UK drilling downturn – cyclical low or start of a new era?
Exploration and appraisal (E&A) drilling activity in the UK North Sea is down markedly so far this year compared with 2008. However, Hannon Westwood’s surveillance of wells planned over the next two to three years suggests that interest remains on par with the rate of activity of the past four years.
The key issues required to deliver the historic average of around 60 E&A wells per year are oil price, return of investor confidence, and willingness among the shelf’s smaller players which currently derive no income to rationalize before they run out of money.
By mid-2009, 14 operators spudded 20 wells and 16 sidetracks on the UK continental shelf (UKCS), a near even split between exploration and appraisal wells. Relative to recent years, only a small number of farm-in deals have been concluded. The Central North Sea has seen the greatest share of drilling, followed by the Southern Gas basin. Current exploration levels are around 70% of the mid-point in 2007 and 36% of the same stage in 2008. Appraisal levels marginally exceed the corresponding period in 2007, and are about 65% of last year’s mid-point equivalent.
Hannon Westwood’s pool of planned E&A wells, which looks two to three years ahead, has hovered consistently around 200 wells since inception in 2005. Since then, more than 270 wells, excluding sidetracks, have been drilled, with an average of more than 60 wells/yr split about 60/40 in favor of exploration.
That broad trend has continued in 2009. Two-thirds of the look ahead, around 130 planned wells, are considered exploratory, the remainder are appraisal. Encouragingly, more than 50 new E&A well plans have been captured since the start of the year.
Planned UK exploration and appraisal well pool by region during mid-2009 – 2013 (Source: Hannon Westwood).
The Central North Sea remains the most attractive arena, with almost half of all planned drilling. Next is the Southern North Sea, although, for some, the Gas basin will take a back seat until rig rates drop. In the near term, areas west of Britain will continue to see a minor resurgence thanks to the East Irish Sea consortium’s use of a single jackup. Subject to a critical mass of discoveries, this rig could undergo an extended stay into 2010.
Three-quarters of the planned pool focuses on oil reserves, with 25% of wells targeting gas, primarily in the SNS, but some also in the costly but highly prospective high-pressure/high-temperature (HP/HT) province of the Central North Sea.
Currently, more than 80% of the wells in the planned pool will be drilled on Traditional Licences, the remainder on acreage converted from Promote Licences. Over a third of wells may be described as discretionary, evenly split between exploration and appraisal drilling. Commitments indicate 55 firm, 34 contingent, and 25 wells on fallow acreage. It is these obligations that will maintain a reasonable level of activity.
There are rumors of extensions granted to 1st and 2nd Round licences in return for further drilling commitments. However, it also is anticipated in some quarters that the Round 26, delayed until early 2010, will include not only acreage resulting from December 2009 Round 23 relinquishments, but also 1st Round acreage relinquished early. The response to Round 26 will depend heavily on the mood in the industry at the time.
Around half of the planned well pool requires funding, potentially around $3 billion over the next three to four years. Just one of these 10 wells is thought to have been farmed-out successfully, a reflection of the state of the market. Targeted farm-ins by both traditional majors and utilities may increase in the higher risk plays, as these parties seek to secure reserves of a materiality commensurate with their stature.
The Southern North Sea likely will experience increased drilling activity only when rig rates drop, a trigger for owners to seek farm-in participants for their Gas basin prospects. Some Gas basin developments may need further drilling to remain viable, and these programs also may be offered as farm-in opportunities.
Rationalization of the UK’s E&P industry looks inevitable, in the form of defensive mergers, amalgamations or liquidations, and hostile bids from large companies – the latter driven by the need to guarantee supply and to replace diminishing production.
A significant number of smaller companies in the UKCS have no cash flow or near-term expectation of cash flow. A number of these will seek to combine technical knowledge with the financial backing and resource demand of larger organizations. Unless the near-term work commitments are funded already, some of these companies will disappear.
Of the 48 operators in the planned well pool, those with no developed reserves account for 29% of wells in our look-ahead, and those with less than 10 MMboe in production account for a further quarter of future planned drilling. The top tier operators (550-850 MMboe producing/project reserves), while accounting for just 10% of the operated well pool, will be in the realm of greater materiality where payback requires deep pockets and a long-term view.
Around 35% of the planned well pool targets near-field reserves, either through exploration (55%), or appraisal (45%) of existing finds, which might rapidly tie-back to existing facilities to extend production and prolong field life. Although not a new trend, it is increasing year-on-year as companies consolidate positions in one or more core areas. This can be at the expense of a varied exploration program that offers a mix of high risk versus low risk.
Sixteen wells currently are indicated for HP/HT plays, three-quarters of which are exploratory, demanding significant lead time for engineering, design, and supply. Eight operators are sited in the HP/HT pool, where wells can cost $80 - $100 million, with majors and utilities predominating, and looking to tap into material gas resources.
The targeting of reserves in the West of Shetland and Atlantic Margin regions has regained popularity. Current and future investment here might prove more secure than some other sectors of the UKCS as deep waters globally tend to attract the longer term view. Although these plays remain high risk with significant upfront costs, they retain the potential for significant reserves. In the shorter term, appraisal of existing discoveries likely will outpace new exploration until additional infrastructure is put in place, although most of the look-ahead for these regions concerns exploration prospects.
Less than 5% of the planned well pool currently comprises wells in the Tertiary to Lower Cretaceous heavy oil plays of the Northern North Sea and the CNS. Exploration drilling looks set to outstrip appraisal drilling, primarily on acreage awarded on a Promote basis, and hence, with very few exceptions, the majors do not figure.
The potential for eight to 10 wells here over the next two years or so may be prompted partly by majors resuming appraisal drilling over the last 19 months. All in all, progress to liberate reserves in the heavy oil play remains very much oil price-driven and anything but rapid, although the UK government’s recently announced Value Allowance measure for heavy oil may assist.
While the look-ahead remains healthy and there is no shortage of operator indications, there is evidence of a recent decline in E&A activity coming through official channels such as the Department of Energy and Climate Change’s PON notifications, where development drilling plans currently dominate.
Of the 50-plus wells indicated in our pool as remaining for 2009, 17 are thought to have secured rigs. This would point to a minimum of 36 wells being drilled in the UKCS sector in 2009, excluding sidetracks, on a par with 2003 levels. Oilexco, the most prolific driller on the UKCS in recent years, is no longer in the equation, impacting both spud and sidetrack numbers. The industry must hope that operator’s demise does not tar other UKCS players with the same brush and frighten off the investment community.
Through 2009, the fewer rigs active in the sector may also be tied up on long duration, deep, and costly wells, to impact the loosely predicted totals for 2009, with average wells per rig likely to decline. Norwegian sector E&A drilling may yet outstrip that on the UKCS.
While some companies may cease drilling in the short term, especially when there are no prevailing commitments, obligations will require some drilling operations to satisfy license terms. The successful model of recent years may continue under which the smaller company with one or two drill-ready prospects, but limited financial resource, agrees with a well management specialist to put together multi-well programs. These programs have resulted in prospectivity being drilled-out in a timely manner that would otherwise not have seen the light of day.
In the medium term, some companies will want to secure first or additional production before commodity prices increase and an opportunity is lost, even if these acquisitions are relatively small. This will further limit the well count with reserves being purchased rather than found through the drill bit. However, some companies will look to strengthen their portfolios to provide drilling opportunities over the next three years.
In conclusion, there is a desire to continue exploration and appraisal in the UKCS and there are plenty of targets to be drilled. This year may turn out to be a cyclical low rather than the beginning of the end.