On February 25, Sir Ian Wood published his long awaited final report entitled “UKCS Maximising Recovery Review Final Report  (Wood Review or Review). The Wood Review, which was commissioned by current UK Oil and Gas  regulator the Department of Energy & Climate Change (DECC) appeared in interim form on 11 November  2013. A great deal of work went into the preparation of the Review including interviews with some  40 UKCS licensees representing some 95% of all UKCS production. The Wood Review has attracted  support from across the political spectrum including the Scottish Government. The Review has also  attracted very substantial support from the industry itself, including the clear endorsement of the  industry trade body, Oil & Gas UK. Nearly seventy pages long, with some fifty-two pages of full  text, the Review is filled with detailed economic and industry analysis and highly specific  proposals for major change in the UKCS licensing regime. Concrete steps to implement the Review  including draft legislation, are now in the works. Anyone interested in the UKCS should carefully  read the Wood Review.

So what does it say? The UKCS Situation

For an excellent economic summary  of where we are in the UKCS, the Activity Survey 2014 (Activity  Survey) published by Oil & Gas UK cannot be bettered. Download from www.oilandgasuk.co.uk. However,  we might summarise the position as follows. The first UKCS licensing  round occurred in 1964 and  our offshore licensing system is thus fifty years old this year. Production from the UKCS peaked in  1999 at over 4 million barrels of oil equivalent (boe) but sharply fell to some 1.4 million boe  last year. Indeed production has fallen some 38% in the last three years. However, the better news is that production is levelling out because new projects are coming  on-stream.

The UK has been very successful at licensing offshore acreage and indeed the last (27th) Offshore  Round was the most successful in history in terms of area licensed. However, the large number of  recent licence awards does not involve a large number of obligatory (drill-or-drop) exploration  wells. Thus companies are interested in having a look but not so many are willing to commit large  risk capital.

The introduction of Supplementary Charge in 2002 and two later increases in the rate of  Supplementary Charge were seen as destabilising by the oil industry. However, the more recent  advent of the many exemptions from Supplementary Charge has been well received. Indeed, Oil & Gas  UK demonstrates that more than half of all last years’ large capital spend was incentivized by  Supplementary Charge exemptions.

Last year, capital expenditure on the UKCS amounted to £14.4bn which is the highest number for  thirty years. This reflects major development spending but also rising supply chain costs. Current  estimates suggest that capital expenditure may fall by 50% by 2016 unless new projects are brought  on for development. Rising supply chain costs and lack of available drilling rigs are major  concerns.

There is little doubt that the most worrying aspect is that exploration and appraisal rates are at  historic lows. As Oil & Gas UK state: “… 2011 and 2013 saw the lowest and second lowest numbers of  exploration wells drilled, respectively, since drilling  began on the UKCS in the 1960’s”. (Activity Survey, page 15). This level of E&A drilling is patently inadequate to inventory the remaining “yet-to-find” prize of the UKCS  before much of the province’s critical offshore infrastructure is lost to decommissioning.

Sir Ian Wood’s Proposals A New Regulator

One of Sir Ian’s key findings is that DECC’s Oil & Gas team is not now fit for purpose. He proposes  the creation of an entirely new regulatory authority (New Regulator). He makes the point that in  the early 1990’s, in the context of a much simpler regulatory system, and some 90 producing fields,  the DTI (DECC’s predecessor) had about 90 employees. Now, with around 300 producing fields, DECC  has only  about 60. By comparison, the Norwegian Petroleum Directorate has some 220 employees and  the (Dutch) Energie Beheer Nederland BV (EBN) has about 100.

Sir Ian believes that the New Regulator should be a body independant from government, partially or  wholly funded by industry. One of the goals is to attract highly qualified people as employees so  the New Regulator  must not be bound by civil service pay scales. Particular importance is being  attached to hiring the right CEO.

The New Regulator would essentially inherit all of DECC’s current duties except for HS&E.

While Sir Ian’s remit was offshore in nature, there is clearly a strong argument for extending the  New Regulator’s jurisdiction to the UK onshore. However, just as important as the New Regulator’s  make-up and jurisdictional scope is its new overall responsibility: to drive and implement Maximum  Economic Recovery from the UKCS which is shortened to “MER UK”. Sir Ian Wood’s Review: A UKCS Game Changer?

MER UK

While MER UK is given no detailed definition in the Wood Review, it is clear that the concept  represents in essence “…a holistic approach in regulating exploration, development and production”.  (Wood Review, page 15). MER UK as a legal obligation would be included in every existing and future  UKCS production licence. It is clear that MER UK would involve licensees being required to take  action to facilitate higher production on a field-wide and area-wide basis. For example, on  Regional Development strategy: “Operators should be required, where appropriate, to co-operate with the [New] Regulator and with other licence holders in the wider adjacent area on  all aspects of field and cluster development, from exploration through to decommissioning, with the  overarching aim of maximising economic recovery from clusters of fields as well as from individual  fields”. (Wood Review, page 16).

New Powers of Regulator Access to Information

The New Regulator would have access to any and all UKCS joint operating or technical committee  meetings. Additionally, licensees will be required to produce more public data (especially on producing fields) and on shorter deadlines. The rationale is that a better informed New Regulator will be much more  powerful, and more transparency will inform the industry and discourage negative behaviours.

New Disputes Powers

The Wood Review finds that “the UKCS is perceived as being one of the most difficult and  adversarial legal and commercial basins in the world, disproportionately driven by risk aversion…”.  (Wood Review, page 27). The Review proposes that the New Regulator be empowered to resolve disputes  within a stipulated timeline through the issuance of a non-binding recommendation. Failure to  accept the non-binding recommendation may be construed as a violation of MER UK, potentially  leading to warnings, sanctions or even licence cancellation. The Review also proposes that industry  be given a year to come up with a scheme to simplify the legal and commercial complexity of UKCS  contracting. If industry cannot do this, the New Regulator should proceed to come up with its own  solution.

