British government must take control of oil and gas sector

February 15, 2010 | 00:00

British government must take control of oil and gas sector

UK oil and gas production has been steadily declining since 1999. The reason is that the UK government, unlike those of most other countries, has abandoned oil and gas production to the private sector and has failed to create attractive conditions for private companies to invest more. The government should follow the example of Norway and many other countries by setting up a Hydrocarbons Authority which would initiate new private-public partnerships to engage in offshore oil and gas production. This would generate many billions of £s in highly-needed revenues.

Apart from the United States, the UK is the only country in the world in which the government does not oversee the exploitation of the nation’s oil and gas resources. The reasons for this are historical: after a partial nationalisation of the oil and gas resources of the UK’s offshore continental shelf (UKCS) by the then-Labour government in the 1960s and 1970s, the Thatcher-government completely handed over exploitation of the UKCS to the private sector. It sold concessions for no less than 359 blocks to BP, Shell and other oil companies. Succeeding Labour governments for various reasons were unable or unwilling to tamper with this Conservative legacy.

As such there is nothing wrong of course with leaving oil and gas exploitation to private companies. The problem with this is that the investment decisions of these companies are based on their own interests rather than the national interest for the UK to maximise production of its resources. The companies are totally free to decide how much they want invest in exploration and production in the UKCS and how much oil and gas they want to produce from their blocks. Since oil companies like Shell and BP operate worldwide, they rank-order their investment decisions internationally, on the basis of their own portfolio of global resources. With its high production costs, the UKCS is relatively unattractive to these companies. They tend only to invest in exploitation in this region when oil prices are very high. Otherwise, they use their UK concessions more or less as a fall-back position should they lack other opportunities elsewhere in the world.

Obviously, this makes sense for the companies, but it results in a severe underproduction of British oil and gas resources. In the last decade, the UK’s oil production has fallen at a rate unparalleled in the global oil industry to just over 50% of its 1999 level. Natural gas output has also fallen sharply – by over 36% since 2000. Indeed, oil and gas production has declined so much that many people believe the UK does not have the resource potential anymore to be a globally significant hydrocarbons producer. Nothing could be further from the truth. The Department of Energy estimates that there remain some 11 to 12 billion barrels of oil equivalents to be produced in the medium term and some 10 billion barrels that still remain to be found – a huge source of wealth at an oil price of $70 a barrel. And in fact there are good reasons to believe actual production could be much larger.

What should be done? The UK should follow the example of countries such as Norway and the Netherlands, which have put highly effective systems in place to maximise production of their hydrocarbon resources. These are based on public-private partnerships (PPPs), with the State having ultimate control over production levels.

The introduction of such PPPs ought now to become the basis on which the very-much needed further exploitation of the UKCS can be achieved. This involves ending the current system which relies on intermittent allocations of concessions on which the successful companies can more or less proceed at the speed they choose. To repeat, they do so only as and when investment funds become available to the company and when there are no alternative investments opportunities open to them.

The government needs to establish a state entity, viz. a Strategic Offshore Hydrocarbons Authority — akin to Norway's PETORO — with the responsibility for creating continually available opportunities for exploration for hydrocarbons across the whole of the UKCS (except, of course, for blocks already licensed). From these opportunities, oil and gas companies could at any time select areas they wish to explore, based on their knowledge of the hydrocarbons potential. The Strategic Authority, in turn, would be required at all times to consider such requests by any reputable company in order to determine, as a matter of urgency, the conditions and terms on which exploration could take place.

Once a company's initial exploratory work confirms the existence of an oil and/or a gas field with production potential, then a PPP can be negotiated between it and the Strategic Offshore Hydrocarbons Authority. Negotiations need not be protracted, once the two essential and intimately related elements of the PPP have been agreed: the maximum production potential of the field and the parameters which determine the shape of the rising cost curve for increasing recovery and the anticipated rate of depletion. Such technico-economic considerations create a basis for both the scale and the timing of the investment requirements, with the objective of determining a best-for-both parties' division of the production of oil and/or gas over the life of the field.

With elections coming up, and the UK finding itself in dire financial straits, this moment represents a golden opportunity for political parties to radically change the UK’s hydrocarbons policy, which has served this country very poorly indeed. Such a change would correct a historical mistake and generate many billions of £s in new revenues. Who could possibly be against this?

This is a short version of an essay written by Peter Odell for his upcoming book Upstream. You can read the complete essay by clicking here

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