Economic Report 2018

ECONOMIC REPORT 2018

ECONOMIC REPORT 2018

Contents

1

1. 2. 3.

Foreword

5 6

Report at a Glance

Industry Context – Business Environment & Performance

8 9

2

3.1 3.2 3.3

Oil and Gas Markets

What do the Trends Mean for Industry? 15

The Role of Oil and Gas in a Changing Energy Landscape

16 20

3

3.4 3.5

Brexit

UKCS Exploration and Production Performance

22 24 25 28 31 36

3.6 3.7 3.8 3.9

Production Performance Industry Expenditure

4

Drilling Activity

Decommissioning Activity

4.

Vision 2035

5

4.1

UK Oil and Gas Industry – Contribution and Opportunity Adding a Generation of Productive Life to the Basin Doubling the Long-Term Opportunities for the Supply Chain Delivery - Converting Vision 2035 to Reality 41 37 38 39

4.2

6

4.3

4.4

5.

The UK Oil and Gas Industry – A Competitive Investment Proposition

7

42 43

5.1 5.2

UKCS Costs in Context

Industry Action to Sustain Cost Improvements – The Efficiency Task Force 50

5.3 5.4 5.5 5.6

Supply Chain Competitiveness Prospectivity and Resource Base UKCS Fiscal Competitiveness ‘The Changing Face’ of the UKCS

51 56 65 69 73

8

6.

Glossary

9

10

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.

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ECONOMIC REPORT 2018

1. Foreword

Oil & Gas UK’s 2018 Economic Report demonstrates that the UK offshore oil and gas industry, now in its sixth decade of production, can continue to transform and reinvent itself.

Industry is emerging from one of the most significant and challenging downturns and the steps taken to date in response to the collapse in oil price have delivered tangible results. However, pressures still remain, particularly on the supply chain and on drilling activity. The drive for competitiveness therefore remains central to the UK’s long-term success. Working closely with government and regulators, the sector has become more competitive and the foundations are being laid to add a generation of productive life to the basin. But we can never rest on our laurels as other basins also continue to make improvements. Recent fiscal and regulatory changes have helped to position the UKCS as one of the leading destinations for investment. Ensuring a stable and predictable fiscal regime will be key to maintaining this position, especially with Brexit approaching. Industry also needs to demonstrate it can continue to improve its business and operational efficiency. Taken together, these actions will enable us to remain on track to maximise economic recovery from the UKCS. Even with increased oil and gas prices, cost control and capital discipline remain high on operators’ agendas. As our report shows, companies are indicating that any new investments need to break even at lower prices, often in the region of $40-50/boe. All evidence shows investors will continue to favour a conservative outlook because of the ongoing volatility of oil price movements. The fact that six major new capital projects have received operator approval in the first eight months of the year, two more than 2016 and 2017 combined, demonstrates the basin’s improved competitiveness. Any increase in activity is positive news for companies across the supply chain, but many still face persistent challenges. Revenue and activity reductions in recent years have stretched cash flow and margins, resulting in a loss of capacity. Coming from such a low baseline of activity, there has to be concern around the ability of the supply chain to sustainably service an increase in demand. We must learn from the past and move away from the boom and bust of previous cycles. We cannot afford to return to a position of cost escalation and instability seen previously. However, increased demand for goods and services will naturally push some costs higher, and margins do need to recover across much of the supply chain. In response, through Oil & Gas UK’s Efficiency Task Force, industry is focussed on driving further efficiency improvements, without which the basin will become less competitive. Further collaboration and more innovative contracting strategies are examples of this new way of working. A healthy balancemust nowbe struck to ensure a sustainable trajectory for the industry. There is renewed confidence in the long-term future of the UKCS, outlined in Vision 2035. This shared ambition aims to add a new generation of productive life to the basin and double the opportunity for the supply chain. However, whilst production performance remains strong, there is serious concern around the longer-term impact of low rates of drilling. A 50 per cent decline in drilling activity over the last five years means real concern about the ability of industry to realise its potential. Allied to this and despite an increase so far this year, we need to continue to see more capital investments being committed to on the UKCS. The competitive foundations are in place, and we must now build upon this to support an increase in activity.

4

1

Behind all of this, of course, are the ingenuity and skills of our people, and the communities we work in. The long- standing importance of the industry in the UK’s economy is clear: it supports hundreds of thousands of skilled jobs across the UK; provides more than 60 per cent of our oil and gas needs; is a significant contributor to the balance of payments through export activity; and provides billions of pounds each year in taxes. Indeed, this sector will also play a leading role in transitioning to a lower-carbon economy. We can provide affordable secure energy for years to come which, through established and developing technologies, will help the UK meet national and international carbon reduction commitments. As this report shows, the steps we take now will ensure we remain competitive and successful for decades to come. Solid strides are being made and industry must remain steadfast on this road to ensure we can realise the ambition outlined in Vision 2035.

