016, it was commonplace for activity that did progress to feature tighter work-scopes. Although the performance of individual companies was extremely wide-ranging, Figure 8 shows that the supply chain was, on average, able to maintain a positive EBITDA margin at around 8.5 per cent in 2016. This suggests that the supply chain has also been able to reduce its costs and improve efficiencies during the period of low activity, but the free cash flow position of many businesses remains a major concern. Restructuring costs are usually classified as exceptional items and therefore have a material impact on cash flow and profitability, but are not picked up within EBITDA. Furthermore, many customers are now extending invoice payment periods to preserve their own cash flow positions – a behaviour that accentuates issues further into the supply chain.

Figure 8: UK Supply Chain Revenue Margins

11.0%

Costs

EBITDA EBITDA Margin

10.5%

10.0%

noilliB £( seuneveR niahC ylppuS - Nominal)

9.5%

9.0%

Average EBITDA Margin

8.5%

8.0%

2010

2011

2012

2013

2014

2015

2016

Source: EY

Performance has varied both across and within different sectors of the supply chain 3 . Capital available for investment in exploration activity has been constrained worldwide, resulting in increased competition for work in the reservoirs sector. The global and mobile nature of this sector means it has the highest exports as a percentage of total turnover, although this has fallen from a high of 64 per cent in 2011 to 53 per cent in 2016. The wells sector has also experienced intense competition due to low levels of drilling activity. It saw an overall drop in turnover of 20 per cent in 2016 – the largest of all the supply chain sectors. EBITDA margins appear to have held up better, but they do not consider financing costs and asset depreciation, which are significant for this sector in particular. There are tentative signs that rig demand may begin to increase gently through 2018, particularly for well intervention and plugging and abandonment campaigns, which should aid recovery. The facilities sector has historically had the lowest margins, but more consistent work due to the regularity of multi-year contracts, particularly in operations and maintenance. This has persisted through the downturn, although average margins dropped from 6.1 per cent in 2014 to 4.5 per cent in 2016 as many contracts were renegotiated. Parts of the sector have been targeting growth overseas, both within and outside of the oil and gas industry, helping turnover return to 2011 levels. Deferral, cancellation or phasing of capital expenditure have been the driving factors behind the decline in turnover in marine and subsea of 27 per cent between 2014 and 2016. However, exports have not been as badly affected in this area due to the highly technical and specialised nature of products and services. The well-earned reputation of the UK market in marine and subsea activity has played a key role in limiting revenue decline. This sector was the only one to achieve an increase in its average EBITDA margin in 2016, which has recovered to 2013 levels. The support and services sector comprises a wide range of businesses, many of which specialise in discretionary activities that often suffer from budget cuts during a downturn, such as consultancy services, IT and infrastructure upgrades, recruitment and non-essential training. This led to a fall in revenue of around one-third and a 2.2 percentage point fall in average EBITDA margin between 2014 and 2016, more than any other sector. In addition, it is harder for support services to diversify geographically due to the localised nature of the work.

3 All data relating to different sectors of the supply chain are taken from the EY Oilfield Services Report available at http://bit.ly/EYOFS18

BUSINESS OUTLOOK 2018

Figure 9: Impact of Downturn on Different Supply Chain Areas

Marine and Subsea

Support and Services

Reservoirs

Wells

Facilities

Least affected

Floating production storage units

Specialist steel and tubulars Engineering, operation, maintenance and decommissioning contractors

Catering/facility management

Health, safety and environmental services

Sea/air transport

Engineering support contractors

Laboratory services

Marine/subsea equipment

Warehousing/ logistics

Seismic instrumentation

Subsea inspection services

Recruitment

IT hardware/ software

Machinery/ plant design and manufacture

Well services contractors

Marine/subsea contractors

Energy consultancies

Engineering consultants

Well engineering consultancies Drilling and well equipment design and manufacture

Inspection services Specialist engineering services

Data interpretation consultancies

Structure and topside design and fabrication

Communications

Subsea manifold/ riser design and manufacture

Geosciences consultancies

Training providers

Most affected

Drilling contractors

Pipe lay/heavy lift contractors

4.2 Insolvencies During 2016, the number of insolvencies within the oil and gas industry reached an annual high of 40, according to statistics from the Department for Business, Energy & Industrial Strategy. A further 18 companies went through insolvency during the first three quarters of 2017. This data does not include companies that filed for insolvency outside of the UK. While a contraction in the market is somewhat inevitable following such a sharp downturn, there is a real risk that core capabilities and skills are being lost to other industries that cannot be replaced if activity picks up. If this trend continues, it may cause long-term structural damage to the UK supply chain and its ability to service both domestic and international markets in the future.

