The North Sea oil fields used to be the shining star of the UK economy but now, as cost spiral, government energy policy remains uncertain and tax issues weigh, companies such as Chevron (NYSE:CVX), Royal Dutch Shell (NYSE:RDS-B)and Talisman Energy (UNKNOWN:TLM.DL) are fleeing; all in all this is a good thing.
Investment in the North Sea is expected to slump by 50% over the next three years, following a 31% drop in oil production between 2010 and 2012. In reality there is no single reason for this decline, but one of the most prominent explanations is the rising cost of production in the region.
The North Sea is one of the older oil fields in the world, but for this reason infrastructure in the region is creaking and the UK continental shelf is now one of the most expensive basins in the world to operate; development costs per barrel have risen five-fold over the past decade. Nevertheless, there is plenty of oil left with 12 to 24 billion barrels estimated to be contained within the region, compared to the 42 billion barrels already extracted. But rather than encouraging extraction the UK government is only increasing taxes and regulation on the industry, putting companies off investment.
In particular, there have been 16 tax changes in the North Sea during the past 10 years, and 14 oil ministers in the past 17 years have consistently changed rules and regulations for the industry. Of course there is also the one-off tax the government imposed on the region back during 2011, costing a total of £2 billion -- some companies have only just recovered from this.
Fleeing the region
There is no greater example of the effect that rising costs are having on the industry than Chevron's Rosebank project.
It is believed that up to 240 million barrels of oil could be recovered from the Rosebank field, but Chevron is now willing to pass this opportunity up:
"[The Rosebank project] does not currently offer an economic value proposition that justifies proceeding with an investment of this magnitude...Rosebank has always been a challenging project. At present, the cost of doing business continues to rise."
This was going to be a huge $10 billion project that could have unlocked up to $24 billion in oil. If Chevron believes that the development is no longer economically viable, then this is a great indication of how costs are spiraling out of control in the North Sea .
Trying to jump ship
Another problem companies operating within the North Sea have is the fact that if they want to sell, there are few buyers.
Talisman has been having trouble with its production in the North Sea for some time, and during the fourth quarter, production from North Sea assets declined 33%, to 14,000 barrels of oil equivalent per day, a terrifying slump. Talisman would, and I quote, "love" to sell all or most of its North Sea assets, but the company is tied to an agreement with a Chinese partner.
Hal Kvisle, Talisman's chief executive has commented that he did not think that getting out of the North Sea would be so difficult, and now the company is not counting on receiving any cash from the sale of its North Sea assets. With production slumping at 30% per quarter, it's easy to see why.
Turning its back on the home market
Perhaps more importantly, Royal Dutch Shell is also looking to offload North Sea assets. The company is looking to offload three projects and related oil fields. For the most part, these are mature fields with high maintenance costs being disposed of as part of Shell's $15 billion asset divestment program. Still, the decision to sell these assets is extremely symbolic as Shell has its roots in the UK and North Sea. Nevertheless, the divestment of these high-cost, mature projects with the cash being reinvested into new developments is good news for Shell shareholders.
Major oil companies are fleeing the North Sea in droves, and this is a good thing for investors. The high cost of operating within the region, along with increasing government regulation and taxes are all signs that profitability in the region could be under threat. As these companies jump out and reinvest the cash in new, more profitable projects shareholders will benefit.