Oil production in the North Sea began in the early 1960's when Norway asserted sovereign rights over natural resources in its sector of the North Sea in 1963 and the UK passed the Continental Shelf Act in May 1964.
Since then both countries have had a shared history of offshore oil and gas production, but that is largely where the similarity ends. Today UK North Sea oil production is struggling under the weight of declining output, higher taxes, low investment and rising decommissioning costs. The US Energy Information Agency (EIA) in fact expects UK North Sea oil production to decrease again in 2016 to just 500,000 barrels per day. In contrast, the sharp decline in Norwegian North Sea oil production has stopped, and production rates, while down from previous highs, have been broadly stable since 2012 because of effective government policies intended to support the industry (see chart below).
It is true that Norway suffered a 47% decline in North Sea oil production from the 2001 production peak of 3.4 million barrels per day, but this is less severe than in the UK, where production is down over 75% for the same period as of 2015. This difference in performance in the two industries is partly due to the disparity between the level of tax deductions related to exploration expenditure offered by Norway and those offered by the UK. According to the Financial Times, companies in Norway can claim back as much as 78% of their exploration spending, triggering an exploration boom and supporting production. In contrast, the UK marginal tax rates on some North Sea oil fields can be as high as 80%, possibly accelerating early decommissioning and reducing output.
Low Oil Prices
Low oil prices are hurting an industry that is already under pressure because of the high costs that became embedded in the industry's operations during the boom times. For example, semi-submersible rig rates hit a multiyear peak of about $400,000 a day in 2014 before sliding 25 per cent, while the average salary for oil workers is almost six figures according to data from the FT. Now that oil prices have fallen, such cost structures are unsustainable. The industry will have to adjust by renegotiating contract rates or firing workers, or a combination of both. (To read about the effects that falling oil prices are having on certain nations, see article: Falling Oil Prices Could Bankrupt These Countries.)
According to Oil & Gas UK, a leading trade association for the United Kingdom's offshore oil and gas industry, a crisis of confidence is unfolding. The group’s business sentiment index in the fourth quarter of 2014 shows that optimism in the oil and gas industry fell dramatically, dropping 16 points to -23 points on a -50/+50 scale. A press release on the group’s website states that “many of the survey respondents expressed a growing concern that the impact of oil price combined with the challenge of operating in a high-cost, mature basin will increasingly have a negative effect on future activity levels. A number of companies say they have been reviewing their budgets for 2015 and there are clear signs that capital expenditure across the sector will drop.” More critically the trade association says “urgent government action on fiscal and regulatory reform is essential to help secure the next phase of development in the [UK] North Sea.” (See: Five Biggest Risks Faced By Oil And Gas Companies.)
The UK’s oil and gas industry makes a substantial contribution to the British economy, accounting for some 450,000 jobs and, in 2013, tax revenues of £5bn, according to the FT. This makes the issue of North Sea oil extremely political. None of the major parties want to be seen to be hurting such an important industry in the run up to the general elections in May. At the same time, the UK has one of the largest budget deficits among European countries at 5.8% of GDP as of 2013, according to tradingeconomics.com. This means the government desperately needs the tax revenue the industry generates and will need to strike a delicate balance when examining any potential tax cuts in future budget reviews. (For related reading, see article: Analysing Risks On The Upcoming UK General Elections.)
The Bottom Line
The UK North Sea oil industry is feeling the pressure of low oil prices, high costs and increasing rates of decline in production. In contrast, Norway’s North Sea operations seem comparatively healthy, with stable production and rising exploration, despite also having to pay high taxes. The UK government may need to consider additional tax breaks for North Sea oil production to give the industry a boost and offset low oil prices. Failure to take decisive action could lead to a series of field shut-ins that will be difficult to reverse even if oil prices rebound, as some expect they will, in the second half of 2015.