The New North Sea – Part 1: the revolution begins here

How much of a difference will the recent reforms of UK offshore oil and gas regulation make to the industry and its stakeholders? It may be too early to say whether the creation of the Oil and Gas Authority (OGA), the articulation of the “MER UK Strategy” and the other changes introduced by the Infrastructure Act 2015 and the Energy Act 2016 will facilitate solutions to all the significant problems faced by North Sea operators, but in our view it is already clear that the changes of the last two years will have a profound impact on the industry.

Government intervention in the UK’s offshore oil and gas industry is nothing new. It has taken different forms at different times, and has included, as well as numerous changes in taxation, Government participation (or at least the ability of Government to participate) in decision-making at the individual asset level through rights granted to state-owned entities.

More specifically, for almost 20 years, Government has been aware of, and has been taking action to address, the particular set of problems that the UK Continental Shelf (UKCS) faces as a mature basin.  Between 1999 and 2004, the Department of Trade and Industry and its successors took a series of steps to foster investment and innovation in the industry and improve its efficiency: a joint Government / industry report (A Template for Change) was published in 1999; task forces were appointed; changes were made to the administration of the licensing regime; new types of licence were introduced.

However, by the time that Ed Davey, as Secretary of State for Energy and Climate Change, commissioned Sir Ian Wood to carry out a review of the industry in 2013 and the Wood Review’s final report was issued early in 2014, it had become clear that all the good work done after the 1999 report had not resolved or prevented some fundamental problems, and that the “vision for 2010” which it articulated had not been fully realised.   Average production efficiency declined from 81% in 2004 to 60% in 2012.  There had been a downward trend in numbers of exploration wells drilled since 2008 (with about 70% fewer being drilled in 2013 than were drilled five years before).  Perhaps worst of all, costs of production per barrel had risen fivefold in ten years.  And all that was before global oil prices began a period of sharp decline which has seen them fall to levels at which most North Sea fields are said to be uneconomic, with no certainty of a rapid or sustained recovery.

Many of the concerns that were articulated in the 1999 report and addressed in the initiatives that followed from are echoed in the Wood Report. Both reports are in favour of such things as “collaboration in place of competition”, “improving relationships between licensees” and encouraging innovation, for example.  But the final results of Wood’s work are very different from those of the earlier report and its follow-up.  Where the 1999 report tends to talk about “deregulation”, the Wood Report has led to the creation of a new, more powerful and better resourced body to regulate the industry.  In the words of the Wood report itself: “In the early days with large fields to be found by major operators, the free market model worked well with a light touch Regulator…However, over time, the number of fields has increased, now to over 300, new discoveries are much smaller, many fields are marginal and very inter dependent, and there is competition for ageing infrastructure. Alongside this, the…Regulator has halved in size in 20 years and…is clearly struggling to perform a more demanding stewardship role.”

There has been general agreement with Wood’s conclusion that “a stronger Regulator with broader skills and capabilities able to significantly enhance the level of co-ordination and collaboration” would “largely resolve” the problems that his review identified.  It is rare for an industry to be so apparently united in its desire for stronger regulation – even if it was clear from the first that a regulator based on Wood’s prescription would be different from many sector regulatory bodies in terms of its remit, composition, and its interactions with industry.  It has probably helped that the fall in oil prices has made the problems identified by Wood more acute, increasing the demand for a powerful independent regulator to get to work on solving them.  This, together with the compelling nature of Wood’s analysis and strong political support, has enabled the necessary legislative changes to be put in place rapidly.

Why do we think that North Sea regulation from now on (or at least from the date on which the relevant provisions of the Energy Act 2016 come into force and the Regulator’s staff complement is up to full strength) will be radically different from what operators have been accustomed to? There are six main reasons.

For the first time, the UK offshore regulatory regime (excluding its environmental and health and safety aspects) has a single governing principle articulated on a statutory basis – the objective of maximising the economic recovery of UK petroleum (MER UK).

Although MER UK is defined in general terms in a strategy promulgated by DECC under the Infrastructure Act 2015, its specific meaning and impact in any given situation will in large measure be determined by the Oil and Gas Authority (OGA).

The obligation to act in accordance with MER UK, as so defined and interpreted, applies – or could be said to apply – to at least one person involved in the taking of almost any commercially important decision in the offshore industry.

Under the new regime, the OGA and DECC will potentially have access to vastly more information about North Sea assets and infrastructure, the commercial intentions of those with interests in them, and the relations between them, than DECC has had to date.

The OGA does genuinely appear to be a new kind of regulator, in terms of its composition, capabilities, culture and combination of functions. It is also likely to take a more proactive approach than its predecessors.

The terms of the MER UK strategy and the robustness of the enforcement tools at the OGA’s disposal suggest that it will enjoy unparalleled leverage over licence holders and others to ensure that collaboration “for the greater good” really does happen.

In future posts in this series, we will explain in more detail how the relevant provisions of the Infrastructure Act 2015, the Energy Act 2016 and the MER UK strategy achieve these results and how we think the application of the new rules by industry parties, DECC and the OGA will affect key moments in the life of North Sea infrastructure and assets.