2

3

4

5

Deirdre Michie, Chief Executive, Oil & Gas UK

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7

8

9

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ECONOMIC REPORT 2018

2. Report at a Glance

$70 This is almost

than the first half of 2017 30% higher than the 2017 average 30% higher

During the first half of 2018, Brent oil price averaged more than

56 p/th

NBP day ahead gas price averaged in the first 6 months of the year

almost

over the last five years higher

20%

Production in the first half of 2018 averaged 1.7 million boepd and by the end of 2018 could be up

£10 bn this year, for the first time since 2010 41 development wells in the first half of the year However, the foundations are in place to spur increased activity

Increased commodity prices, strong production and continued cost discipline mean that free cash flow on the UKCS could be more than

Drilling activity is a serious concern, with figures at record-low levels so far this year:

4

5

Only appraisal wells were spudded in the first eight months of the year exploration and

6

£2.5 bn

of new capital investment

major projects gained operator approval in the first eight months of the year, potentially unlocking

E&P companies remain focused on sustaining the business and operational improvements seen in recent years relentlessly

Around two-thirds of the cost reductions are in industry's control

The oil and gas industry remains a significant contributor to the UK economy and has a vital role in the transition to a lower-carbon economy

Supply chain company revenues and margins have fallen. Further collaboration and innovative contracting models are needed to provide support

6

1

There are 10-20 billion boe still to be recovered from the UKCS

The people and skills to effectively service projects and operations

The UKCS has become much more cost-competitive Reductions in unit operating costs and unit development costs are the greatest seen across comparable basins

2

3

The availability of a robust and world-leading

4

supply chain to service the industry

The UKCS : an attractive investment proposition

The UKCS is now fiscally competitive After a decade of fiscal uncertainty, investor

5

6

confidence is returning

Access to finance is improving

7

There is a competitive regulatory regime in place – focused on Maximising Economic Recovery

The UKCS has the largest network of

8

infrastructure in place across comparable basins to service offshore developments

9

10

11

Industry is aligned behind Vision 2035 which outlines the potential to add a new generation of productive life to the basin and double the opportunity for the supply chain

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ECONOMIC REPORT 2018

3. Industry Context – Business Environment & Performance

In Summary D espite recent increases in oil prices, the UK oil and gas industry continues to operate in an ever-changing and challenging business environment. Variations in supply and demand coupled with political issues, both in the UK and internationally, contribute towards continued uncertainty in an industry which needs stability after the recent downturn in oil price. In addition, the global energy market is undergoing a transition towards a lower-carbon future. Oil and gas companies – and the wider energy industry – are reacting to this shift and are well-positioned to contribute positively towards this transition, whilst remaining a key component of the future energy mix. The challenging market conditions resulted in a fall in expenditure levels in recent years, as companies have looked to preserve cash flow and only invest in the most attractive opportunities. As a result, new project sanctions and drilling activity were at record-low levels in 2016 and 2017, with the trend in reduced drilling activity continuing into in 2018. However, there are signs that industry confidence is beginning to improve. There have been six final investment decisions taken on major new projects in the first eight months of the year, bringing a much- needed boost to supply chain companies. Production performance also continues to be strong and by the end of this year could be up by 20 per cent compared with five years ago. Meanwhile, unit operating costs have stabilised at around $15-16/boe. It is vital that industry continues to focus on its efficiency and competitiveness to ensure that more projects gain approval and provide further support to production volumes and the supply chain.

The oil and gas industry has a vital role The oil and gas industry has a vital role The oil and gas industry has a vital role

in the transition to a lower carbon economy in the transition to a lower carbon economy in the transition to a lower carbon economy E&P companies are relentlessly focussed on sustaining recent business and operational improvements E&P companies are relentlessly focussed on sustaining recent business and operational improvements E&P companies are relentlessly focussed on sustaining recent business and operational improvements

An increase in drilling activity is required to support production and the supply chain An increase in drilling activity is required to support production and the supply chain An increase in drilling activity is required to support production and the supply chain

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3.1 Oil and Gas Markets

1

Oil Market During the first half of 2018, Brent crude averaged $70.3 per barrel (bbl), 29 per cent higher than in 2017 ($54.2/bbl) and more than 60 per cent higher than in 2016 ($43.4/bbl). The increases so far this year were seen mainly during the second quarter (April to June), when prices averaged almost $74/bbl – the highest quarterly average since the fourth quarter of 2014 – and briefly hit $80/bbl in May for the first time in more than three years, before falling back to the low $70s more recently.