Figure 10: UK Oil and Gas Insolvencies

Support activities for petroleum and natural gas extraction Extraction of crude petroleum and natural gas

Number of Insolvencies

Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3 2010 2011 2012 2013 2014 2015 2016 2017

Source: BEIS

BUSINESS OUTLOOK 2018

4.3 2018 Outlook

Figure 11: Snapshot of Contractor Company Sentiment for 2018

This year the supply chain is set to benefit from increased operational spend and the largest amount of fresh capital activity in the basin since 2014 (see section 5.2 on expenditure). In a survey of 58 Oil & Gas UK supply chain companies, 62 per cent had a more positive outlook for 2018 than they had 12 months prior. Oil & Gas UK forecasts that supply chain companies will generate revenue of £25-30 billion during 2018, which could represent the end of three successive years of decline, as contracts are awarded for new work programmes. However, it must be noted that there is likely to be an imbalance across the supply chain, with project development, turnaround and maintenance, and subsea activity the areas where

Much better than 2017

Better than 2017

Same as 2017

Worse than 2017

Much worse than 2017

Source: Oil & Gas UK Supply Chain Survey

any upturn is likely to be most felt. Although revenues may stabilise in some sectors, EBITDA margins across the supply chain may continue to fall as many companies begin work on fresh activity where rates were negotiated during the downturn. There have been other impacts from the downturn that will continue to challenge contractors this year. Examples include longer payment terms impacting cash flows, consolidated work scopes limiting access for sub-contractors in the supply chain, and more expensive access to finance for service companies that have seen credit ratings fall.

Figure 12: Snapshot of Contractor Company Revenues

Generated Revenue, 2018 versus 2017

Generated Revenue, 2017 versus 2016

Increased by over 10% Decreased by 0 - 10%

Increased by 0 - 10% Decreased by over 10%

Remained flat

Increased by over 10% Increased by 0 - 10%

Remained flat

Decreased by 0 - 10%

Decreased by over 10%

Source: Oil & Gas UK Supply Chain Survey

In order to survive, the supply chain has had to adapt to the harsh business environment of the past three years by finding ways to work smarter, restructuring and consolidating their offerings with other businesses. It appears that those in the best position to come through the downturn are those that are: • Diversifying into tangential industries – by applying their expertise to reach new markets and sectors to unlock new revenue streams. Share Fair 2017, organised by Oil & Gas UK, for example, promoted new business and diversification opportunities in renewables and nuclear. Nevertheless, as confidence in the oil and gas sector improves, almost 50 per cent of Oil & Gas UK members expect the proportion of revenues from oil and gas activity to increase in 2018, suggesting a return to traditional core business.

Figure 13: Snapshot of Contractor Revenue from Oil and Gas Specific Business

Revenue from Oil and Gas, 2018 versus 2017

Revenue from Oil and Gas, 2017 versus 2016

Increased by over 20% Increased by 0 - 20%

Remained flat

Increased by over 20% Increased by 0 - 20%

Remained flat

Decreased by 0 - 20%

Decreased by over 20%

Decreased by 0 - 20%

Decreased by over 20%

Source: Oil & Gas UK Supply Chain Survey

• Exporting into new geographical areas – although average export revenues fell by 24 per cent from £16.2 billion in 2014 to £12.3 billion in 2016, the decline was less sharp than the fall in domestic revenues. There was a slight increase in exports as a percentage of turnover in 2016, and this is expected to rise further as companies diversify into other geographical regions. Exports are expected to account for 43 per cent of supply chain revenues in 2017. The long-term vision for the UK oil and gas industry involves increasing the UK’s share of the global oilfield services and technology market. Significant value can be unlocked by the supply chain growing an export business to become a global leader in mature basin management. • Driving technological and digital innovation – if a supply chain company can provide a solution to its clients that improves efficiency and reduces costs, it has typically been able to protect or grow market share. The Oil & Gas Technology Centre was established in October 2016, with £180million of funding to support new projects that have the potential to enhance all areas of the business. In its first year, the Centre co-invested £37 million in industry-led projects that initiated 72 technology solutions. This work demonstrates the industry's desire to embrace innovation to prolong the life of the basin.

