The framework governing the UK upstream offshore oil and gas industry is set to face a radical overhaul. Oil and gas production from the UK Continental Shelf (UKCS) provides a significant source of revenue for the UK, having contributed £6.5 billion in corporation taxes in 2012/2013¹ and with the industry currently meeting approximately half of the UK’s primary energy demand. Although 2013 saw the highest levels of capital investment in the UKCS on record², the industry faces a number of challenges to its long-term economic success. These relate to decline of production efficiency in the UKCS, rising development costs and the general maturity of producing fields. Concurrently, the UKCS is facing an “exploration crisis” in which exploration levels are at an all-time low³. Capital expenditure is also expected to decrease in the near future until new developments are brought on-stream.

Sir Ian Wood’s review

Against this backdrop, and in a bid to address these concerns, Edward Davey MP, the Secretary of State for Energy and Climate Change (Secretary of State) commissioned Sir Ian Wood, the former chairman of Wood Group, to conduct an independent review of UK offshore oil and gas recovery and its regulation. Sir Ian published his initial findings and recommendations in an Interim Report on 11 November 2013, which was followed by a Final Report on 24 February 2014. The Final Report follows the same vein of the Interim Report, and builds upon its recommendations in setting out a strategy for maximising economic recovery from, and for attracting more investment in, the UKCS.

The Final Report has received strong support from the UK Government and the oil and gas industry. Shortly after the Final Report was published, the Prime Minister and the Department of Energy and Climate Change (DECC) issued a statement supporting Sir Ian’s proposals and setting out plans for their speedy implementation. Sir Ian has stated that the timely implementation of his recommendations would serve to add at least £200 billion to the UK economy over the next 20 years by facilitating the production of an extra three to four billion additional barrels of oil equivalent that would not otherwise be realised.

The overriding observation in Sir Ian’s review is that a new approach is necessary to extend the longevity of the UKCS and to maximise its economic potential. There is an urgent need to address the dated “light touch” regulation currently in place, which originates from the early years of large fields and few operators. In contrast, the UKCS today represents “a patchwork of interconnected and interdependent operations” with over 300 smaller discoveries and marginal fields. This landscape is one which the current regulator is inadequately equipped to manage effectively.

Sir Ian’s recommendations

In this article, we provide a summary of the Final Report’s four principal recommendations, and we seek to offer an insight on the potential impact that their implementation may have on the industry.

Recommendation 1: UK Government and industry to develop and commit to a new strategy for maximising economic recovery from the UKCS (MER UK)

Sir Ian envisages a fully collaborative approach between the regulatory and economic entities in the UK oil and gas industry as key to the success of his recommendations. The Final Report suggests that the UK Government needs to make a concerted effort to ensure that the UK is viewed as an attractive place to invest, particularly in the face of international competition. To achieve this, there needs to be a tripartite approach between the UK Government, an independent, “arm’s length” regulatory body (Regulator) and HM Treasury (HMT). Greater cooperation within the industry itself, particularly between operators, is also recommended.

The Final Report emphasises that the UKCS is not a uniform mature basin, but one made up of a mixture of new plays, frontier areas and mature regions, and that investment strategies  need to be sufficiently flexible to reflect this. Sir Ian’s recommendations in this respect include measures to incentivise exploration of seismic and exploration wells for operators, as well as the UK Government sponsoring seismic companies to carry out more speculative seismic shoots to increase the amount of technical information readily available. The Regulator will also have a role in evaluating “new plays” in order to encourage operators to pursue and develop these commercially risky, but potentially highly prospective areas.

Although taxation is not specifically within the remit of the Final Report, the importance of collaboration with HMT to ensure that the UKCS has a stable fiscal regime, together with suitable fiscal incentives to encourage investment and stimulate exploration, is recognised by Sir Ian.

