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# north sea blocks worth big money, big potential!

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    August 2005 - Analysis - Offshore Europe << Issue Index

    UK: looking for a foothold

    High oil prices mean the majors are less willing to part with UK North Sea assets. But, reports James Gavin, innovative operators are still able to secure promising offerings on the UKCS, which, despite declining production, could continue producing until 2050

    CONFIDENCE has returned to the UK North Sea. Some 70 exploration and appraisal wells are expected to be drilled on the UK continental shelf (UKCS) this year. Applications under the country's latest offshore oil and gas round, which closed on 9 June, hit a three-decade high, with firms bidding for a record 279 blocks – an increase of 115 on the previous round.

    A survey last year of 200 oil and gas companies, by the geophysical company Robertson Research, found the UK the top destination for new upstream investments.

    The UK Offshore Operators Association (UKOOA) claims only half of the UK North Sea's oil and gas has been exploited. It estimates that the basin contains some 28bn barrels of oil equivalent (boe) and could continue producing until 2050. As such, it represents an attractive long-term investment opportunity for a range of companies, it says.

    UKOOA says a record number of companies are now active on the UKCS, attracted by a relatively stable political and fiscal regime and a positive business environment. Yet concerns remain about the UK's prospects. Not only is production declining year-on-year (see Figure 1) – total oil production in the UK was 2.03m barrels a day (b/d) in 2004, a 13% decrease from 2003 – but the average size of finds is also falling. It is now estimated to be around 24m boe.

    Additionally, the traditionally active asset market has shown increasing signs of sluggishness as high oil prices have endured, making it more difficult for new entrants to get a foot on the asset ladder. Assets are just too expensive, says Graeme Sword, head of oil and gas at 3i, a private equity group with investments in a number of oil companies active in the UKCS. "We've seen a slow-down in asset sales at the smaller end. For those seeking to acquire assets there has been little activity."

    Over-optimistic
    Some large individual deals continue to be announced. For example, Canada's Nexen bought EnCana's UKCS assets for $2bn in late 2004. But projections that the asset market would remain highly liquid, with £4bn ($7bn) worth of deals being struck over the next four or five years, appear over-optimistic.
    The majors seem to have lost their appetite for selling North Sea assets because they can generate strong cash flow, slowing down a process that had seen them offloading what they regarded as marginal assets to independents.

    Even after the period of asset divestment – with Ireland's Tullow buying the southern North Sea's Ketch and Schooner gasfields from Shell and ExxonMobil for $382m in December, or Apache buying the Forties field and other assets from BP in 2003 for $1.3bn – the UKCS remains dominated by the big beasts. Eight companies own 75% of the UK's offshore oil and gas assets and infrastructure. BP leads in production terms.

    The result is a very competitive mergers and acquisitions market, with a small pool of assets being chased by an array of potential buyers. "A bit of nervousness has crept in," says Richard Slape, an oil analyst at investment bank Seymour Pierce. "The majors were selling assets quite aggressively a year or two back. Then, the oil price rose substantially and some of the assets they had sold were resold by the new owners at substantial profits in quite short order. That may have had a bearing on the decision not to sell quite so much."

    Resources diverted
    In addition, 3i says there has been a large fall in the number of companies looking for North Sea acreage because of a switch to areas of greater geopolitical risk. Private-equity funding, while still an important source of capital for the UK market, is increasingly being diverted to other countries, says Sword. "We're still seeing quite attractive capital-raising marketing in terms of the Alternative Investment Market, but a lot of that capital is being spent to acquire assets outside the North Sea."
    Despite the slow-down, however, deals continue to trickle through and the market is not expected to dry up completely, even if the majors have a greater incentive to sweat their assets under a high-price environment. In mid-2005, Shell and ExxonMobil announced they are seeking bids for their interests in the Auk, Fulmar and Dunlin fields. In July, BP said it was transferring operated interests in the UK southern North Sea to Dana Petroleum.

    An average of 11% of total UKCS proved reserves have been traded in each of the last 10 years, reaching a peak of 28% in 2000. Disposals in 2003, as a proportion of total UKCS reserves, amounted to 7%. UKOOA says that, despite the increase in the oil price, the volume of reserves changing hands in 2004 was up from 2003 – the 1.4bn boe of traded assets in 2004 represents a doubling of trading assets on the previous year, although this was inflated by Nexen's acquisition of EnCana's entire North Sea portfolio, including the 400m barrel Buzzard field.

    Independents with cash to spare and that view the UKCS as a good fit with their other assets, say plenty of deals remain to be done – although they may find it hard to replicate the profitable deals that groups such as Tullow achieved in the heyday of 2000, when offerings could be bought at much lower prices.

    Opportunities out there
    Perenco, a UK-French independent with seven licences in the southern North Sea gas basin, is turning its sights on the central North Sea and is confident that it will be able to beef up its portfolio. "In the early part of this year, there was a dearth of activity and it was very quiet on larger-scale deals, but now we don't think that's the case," says Paddy Spink, vice-president of business development at Perenco.
    "There are opportunities out there of a reasonable scale for the focused buyers that have specialist interest. We have a clear strategy to build up our focused operating regions and if the right opportunity to buy something of a significant size comes up then we'll adapt our strategy to suit it," Spink adds.