• Merging, acquiring or setting up alliances – there has been consolidation across the supply chain, with companies seeking to buy-out competitors and/or enhance capabilities to offer a more integrated service.

BUSINESS OUTLOOK 2018

4.4 Share Price Performance

The market has responded positively to the increase in oil price and anticipated pick-up in activity this year with oil and gas supply chain companies seeing a general upward trend in share prices in the second half of 2017.

Figure 14 shows the share price performance of a sample of listed supply chain companies that have a strong UK presence across a number of sub-sectors. It is a positive sign that all sub-sectors have outperformed an indexed Brent price since 2013 with notable recovery since the trough in early 2016. On average, oil and gas supply chain share prices are now almost back to where they were at the beginning of 2013, before both the downturn and unprecedented highs in activity of 2014.

Figure 14: Share Price Performance of Supply Chain Companies

200

Support and Services

Facilities

Marine and Subsea

Wells Services

180

Sector Average

Oil Price

160

140

120

100

Index

2013

2014

2015

2016

2017

2018

Source: Yahoo Finance, Oil & Gas UK

4.5 Employment As reported in Oil & Gas UK’s Economic Report 2017 4 , the number of jobs supported by the oil and gas industry fell from 315,000 in 2016 to 300,000 last year. The 4 per cent decline, however, was the lowest in three years suggesting that companies are beginning to stabilise after tumultuous periods of restructure.

Figure 15: Snapshot of Contractor Company Employment Trends

Number of Employees, 2018 versus 2017 A survey of Oil & Gas UK members shows that around a third of companies reduced th ir headco nt in 2017, while just over a quarter increased their staff numbers. This is in line with the aggregate industry figures derived using a macro approach. Looking ahead to this year, the outlook is far more positive with 56 per cent of companies expecting their employee numbers to increase in 2018, while only 6 per cent are anticipating further reductions. Given a modest increase in operating expenditure is forecast this year (see section 5.2) and the capital associated with new development projects is expected to be at its highest in five years, more activity is likely to filter through to the service sector. However, some companies are already reporting challenges in recruiting people with the desired skillsets and right competencies. As a long-term solution to this, some companies are refining their trainee and apprentice schemes, with the recognition that these are vital to their sustained growth. Increased by over 10% Decreased by 0 - 10% Increased by 0 - 10% Decreased by over 10%

Number of Employees, 2017 versus 2016

Remained consistent

Increased by over 10% Decreased by 0 - 10%

Increased by 0 - 10% Decreased by over 10%

Remained consistent

Source: Oil & Gas UK Supply Chain Survey

Number of Employees, 2018 versus 2017

Increased by over 10% Decreased by 0 - 10%

Increased by 0 - 10% Decreased by over 10%

Remained consistent

Source: Oil & Gas UK Supply Chain Survey

4 Oil & Gas UK’s Economic Report 2017 is available to download at www.oilandgasuk.co.uk/economicreport

although free cash flow remains a major concern

BUSINESS OUTLOOK 2018 3. Market Outlook

25% up on 2016

4. Supply Chain Outlook Although the Brent spot price briefly surpassed $70/bbl in January 2018, future contracts for Supply chain revenues are expected to stabilise in 2018 delivery beyond 2019 remain at sub-$60/bbl

Brent oil price averaged $54.2/bbl in 2017

The NBP day-ahead gas price averaged 45 p/th in 2017

5. Exploration and Production Outlook

5. Exploration &Prod The average share price of supply chain

Around companies active on the UKCS increased by 30% higher than 2016 of post-tax cash flow was generated on the UKCS in 2017, more than in any year since 2011 8% in 2017 62% of supply chain companies surveyed by Oil & Gas UK have At least 12 new developments – worth around £5 billion of capital investment – are expected to be sanctioned in 2018 a more positive outlook for 2018