2

Figure 1: Monthly Brent Price

3

140

120

4

100

5

80

60

6

40

Dated Brent Nominal Price ($/bbl)

7

20

0

2010

2011

2012

2013

2014

2015

2016

2017

2018

8

Source: EIA

The oil market continues to be characterised by uncertainty around the balance between supply and demand. The International Energy Agency (IEA) has forecast that total annualised demand growth will increase by around 1.4 million barrels per day (bpd) throughout 2018. 1 Demand growth throughout the first half of the year was, in fact, greater than this (1.5 million bpd), largely driven by:

9

• Extremely cold weather conditions across Europe and the US • Increased refining demand in the US • Strong global economic performance within both OECD and non-OECD countries

10

This growth, however, is expected to slow to 1.3 million bpd throughout the second half of the year, as a result of the knock-on impact of higher oil prices and expectations of a slowdown in the economic growth outlook, particularly within non-OECD countries.

11

1 www.iea.org/oilmarketreport/omrpublic/

9

ECONOMIC REPORT 2018

Figure 2: Global Oil Supply and Demand Balance

100

Global Demand Global Supply

98

96

94

92

90

88

86

84

82

Global Oil Supply and Demand (Million Barrels per Day)

2010 2011 2012 2013 2014 2015 2016 2017 2018 Q1

Source: IEA

There are also persistent questions around the rate of global oil supply. This has been driven by factors including uncertainty around OPEC production caps, as well as the impact of the US’ decision to withdraw from the Iran nuclear deal inMay 2018 and the subsequent reinstatement of economic sanctions, including on Iranian oil exports. The effects of this are likely to be significant; Iran is the world’s fifth-largest oil exporter, having exported around 2.1 million bpd last year 2 , and when sanctions were first imposed on the country between 2012-15, exports were cut by more than 1 million bpd. Immediately after the US’ decision to withdraw from the Iran nuclear deal, Brent increased by more than 3 per cent to rise above $80/bbl, the highest level since 2014, although it has since fallen back. However, the long-term impact of the re-imposition of US sanctions on the global oil market is yet to be fully realised, with any US sanctions on Iranian oil exports likely to take effect from November 2018. As a result of the potential reduction in Iranian oil exports, there had been increased speculation that OPEC would ease previously agreed cuts on output in order to offset any global supply shortfall. OPEC members and non-OPEC participating countries, most notably Russia, agreed a cut in overall output of 1.8 million bpd at the start of 2017, and at the 173 rd meeting of OPEC in December 2017 it was agreed that the cuts would be extended throughout 2018. This was the first time that Russia had supported an OPEC supply reduction. This agreement ensured that combined output from OPEC countries would remain below 32.5 million bpd in an effort to stabilise market conditions. The reduced level was equal to around one-third of total global daily oil production during the first half of the year.

2 www.opec.org/opec_web/en/about_us/163.htm

10

In reality, total reductions in output from OPEC and non-OPEC participating countries have been around 20 per cent greater than the 1.8 million bpd target, largely due to production issues in Venezuela and declines in output from Mexico. At the 174 th OPEC meeting in June 2018, members and supporting countries agreed they would aim to increase total production to be in line with the agreed levels, effectively meaning that countries such as Saudi Arabia would be able to increase output to offset reduced production. This action has helped ease concerns around a disruption to Iranian exports and will add around 1 million bpd to global supplies during the second half of 2018, helping to balance the global market and increase stability. Although it may have been expected that increased supply would act to reduce oil prices, Brent crude prices increased by around 8 per cent in the week following the decision to increase OPEC supply.

1

2

3

OPEC The Organization of the Petroleum Exporting Countries (OPEC) represents the interests of 15 Member Countries, with the aim of bringing stability to the oil market whilst ensuring continued supply to consumers, continued income to producers and a fair return on capital for investors.

4

Membership of OPEC is open to countries with ‘substantial net exports of crude petroleum’ and which have ‘similar interests’ to other member countries.

5

Membership of the organisation has been subject to change in recent years. At its 174 th meeting in June 2018, the Republic of Congo (Brazzaville) gained Full Member status, following a request made in January. The country produced around 291,000 bpd in 2017 3 , and has targeted production of 350,000 bpd by the end of 2018, making it the third-largest producer in sub-Saharan Africa after Nigeria and Angola. Congo’s proved reserves stand at 1.6 billion bbls.

6

The addition of Congo also follows the admission of Equatorial Guinea in 2017, and the re-joining of Gabon in 2016.

7

The reduced OPEC supply throughout the first half of 2018 has largely been offset by strong non-OPEC production. IEA forecasts estimate that non-OPEC production could grow by almost 2 million bpd, driven largely by increases in output from US shale plays, where production has grown by 1.6 million bpd so far this year. The US’ rig count 4 , a good indicator of future US shale production, is up around 10 per cent on last year, and the onshore industry is also benefitting from improved well productivity and drilling efficiency. However, concerns persist around the continued longer-term growth in output of US shale oil. Capacity limitations are constraining many US onshore operators as access to infrastructure, drilling equipment and labour limit growth potential. Capital efficiency, as well as prioritising returns to shareholders, will also remain at the top of the operator agenda.