Recommendation 2: Creation of a new Regulator charged with effective stewardship and regulation of UKCS hydrocarbon recovery, and maximising collaboration in exploration, development and production across the industry

Sir Ian views the presence of an informed, proactive and relatively autonomous Regulator, staffed by top quality personnel and led by an individual with substantial industry expertise, as integral to the success of MER UK over the next 30 years. The Final Report recommends that the Regulator's role should be to guide investment decisions towards achieving the full realisation of the economic potential of the UKCS, and that the Regulator should work closely with the industry, the UK Government and HMT to achieve this.

The new Regulator, which is likely to be funded by the industry, will be responsible for the effective stewardship and regulation of oil and gas exploration and development activities. Over 42 billion barrels of oil equivalent have already been produced from the UKCS, but a reported 24 billion barrels of untapped resource remains to be extracted. Sir Ian’s primary concern is that the current industry regulator (situated within DECC) has unsuccessfully adapted to the demands of an evolving, maturing basin, and lacks the stewardship capabilities to fully exploit this resource potential. This is partly due to the current UK regulator’s make-up; it is staffed by only 50 personnel tasked with overseeing the regulation of over 300 producing fields (in contrast to the Norwegian regulator which has over 200 personnel).

In terms of day-to-day management, it is recommended that the Regulator is charged with promoting active exploration, facilitating data sharing, and encouraging the full deployment of existing technologies and the development of new technologies. It should be noted that Sir Ian considers that the current licensing model is fundamentally “the right one”, but he suggests that a review by the Regulator of existing licence terms will be of immediate importance to ensure that they reflect the requirements of MER UK. Consequently, it is recognised that some changes will be made to the UK licensing regime. The Final Report further suggests that greater flexibility on licence commitments should be considered, particularly where a deviation from the terms of the licence may be economically beneficial. For example, it is recommended that licensees should not be compelled to drill wells which are likely not to be commercially viable.

The Final Report states that DECC will continue to have ultimate responsibility for the UK Government’s policy development and will therefore retain an oil and gas policy team, and this will be supported by the Regulator insofar as MER UK is concerned.

Recommendation 3: The Regulator should take additional powers to facilitate implementation of MER UK

The Final Report highlights the need for a strongly-resourced regulator with broader powers to provide strengthened stewardship of petroleum activities and to enable it to bring operators’ conduct of field operations in line with MER UK strategy. However the Final Report anticipates that, as operators increasingly collaborate within this strategy, the Regulator should not need to use these additional powers, which include:

• Attendance at operating and technical management committee meetings: The Regulator will have a right (but not a duty) to attend meetings of licence holders as an observer, primarily where it has particular concerns or where issues relating to MER UK or disputes are to be raised.

• Powers of mediation: In the event of a dispute, the disputing parties will be required to submit their grievance to the Regulator in the first instance, with the Regulator having the power to issue a non-binding opinion. A failure to comply with this opinion could give rise to sanctions (see below).

• Sanctions to encourage compliance with MER: If a licence holder or a consortium is deemed not to be acting in accordance with MER UK strategy, and fails to correct such conduct after receiving notice from the Regulator, the Regulator may have the right to issue private and public formal warnings, facilitate a change in operatorship, and even suspend or terminate the licence.

Recommendation 4: Development and implementation of important sector strategies

Sir Ian has proposed six sector strategies which embody focused objectives aimed at achieving MER UK. The Final Report recommends that this set of commitments should be adopted by the industry as a whole. Among other targeted objectives, these sector strategies aim to ensure that licensees move away from pursuing wholly individual commercial objectives in respect of their oil and gas operations, and afford greater consideration to the wider success of the UKCS.

The six sector strategies are:

• Exploration: Aimed at revitalising exploration by ensuring efficient access to well data, appropriate data sharing within regional development plans, creating a bespoke licensing regime and promoting UKCS exploration activities internationally.

• Asset stewardship: Clear expectations should be set by the Regulator and field operators’ performance should be rigorously monitored. It is suggested that asset operations should be reviewed annually, with such reviews focusing on production and recovery efficiency. This could include a requirement for operators to share their personal “asset stewardship strategy” with the Regulator, who may also have the power to publish asset performance data to promote performance improvement.