Third Party Access to Infrastructure

In recent years, the average UKCS discovery has been relatively small and therefore most such  fields must be tied into existing infrastructure. Negotiating access to such infrastructure, which  is owned usually by other licensees, is often difficult. The Review notes: “Both exploration and  field development are being badly affected by a lack of anticipated infrastructure availability”.  (Wood Review, page 26). The New Regulator will continue to enforce the current ICOP regime, and the  licensees’ new MER UK obligations would certainly  be relevant here. Interestingly, Sir Ian also  proposes that encouragement should be given to specialist infrastructure companies.

Regional Strategy

Related to but distinct from access to infrastructure is the Wood Review’s proposal to require  licensees (pursuant to MER UK) to collaborate on regional or play-wide development strategies. As a  priority, the Regulator will develop a Southern North Sea regional plan. The goal will be to boost  “cluster” type development.

Asset Stewardship

One of the major themes of the Wood Review is that licensees are often failing to properly manage  their producing assets. One theme is the falling levels of production efficiency. Another theme is  the lack of appropriate investment in brownfields. The Review notes: “Whilst there are some obvious  exceptions, in many cases it appears that companies have constrained asset investment and  expenditure in a drive to deliver short-term returns”. (Wood Review page 25). The New Regulator will establish production guidelines  for each field and will have the power to issue warnings, sanctions and effectuate licence  cancellation, if a licensee fails the tests. This is the flipside of MER UK. The stewardship prize is a big one.

The Review also considers how to encourage more use enhanced oil recovery (EOR) and of improved oil recovery (IOR) technologies.

The Exploration Problem Tax Incentives?

Oil and Gas Taxation was not on the remit of the Wood Review but taxation is central to the whole  UKCS situation. The Review notes that Holland and Norway do things differently. In Holland, the  state takes a 40% share in all Oil and Gas ventures and hence funds exploration to the tune of 40%.

In Norway, on the other hand, the state provides guarenteed direct tax relief on exploration costs  even if the licensee has no production. Given the high Oil and Gas tax in Norway, this means that  the state funds exploration costs to the tune of 78%. Loan finance can be raised against this  refund.

The Wood Review has encouraged a re-think of UK Oil and Gas Tax and a new Fiscal Review is pending.

Stimulate New Seismic Acquisition

The Review suggests that Government might finance new seismic and sell it on to industry on  commercial terms.

Status of Wood Review

An Interim Advisory Panel (IAP) on Wood Review implementation led by Sir Ian Wood and including  representatives from DECC, HMT, Competition & Markets Authority, Oil & Gas UK and other  stakeholders has been formed. Its first meeting was  held on 16 April. DECC is currently working on  the structure of the New Regulator, with a view to establishing a shadow body. Legislation to  implement the Wood Review is pending. Clearly Government and Industry are determined that the Wood  Review will actually be implemented.

Reflections

The New Regulator Sir Ian makes fairly compelling arguments for the creation of a New Regulator. There is no doubt  that DECC is under-staffed, under-funded, under-powered and under-informed. Undoubtedly, the New  Regulator needs to attract top industry talent and its focus should entirely be on UKCS oil and  gas. Sir Ian is also right that a much better informed New Regulator will automatically be more  powerful (for information is power) and more transparency will also lead to better licensee  behaviour. However, a better informed New Regulator will obviously have to guard much more  sensitive information.

MER (UK)

Perhaps the most radical aspect of  the Wood Review is that it is proposed to alter all existing  licences to require licensees to abide by MER UK. This powerful and overriding new duty is not well  defined in the Review, but it clearly underlies a range of new obligations, such as enhanced  stewardship of petroleum fields, third party access to infrastructure and clustering. At Page 2 of  the Review, Sir Ian states: “The additional powers are not designed to force operators to invest…”  While that may be true in the literal sense of operators not being forced to write cheques, it is  clear that failure to abide by MER UK must open recalcitrant licensees to private and public  warnings, loss of operatorship and ultimately loss of licence. This means a major change in the  terms of licences and (perhaps separately) major new regulatory powers for the New Regulator.

Tax Incentives?

Tax incentives, particularly for exploration and appraisal are the disembodied ghost of the Wood  Review. The biggest desired change of all is more exploration or, should we say, more successful  exploration. By calling for a tri-partite approach between the New Regulator, HMT and Industry, Sir Ian clearly prioritises the critical tax element of any future regime. He has also  initiated a debate between those who laud the impressive results of the current piece-meal system of exemptions and others who want a simpler lower tax regime. We should also  remember how important a part EOR is in the whole picture. Widespread adoption of EOR will be key  to securing the Stewardship prize.

General

At its most essential the Wood Review has asked industry and UK and Scottish governments a  fundamental question: “Given where we are on the UKCS journey, are you willing to take every  reasonable practicable step to maximize our economic recovery?” The answer would appear to be “Yes”  and, in the Review, Sir Ian outlines his vision of a positive future with very considerable detail.  It is for now largely up to the organs of the UK Government to create the institutions and enact  the legislative regime required to realise the future envisaged by the Wood Review.

Recent News

On 12 June, Chief Secretary to the Treasury the Rt Hon Danny Alexander announced that the New  Regulator will be called the “Oil and Gas Authority”. Its headquarters will be in Aberdeen. A  search process has begun for the new CEO of the Oil and Gas Authority.