8

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3 www.bp.com/content/dam/bp/en/corporate/pdf/energy-economics/statistical-review/bp-stats-review-2018-full- report.pdf 4 phx.corporate-ir.net/phoenix.zhtml?c=79687&p=irol-rigcountsoverview

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ECONOMIC REPORT 2018

Gas Market Throughout the first half of 2018 the National Balancing Point (NBP) day-ahead gas price has averaged 56 pence per therm (p/th), up 29 per cent on the first half of 2017 (43.3 p/th) and 81 per cent higher than the first half of 2016 (30.9 p/th). This has largely been driven by a colder-than-average 2017-18 winter, with the so-called ‘Beast from the East’ storm bringing exceptionally low temperatures. On 1 March the National Grid issued a gas deficit warning for the first time in eight years. This period of increased gas demand coincided with supply disruption in continental Europe, resulting in reduced import availability. The combination of these factors led to in-day gas prices spiking at more than 300 p/th – the highest figure in 12 years.

Figure 3: Day-Ahead NBP Price

100

90

60 )mrehT rep ( ecirP saG ylhtnoM lanimoN PBN Pence 70 80

50

40

30

20

10

0

2010

2011

2012

2013

2014

2015

2016

2017

2018

Source: ICIS

Gas Market Performance Gas markets are, by their nature, more localised than oil markets, as consumption occurs predominantly in or near the area of production. Within the UK, all gas is delivered to the UK onshore network – the National Transmission System – where the majority is consumed domestically (with the exception of a few southern North Sea fields which deliver direct to the Netherlands). During summer months when domestic demand is low, some gas is exported through interconnectors to the European market, where it is re-sold. While there is generally a close correlation between oil and gas prices, the gas market is often affected by factors unrelated to the oil market such as weather/seasonal demand, storage capacity utilisation and the activity level of the global market for liquefied natural gas (LNG). This results in the gas market being more volatile than the oil market on a day-to-day basis. Environmental and cost pressures have driven the increased use of gas in power generation, making it a more economic and attractive alternative to sources such as coal. However, more recently, the displacement of gas for electricity generation by renewable sources has affected demand, as the support provided by contracts for difference (CFDs) has provided a route to large-scale investments in capacity.

12

Increasing renewable generation contributed to an overall demand reduction for natural gas of 2.6 per cent from 2016 to 2017. Warmer temperatures also further reduced demand in 2017, with consumption from domestic final users falling by 4.6 per cent in 2017 compared with 2016. Increased Flexibility in Supply Sources Indigenous natural gas production remained stable in 2017, despite unforeseen external factors such as the temporary closure of the Forties Pipeline System in December. However, there were significant additional volumes from the Rough storage facility in the southern North Sea that helped to manage the supply and demand gap. Rough is now producing its remaining gas reserves (cushion gas), before closure. In order to meet the gap between indigenous production and domestic demand, the UK imports natural gas, primarily from Norway (75 per cent of imports in 2017) via the Langeled, Tampen Link and Gjoa/Vega pipelines. Smaller volumes are imported from Belgium (6 per cent in 2017) via the UK-Belgium Interconnector (IUK) and the Netherlands (4 per cent in 2017) via the Balgzand to Bacton line.

1

2

3

4

Figure 4: UK Gas Supply Sources

120

Indigenous Production (Consumed Within the UK) Pipeline Imports LNG Imports Forecast Total Demand

5

100

6

80

7

60

40

8

20

9

0

UK Primary Gas Supply (Million Tonnes of Oil Equivalent)

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

2022

2024

2026

2028

2030

2032

2034

Source: OGA, Oil & Gas UK

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ECONOMIC REPORT 2018

The contribution of different sources of UK gas supply is shown in Figure 4. LNG imports fell by more than a third in 2017 – a sharper fall than the 20 per cent reduction between 2015 and 2016 – as improved UKCS production resulted in a reduced need for external supply and growing Far-Eastern gas demand drew higher margins for shippers. Most of the UK’s LNG imports are sourced from Qatar (84 per cent), however there are a range of more minor LNG sources including Algeria, Norway, Trinidad and Tobago, Russia and the US, providing further evidence of increased flexibility in the UK’s ability to use imports to meet demand. This improved flexibility was evident during the recent cold snap in the first quarter of 2018, where weather conditions meant that natural gas imports reached a record high. Pipeline imports increased by 18 per cent during the quarter and flows through the IUK and Balgzand to Bacton lines during quarter one exceeded the total imported via these two routes during the whole of 2017. LNG also contributed to meeting demand, initially via short-term storage terminals and subsequently via imported cargoes. However, the closure of Rough as a seasonal natural gas storage site has raised questions over the adequacy of UK storage capacity and security of supply. Oil & Gas UK estimates that the remaining short-term UK natural gas storage infrastructure could operate for just over a week of “N-2 conditions” seen during that period (i.e. a ‘double jeopardy’ scenario whereby a cold spell occurs during a period of disrupted supply), providing up to 100 million cubic metres (mcm) per day. During longer periods of severely restricted gas supply, demand from the market would be met by increased LNG supplies, with increased market prices in a scenario such as this being sufficient to attract LNG shippers to the UK.