• Regional development: Aimed at ensuring that operators conduct their operations on a regional basis, i.e. with the aim of maximising economic recovery of not only their individual fields but also of surrounding field clusters. This will include increasing third party access rights to enable the tie-back of smaller, marginal discoveries into existing infrastructure (infrastructure sharing is a topic that threads through Sir Ian’s recommendations). The Final Report suggests that the Regulator should work with the industry to develop “regional plans” which will seek to integrate various perspectives on prospectivity, exploration and development of certain defined areas in the UKCS.

• Infrastructure: Aimed at prolonging the life of existing infrastructure and securing investment in new infrastructure, to the benefit of both MER UK and individual licence holders. Sir Ian observed that the use of existing infrastructure should be carefully considered before undertaking the expense of commissioning new infrastructure. For example, although appropriate in certain circumstances, floating production and storage units which are enlisted for new fields are reported to have higher operating costs and poorer field recovery than if existing infrastructure was employed.

• Technology: Aimed at using existing technologies to their full effect, and ensuring that relevant new technologies are developed to maximise recovery from the UKCS. It is also recommended that the Regulator should be tasked with encouraging the UK to become “a global centre of expertise” for mature hydrocarbon basin exploration.

• Decommissioning: Aimed at fully realising production from existing assets and avoiding premature decommissioning; and where decommissioning is appropriate and necessary, to ensure that decommissioning is conducted in an environmentally sound and cost efficient manner.

What does this mean for the future of the UKCS?

The UK oil and gas industry is tasked with tackling the decline in production levels and the limited exploration success of recent years. The stabilisation of the fiscal regime, greater collaboration between industry players through data sharing, and a more efficient use of technology are all factors that, if implemented, could contribute to stimulated exploration levels and an extended economic longevity of the UKCS. The Final Report aims to reinforce that seeking to maximise economic recovery on a wide-scale basis, rather than merely in respect of individual assets, will be essential in order to facilitate the maximisation of the petroleum that remains in the UKCS.

In immediate response to Sir Ian’s recommendations, the Secretary of State has proposed to introduce legislation to establish a new Regulator by Autumn 2014. In the interim, it is expected that Sir Ian will chair an interim advisory panel which will advise DECC on the various practical issues of creating a new Regulator, on the basis that the UK Government will fast-track the implementation of the Final Report’s recommendations.

The Final Report comes at a potentially critical turning point in the history of the UKCS. A referendum on Scottish independence will be held in September this year, which could result in UK North Sea oil fields being divided between the UK and a newly independent Scotland; although how this would be effected continues to be a topic of debate. Concerns have been raised that the fragmentation of regulatory and fiscal regimes as a direct consequence of Scottish independence could jeopardise the success of Sir Ian’s recommendations.

Conclusion

It remains to be seen how straightforward the implementation of Sir Ian’s recommendations will be in practice. Adapting existing contractual agreements and practices, the majority of which are historical, to accommodate MER UK strategy could prove more challenging than the Final Report envisages. Additionally, changes to existing legislation which may be required are not specifically addressed in the Final Report. It is likely that these will be necessary to accommodate the recommendations, particularly in light of the review of the licensing regime.

Practically, the extent to which the new Regulator’s increased presence will be willingly embraced by the industry is questionable, particularly in relation to the increased monitoring of operator's activities and the potential for more stringent obligations in respect of increased data sharing. It is likely to be several years before the impact of these measures can be assessed.

Although the recommendations are ambitious, it is undeniable that a concerted, dynamic effort is required to address the current challenges faced by the UKCS in order to ensure its future profitability. Whether the recommendations are viewed as a welcome or an unnecessarily heavy-handed intervention, the participants in the UK upstream oil and gas industry should brace themselves for a more rigorous UK oil and gas regulatory landscape.

_{1. Oil & Gas UK Economic Report 2013}

_{2. According to the Oil & Gas UK Activity Survey 2014, capital investment in the UKCS in 2013 was recorded at £14.4 billion.}

_{3. According to figures from DECC, only 15 exploration wells were drilled in 2013.}

Angela Wallace of Andrews Kurth authored this article.