In Summary M ost E&P businesses appear to have strengthened over the last 12 months, with more free cash flow generated by the basin than in any year since 2011. Production efficiency improvements and the addition of new capacity resulted in flat production, despite some significant unplanned outages last year. Output is expected to grow over the next two years, before the lack of investment during the downturn begins to have an impact with the likely consequence that production reverts into decline. The investments made today will therefore be key to managing production performance in the 2020s. It is particularly encouraging that up to £5 billion of new capital projects could be approved this year, providing much needed new business for the supply chain. These developments have been boosted by significant efficiency gains on the UKCS over the last three years. It is crucial that this is built upon, both operationally and commercially, to continue to attract investment in new opportunities and extend the life of existing assets. Drilling remains an area of serious concern with less than 100 wells drilled on the UKCS for the first time since 1973 when the basin was still in its infancy. Development drilling has fallen by around 45 per cent in just two years, which is a particularly worrying trend for the future health of the basin. On the exploration side, although just 14 wells were drilled last year, at least five successful discoveries have already been announced that could carry a combined 350 million boe based on early estimates. Material improvements to non-technical factors, such as the fiscal regime, the cost base, access to infrastructure and commercial behaviours should enhance the value proposition of exploration drilling. However, early signs for 2018 suggest that many companies will opt to commit available capital to other parts of the business that pay back faster and offer more certain returns. Around of post-tax cash flow was generated on the UKCS in 2017, more than in any year since 2011 £ although free cash flow remains a major concern 4. Supply Chain Outlook 5. Exploration &Production Outlook Supply chain revenues are expected to stabilise in 2018 The average share price of supply chain companies active on the UKCS increased by Around At least 12 new developments – worth around £5 billion of capital investment – are expected to be sanctioned in 2018 25% up on 2016 of post-tax cash flow was generated on the UKCS in 2017, mor than in any year since 2011 8% in 2017 £ although free cash flow remains a major concern

5. Exploration &Production Outlook

Just 94 wells (71 development, 14 exploration and 9 appraisal) were spudded on the UKCS in 2017, the fewest since 1973

5.1 Production

UKCS production in 2017 was equal to that of 2016 at 598 million boe or 1.64 million boe per day (boepd), a continuation of the recent strong production performance on the UKCS.

Despite some start-up delays and challenges with new fields, a small production increase in 2017 was anticipated until the unexpected closure of the Forties Pipeline System (FPS) due to a technical issue in the last few weeks of the year. This led to a dip in production in December and a flat outturn for the year. This key piece of infrastructure carries around 40 per cent of total UKCS liquids production and is essential for over 20 per cent of UKCS gas production. Moreover, the system closure highlighted the importance of the oil and gas industry to the UK economy, with total domestic month-on-month industrial output falling by 1.3 per cent in December 2017, driven mainly by the FPS outage 5 .

Figure 16: Monthly Production

2014

2015

2016

2017

Production (Million boe)

Jan Feb Mar

Apr

May Jun Jul

Aug Sep Oct

Nov Dec

Source: OGA

Since 2014, production has increased by 16 per cent, reversing a 14-year declining trend. This improvement has been driven by a wave of new project start-ups and efforts to improve production efficiency 6 across the basin.

Over the past five years, the UKCS has seen production efficiency increase from 60 per cent in 2012 to 73 per cent in 2016, with further improvements expected for 2017. This basin-wide shift increased production by around 80 million boe between 2012-16, with the two-percentage point increase between 2015-16 contributing 33,000 boepd; equivalent to the output from the seventh largest producing field on the UKCS. These recent gains have been largely driven by continued reduction in plant-related losses, with improved compression system efficiency a key contributor 7 . 5 See http://bit.ly/IndexofProduction 6 Production efficiency is the total annual production divided by maximum production potential of an asset. 7 Guidelines to Maximise Compression System Efficiency are available to download at http://bit.ly/CompressionGuidelines

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