Figure 5. UK Gas Supply Scenarios – Additional Supply Required Over and Above Indigenous Supply

Aggregate LNG Imports - Daily Flow Storage - Delivery Interconnector - Delivery UKCS Production and Pipeline Imports from Norway - Daily Flow

450

400

350

300

250

200

150

100

50

UK Gas Imports (Million Cubic Metres per Day)

0

Typical Summer Day

Typical Winter Day Shock Low Production Extreme Cold Weather

Source: National Grid, Oil & Gas UK

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3.2 What do the Trends Mean for Industry? Increased commodity prices have a positive effect on the oil and gas industry, especially within E&P companies, through increased cash flow and a growing sense of optimism. As outlined in Business Outlook 2018 , Oil & Gas UK predicted that the UKCS could generate free cash flow of more than £7 billion this year, as a result of reduced costs, relatively low investment levels and increased commodity prices (based on estimates of $60/bbl and 45 p/th). However, following higher-than-anticipated oil and gas prices in the first half of 2018, it is possible that free cash flow levels this year could exceed £10 billion for the first time since 2010, with this figure being inclusive of an expected increased tax take for the government. The overall level of cash flow will be dependent on how commodity prices develop during the second half of 2018 and the industry’s ability to maintain its focus on cost discipline.

1

2

3

Figure 6: Exploration and Production Revenue, Post-Tax Expenditure and Cash Flow

Gross Revenue

60

4

Post-Tax Expenditure

Post-Tax Cash Flow

50

5

40

30

6

20

7

10

Cash Flow (£ Billion - 2017 Money)

0

8

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

-10

Source: OGA, Oil & Gas UK

In recent years E&P companies have been focused on business transformation and, as a result of cost and efficiency improvements, are now in a much healthier position. However, it is important to note that the cash flow position of UKCS E&P companies will vary significantly, depending on operating costs and investment and production levels. The majority of the free cash flow being generated in the basin will come from a relatively small number of companies. It must also be acknowledged that a number of challenges persist for supplier companies. It is not certain that the increased cash flow in E&P companies will translate directly into new investment and much-needed new activity for the supply chain, at least in the short term. Companies remain focused on maintaining confidence, as evidenced through the maintenance of dividend payments throughout the downturn, demonstrations of sustained cost discipline, and the servicing of debt incurred over the last four years. In terms of their longer-term market outlook, major E&P companies remain highly conservative. This is in attempt to compensate for market volatility and signals that industry does not yet have the confidence that increased commodity prices will be maintained in the long term.

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ECONOMIC REPORT 2018

This outlook is also reflected in the investment criteria being applied by major operators. Shell now requires that any investments in upstream projects must break even at less than $40/boe – half the level of some project sanctions prior to 2014 – and BP has set a target of reducing its break-even costs to $40/boe by 2021. There is also a continued global trend towards smaller projects, which are less capital intensive, have lower levels of associated risk and offer a quicker return on investment. 3.3 The Role of Oil and Gas in a Changing Energy Landscape Oil and gas have provided the majority of the world’s primary energy needs since the mid-1960s. Transport has been almost totally reliant on petroleum-based products. Meanwhile, natural gas has gradually increased its market share over coal and biomass for heating. Likewise, technological improvements have increasingly made natural gas an attractive option for electricity generation in view of the efficiency and flexibility offered, coupled with its lower carbon footprint. Oil and gas combined provided 54 per cent of global primary energy in 2016 5 , with worldwide demand for oil continuing to increase and reaching 98 million bpd in 2017. To serve this demand, the oil and gas sector has developed a global presence based on its products' ease of use, high energy density, affordability, accessibility and flexibility of supply. There are comprehensive domestic and international routes to market in place which have been a major contributor to economic growth and higher living standards. Even though new renewable electricity generation and storage technologies are developing rapidly and nuclear power generation will continue to have a role, the reliance of the global energy system on oil and gas will remain close to the current level well into the 21 st century. There are several key drivers behind this: • Continued worldwide population and economic growth will result in an ongoing increase in total energy demand. A large part of this growth is expected to occur in Africa and Asia and will lead to increasing disposable incomes and living standards. Although efficiency improvements are likely to reduce the energy intensity of all economies this will not be enough to offset these economic and demographic trends. As a result, global energy demand is expected to grow by 30 per cent by 2040. • Some of the reduction in carbon intensity of energy will come from switching from coal to gas. Approximately one-third of total annual global carbon emissions still come from the combustion of coal in power generation. Switching to natural gas will lead to both significant reductions in carbon and particulates such as nitrous and sulphur oxides (NOx and SOx), as well as improvements in overall air quality. • There are many sources of energy demand where emerging technologies and methods of supply do not yet provide an effective alternative to the use of oil or gas. For example, the requirements for heavy freight delivery and marine transport cannot at present be met from renewable or electricity-based technologies. Despite the rapid development of these methods, there is an ongoing gap between what society requires for continued economic development and the capacity of these technologies. This, however, does not mean the oil and gas sector can continue to operate in isolation from the ongoing fundamental changes that are taking place. As with any industry, businesses need to respond to shifting economic and societal demands and the consequent changes in energy needs and usage. More recently, and as a result of the Paris agreement, the challenge of climate change and the imperative of moving to a low-carbon economy have been added to the traditional objectives of affordable and secure sources of energy. These criteria are the basis for the Energy Transition. Increasingly, investors, consumers and policymakers are looking to energy businesses to reflect these criteria as the basis of their ongoing licence to operate. Oil & Gas UK is working closely with its member companies in this regard.