    It is not just established independents that are on the prowl for new assets. They are being joined by start-up companies such as Revus Energy and Altinex, which are often technology-driven. They are also increasingly differentiated from traditional upstream players. Whereas two years ago, most of the start-ups would have been in exploration and production, now they are mainly on the services side, Sword says.

    Analysts predict that besides the majors continuing to tweak their North Sea portfolios, smaller operators will also sell assets if they can secure a good price for them. In January, for example, Paladin sold its Ross and Blake fields to Japan's Sumitomo for $75m. "Venture Production has just bought a package of undeveloped fields from Amerada Hess and there are going to be a lot more," says Seymour Pierce's Slape. The Venture package, which is strongly weighted towards oil, comprises operated and non-operated interests in eight undeveloped discoveries in the central North Sea, together with an interest in an Inner Moray Firth discovery close to existing infrastructure.

    Priced out of the market
    Rather than view the UKCS asset market drying up, Slape sees the UK independents as being priced out of the market because of stiff competition from abroad. "When an operated asset comes up for sale, very often the Canadians have been jumping in and paying prices for them that the UK companies can't compete with. The Japanese have been bidding aggressively for non-operated assets. These companies typically have a much lower cost of capital than the UK independents."
    The alternative to acquiring existing assets is to bid for new unlicensed acreage, which, for new entrants, means a higher level risk than that involved in taking on proved assets. However, the efforts of the Department of Trade and Industry (DTI) to spur exploration in the unexplored regions to the north and west of the Shetland Islands seems to be paying off.

    The 23rd licensing round offered two types of licences for exploration and development in addition to the traditional licence. The Frontier licence, introduced in last year's 22nd licensing round, aims to spark interest in the relatively unexplored areas north and west of the Shetland Islands, allowing explorers to apply for relatively large amounts of acreage and then relinquish three quarters of that acreage after an initial screening phase, during which the normal rental fees will be discounted by 90%. Of the 134 applications submitted, seven were for Frontier licences.

    The Promote licence, first introduced two years ago, in the 21st licensing round, offers the licensee the opportunity to assess and promote the potential of the licensed acreage for an initial two-year period without the stringent entry checks required as part of a traditional licence; 60 promote licence applications were received in the latest licensing round.

    In addition, the Stewardship initiative was launched in June by Pilot, the government and industry forum. It is designed to ensure fields that are nearing the end of their producing life will fulfil their potential and it is estimated that the programme could result in the production of an additional 3bn-5bn boe. In theory, the DTI could force the relinquishment of mature fields that it believes are not being developed optimally, but industry sources say it is unlikely to take this course of action. UKOOA says it is a logical extension of the Fallow fields initiative, introduced in 2002, which forces licensees to relinquish assets that are lying dormant.

    Confidence on the rise
    The industry's reaction to the latest government measures stands in contrast to its vociferous objections to the 10% supplementary corporation-tax rate introduced in 2002. According to UKOOA, the tax rise had a marked effect on investment on exploration activity and on business confidence. "There was a measurable effect. Only now is confidence beginning to rise again," says a UKOOA spokeswoman, Trisha O'Reilly. "The success of the licensing round is partly a result of the government listening to the industry, particularly through the Pilot forum," she says.
    The government will no doubt be hoping that the tough competition for UKCS assets is a reflection of the measures it has introduced and that those measures will prove effective in preserving the basin's long-term productive capacity.

    Vive la différence
    DIFFERENTIATION, whether in the upstream or further down the supply chain in services, is now seen as one of the keys to gaining entry to the UK Continental Shelf. An Aberdeen-based start-up company, Energy Development Partners (EDP), is attempting to pioneer a new model in a climate where the majors appear more resistant to letting go of their assets.
    Founded by entrepreneur Larry Kinch, in September 2003, EDP is to invest capital in fallow oil and gas development projects in the North Sea. The Aberdeen-based firm has been described as a blend of equity provider, traditional independent oil firm and services company. It aims to form partnerships with assets owners and take technical control of projects – without owning the assets. With over 300 oilfields lying dormant in the North Sea, EDP provides the capital and expertise to execute companies' dormant projects.

    "EDP gives existing asset owners a third choice – now, they have to either release capital expenditure (capex), or sell these assets," says Graeme Sword, a director of 3i, the private-equity group.

    The majors have a shortage of technical resources in the North Sea, with resources deployed on bigger projects outside the basin. Meanwhile, smaller companies do not have the in-house capability and run virtual organisations in many cases, says Sword. "EDP is saying you might have interesting assets, but you won't raise the capital internally to develop it and you don't have the people. We will invest in the project, funding capex and taking technical control," he says.

    This lowers risk for asset owners, whose resource is being developed at no additional cost, and for EDP, which can focus on providing technical solutions without having to acquire assets. EDP is rewarded with a share of the production.

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