5 IEA World Energy Outlook 2017

16

1

The Global Energy System (2020-2040) Increasingly, the development and deployment of new technologies means that energy sources have the ability to meet one, two or even all three elements of the ‘energy trilemma’ criteria (low cost, secure, and low carbon). The shift towards such technologies will undoubtedly form what has become widely known as the ‘Energy Transition’, whereby carbon-intensive sources of energy are either replaced with low-carbon alternatives, or retro-fitted with new technology to better meet these criteria. Oil and gas will continue to form the largest component of the world’s energy system for at least the medium term. Various estimates and scenarios have been developed which project when peak oil demand will be reached, and range between the mid-2020s and dates post-2040, after which a gradual decline is expected. Meanwhile the use of gas continues to grow moderately over most long-term forecasts. Oil and gas will therefore form a key pillar of the transition over this period and will have opportunities to be part of the final, future energy mix.

2

3

4

The World in 2040

5

6

Global Population Increase + 20%

Total Economic Growth + 100%

Growth in Primary Energy Demand + 30%

7

Figure 7: Global Energy Demand Forecast (IEA New Policies Scenario)

8

Coal

Oil

Gas Bioenergy Nuclear Hydro Other Renewables

10,000 12,000 14,000 16,000 18,000 20,000

sennoT noilliM( ecruoS yb dnameD ygrenE

9

)tnelaviuqE liO fo

10

0 2,000 4,000 6,000 8,000

11

2000

2016

2025

2030

2035

2040

Source: IEA

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ECONOMIC REPORT 2018

The UK Energy System – The Transition is Well Under Way Energy provision in the UK has already undergone significant change. Carbon emissions have been successfully reduced by 43 per cent compared with the levels prevailing in 1990. Much of this reduction has been achieved in the power generation sector through the substitution of natural gas for coal and increased use of renewable energy. Further reductions in emissions, required by the UK Climate Change Act 2008 and Carbon Budgets, imply more rapid progress in the transportation and heating sectors. As set out in the chart below, these segments form a very significant part of UK energy demand and are still highly dependent on oil and gas.

Figure 8: UK Domestic Energy Flow

Hydro, Wind & Solar Bioenergy †

Coal ‡

Crude Oil & Petroleum Products

Nuclear

Natural Gas

Domestic Imports

40

15.1

50.9

5.8

12.9

1.9

95.2

45.1

0

1.6

3.5

6.5

Energy industry use and losses

PRIMARY SUPPLY 278.6

15

Exports Marine bunkering Stock change

Transformation and conversion losses

78.5

35.8

TRANSPORT DOMESTIC INDUSTRY SERVICES MISCELLANEOUS

Petroleum 8.8

Petroleum 55.1

Petroleum 2.5

Petroleum 4.3

Petroleum 0.7

Gas

4.4

Gas

0

Gas

25.5

Gas

8.7

Gas

4

Coal

0.05

Coal

0

Coal

0.6

Coal

1.3

Coal

0.02

Bioenergy 1.7

Bioenergy

1

Bioenergy 2.2

Bioenergy 1.2

Bioenergy 0.07

Electricity 6.7

Electricity 0.4

Electricity 9.1

Electricity

8

Electricity 1.7

Other

0.2

Other

0

Other

0.3

Other

0.7

Other

0.1

FINAL CONSUMPTION 149.1 ∆

*all values in million tonnes of oil equivalent (mtoe) † Includes geothermal and solar heat ‡ Includes manufactured fuels, benzole, tars, coke oven gas and blast furnace gas ∆ Total does not equal sum of the sources due to statistical difference, stock changes, marine bunkering and rounding

Source: BEIS

Indigenous supplies from UKCS production accounted for 60 per cent of total UK oil and gas demand in 2017 (65 per cent of oil demand and 54 per cent of gas demand) and will be crucial to meet the expected needs of the economy over the next 20 years and avoid over-dependence on imports. Meanwhile, as we approach the end of this period and look forward to 2050 and beyond, the contribution of the oil and gas industry must evolve to reflect the needs of the low-carbon economy.

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It is not yet clear exactly how the Energy Transition will play out in terms of either the mix of technologies being adopted or the rate of change, particularly in the cases of transport and heat. The outcome is dependent on a range of key technological, regulatory and policy drivers which point in the direction of the low-emission future. Oil & Gas UK sees four key pathways which will be key to understanding the long-term future for oil and gas in the low-carbon economy.

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Figure 9: Key Determining Pathways for Oil and Gas in a Low-Carbon Economy

Technological

Societal/Political

Commercial

Regulation & Policy

Investor appetite for continued investment in fossil fuels

Scope for more local and regional-level solutions to be developed

Realising the opportunities from the development of the North Sea economy Degree to which changing attitudes to the oil and gas sector will engender change Appetite of governments to consistently drive change in the energy sector

Extent to which electric- based technologies can efficiently replace oil and gas in transport and heat Scale and footprint of necessary hydrogen production facilities to de-carbonise gas Challenges for developing CO2 transport and storage in the UK

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4

Ability of businesses to re-organise their activities and expertise

Business models for CCUS infrastructure to be financed and regulated

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Realising value from a more regulated investment landscape

Coping with the potential loss of tax receipts from the energy sector

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Many oil and gas companies are already adapting their businesses in response to these issues and the variety of challenges posed by the Energy Transition. Progress seen in this area includes:

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• The average emissions per unit production on the UKCS, or ‘carbon intensity’, has fallen year on year since 2013. Total emissions have been in decline from their peak in 2000. • Large international companies are increasingly becoming end-to end energy providers building on their direct relationships with consumers. Several have recast their strategic objectives to accord with the objectives of the Paris agreement in response to the wishes of investors and consumers. Many are important investors in renewable energy projects and have also diversified into areas such as electric vehicle charging technology and the expected developments of the hydrogen economy. • Likewise, infrastructure owners and operators in the oil and gas sector are often already part of a wider portfolio across a range of conventional and renewable energy sources. Specialised infrastructure and sovereign wealth funds are well attuned to the requirements and objectives of governments with respect to the energy transition and have tailored their investment criteria to reflect the different balances of risk and return associated with government driven energy investment. • Contractors and supply chain companies with expertise in offshore operations and maintenance are also providing solutions across a range of energy industries to diversify and replenish their order books.

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ECONOMIC REPORT 2018

The recent establishment of, and subsequent report from, the Carbon Capture, Usage and Storage (CCUS) Cost Reduction Taskforce 6 , has provided a new focus on the opportunities for this technology in the UK. This will be essential to provide the gateway to the hydrogen economy and the diverse, low-carbon energy mix required for the long-term commitments of the Climate Change Act. The UK oil and gas sector has the necessary infrastructure, an experienced workforce with relevant skills and is well placed to support the development of CCUS. The development of the government Pathway Document in the second half of 2018 and the policy framework in early 2019 will give further opportunity to explore the contribution of the sector to this essential technology.

The UK oil and gas sector has always been a pioneering industry which, at every stage, has shaped the nation’s energy journey. The further development and acceleration of the Energy Transition will be no exception.

3.4 Brexit The management of the UK’s exit from the European Union (EU) continues to provide uncertainty within the market, with the future trading relationship yet to be determined. At the time of writing the UK has not yet agreed a deal over the future interface with the EU for customs, trade, access to shared energy markets or movement of goods and people. The UK Government’s ‘ Future Relationship Between the United Kingdom and the European Union ’ white paper outlined its preferred position on the future trading relationship with the EU. On customs specifically, the white paper confirms the UK’s plan for a ‘Facilitated Customs Arrangement’ (FCA), which will aim to minimise constraints on the trade of goods, through the creation of a new UK-EU free trade area underpinned by a ‘common rule book’. As is the case with other industries, the UK oil and gas industry values stability and certainty, and there is concern that the current uncertainty around the UK’s future trading relationship with the EU could result in a negative impact on business and investor confidence. • Fresh opportunity, where the UK is free to negotiate international trade deals and has minimal EU tariffs. In this scenario there is the potential for a fall in current oil and gas industry trading costs by around £100 million per year. • Reverting to World Trade Organization (WTO) rules, where there is the potential for the cost of trading for the oil and gas industry to increase by around £500 million per year. Given the challenges around attracting new investment seen by the oil and gas industry in recent years, additional costs such as those envisioned in a possible ‘hard Brexit’ scenario would be potentially detrimental to the ongoing international competitiveness of the UKCS. Analysis commissioned by Oil & Gas UK in 2017 modelled the impact of two potential Brexit scenarios:

6 assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/ file/727040/CCUS_Cost_Challenge_Taskforce_Report.pdf

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Brexit also poses potential challenges around industry’s continued access to skilled labour. Around 5 per cent of the total oil and gas workforce, and around 7 per cent of the offshore workforce, come from other EU countries. It is vital that arrangements are in place between the UK and EU to allow the continued frictionless movement of people, ensure that there is no increase in labour costs and to mitigate concerns around potential skills shortages. Delays in access to skilled resources from EU countries have the potential to lead to project delays, or to projects being managed from outside of the UK, and in some instances could lead to production having to be shut in. As an example, some vessels working offshore such as Emergency Response and Rescue Vessels (ERRVs), require skilled engineers. If there are difficulties in recruiting them from in or outside the UK, then the ERRVs will not be able to provide the vital standby service to offshore platforms – without which the platforms would have to shut down operations and production. As well as attracting skilled workers to the UK, there are concerns around potential delays to accessing equipment and materials to service projects and operations on the UKCS. For example, prior to Bulgaria joining the EU it took around four days to transport goods from Bulgaria to Aberdeen. However, since goods were being transported from outside the EU it was common for them to be delayed at border controls for up to an additional week. There are concerns that similar delays could be reintroduced when the UK leaves the EU, affecting vital pieces of equipment for operations which currently face no customs checks or border delays. The UK has established world-leading technologies, resources, skills and expertise within the oil and gas industry, with a number of these servicing international projects and operations. It is important that the ability for UK-based companies to service international projects is not negatively impacted as the industry seeks to grow its share of the global oilfield services market (see section 4 on Vision 2035).

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In order to minimise the impact on the UK oil and gas industry, Oil & Gas UK has three key requests of the UK government around Brexit:

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• Maintain frictionless access to markets and labour • Maintain a strong voice in Europe for this industry • Protect energy trading and the internal energy market

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Ensuring this will allow the UK oil and gas industry to continue to be competitive within the global market. This is essential to help the UK attract the investment required to maximise economic recovery and achieve the potential outlined within Vision 2035.

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ECONOMIC REPORT 2018

3.5 UKCS Exploration and Production Performance

Figure 10: Key E&P Performance Indicators at a Glance

2010

2017

2018

Production (Million boepd)

Forecast

2 0 1 0

2 0 1 1

2 0 1 7

2 0 1 6

2 0 1 5

2 0 1 2

2 0 1 3

2 0 1 4

1.7- 1.75

2.23

1.81

1.42 1.42 1.54

1.57 1.64 1.64

The recent strong production performance on the UKCS has continued into 2018, with production in line with the first half of 2017 and 4% up on the total 2017 average.

Operating Expenditure (£billion – 2017 Money)

2 0 1 4

2 0 1 3

2 0 1 5

2 0 1 2

2 0 1 0

2 0 1 1

2 0 1 7

2 0 1 6

7-7.5

7.4 7.4 7.8 9.1 9.8

8.3 7 7

Following a period of significant realignment, operating expenditure has returned to levels in line with the longer-term trend prior to 2012.

Unit Operating Costs ($/boe – 2017 Money)

2 0 1 4

2 0 1 3

2 0 1 2

2 0 1 5

2 0 1 1

2 0 1 6

2 0 1 7

2 0 1 0

15.8- 16.4

13.2 17.1 20.8 26.2

29.6

21 15.2

15.2

Unit Operating Costs halved between 2014-16 and have now stabilised around $15-16/boe.

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2010

2017

2

2018

Number of Exploration Wells

2 0 1 0

Forecast

2 0 1 2

2 0 1 3

2 0 1 6

2 0 1 1

2 0 1 7

2 0 1 4

2 0 1 5

3

10-12

28

14

22

15 13 13 14 14

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Only 4 exploration wells were spudded in the first 8 months of the year. Although an increase is expected in the second half of the year, exploration activity will remain amongst record-low levels.

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Number of Development Wells

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2 0 1 0

2 0 1 5

2 0 1 4

2 0 1 1

2 0 1 2

2 0 1 3

2 0 1 6

2 0 1 7 130 123 122 120 126 129 88 71

60-80

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Development drilling remains significantly challenged, with the outlook remaining around record-low levels. An increase in activity is required to support production and provide new opportunities for the supply chain.

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Capital Investment (£billion – 2017 Money)

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2 0 1 4

2 0 1 3

2 0 1 5

2 0 1 2

2 0 1 1

2 0 1 6

2 0 1 0

2 0 1 7

5.5-6

6.7 9.8 11.5 14.8

15

11.7 8.3 5.6

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Capital investment has fallen due to a lack of new project sanctions and ongoing projects reaching the end of their development cycle. Increased capital efficiency is also being seen in new investments.

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