Often during the ups and downs of the energy industry's cycles, people dismiss the front-running offshore plays-Gulf of Mexico and the North Sea-as viable exploration and production arenas. But just when these offshore areas are thought to be passé, new discoveries prove them otherwise.

On the U.K. Continental Shelf (UKCS), June oil and gas production was down 18% from the year before, according to The Royal Bank of Scotland. But activity is increasing.

Last year, total investment in the UKCS for exploration, new-field development and operations rose 15% to £9.7 billion from the prior year, according to the U.K. Offshore Operators Association (UKOOA). The number of wells drilled rose 30% to about 300. These were mostly development wells. But operators spudded 61 exploration and appraisal wells of that total, up from 49 in 2004.

In the 24th UKCS licensing round, held in June, 121 companies applied for 255 blocks; awards are to be announced this fall. Twenty-four new E&P players participated in the round; some 28 newcomers bid last year. Several are start-ups that are newly public on London's Alternative Investment Market (AIM).

"We're in a very attractive window right now. We've had a poor reputation for the past 10 years, but it's changed," says Jim Hannon, managing director of Hannon Westwood in Glasgow. The consulting firm, with an office in Houston, tracks UKCS merger and acquisition, licensing, farm-in and drilling activity as well as providing strategic business and geological advice.

"There should be plenty of opportunity," he adds. "Farm-in promote levels cannot afford to get wild because of rising drilling costs and pressure by the U.K. Department of Trade & Industry (DTI). If the fast-track fallow-acreage licenses created by DTI have not been acted upon within two to three years, they expire and must be handed back so that other companies have a chance through new license rounds."

Hannon Westwood estimates some 15% of the UKCS currently qualifies as fallow acreage. "It's almost indigestible because there are not enough rigs to cover the prospects," Hannon says. "If an oil company can get its prospect matured, get a rig and get a farm-in partner, it should welcome the opportunity with open arms. American companies coming here have to work smart, and get to know both about the right combination of prospects and available rig slots."

The U.K. produced some 3.2 million barrels of oil equivalent (BOE) per day in 2005.

"Production appears to have flattened out and is probably even going up a bit, maybe for three to five years to 2010," says Hannon. "Buzzard Field is a 500-milllion-barrel field coming onstream this year and is part of the story behind this trend."

BG announced in September a successful sidetracked exploration well in the central North Sea's Judy Field area. Operated by partner ConocoPhillips, the well confirmed their Shoie gas and condensate discovery drilled earlier this year. With estimated recoverable reserves of 100- to 275 million barrels, this is the largest find on the UKCS since Buzzard in 2001 and one of the largest in a decade.

It is the fifth discovery BG has made in the North Sea in the past 12 months, including Jackdaw, which may hold 200 million barrels. An average discovery size is normally expected at around 15- to 20 million barrels, so these finds are breaking the mold.

This is good news because energy supply is very much on the agenda of those in power in London and Aberdeen. In July, the government published a broad energy review calling for more investment in oil and gas drilling, infrastructure and alternative fuels. About a week later, the UKOOA released its annual energy report "Energy Now and for the Future." It warns that ever-higher costs, rig scarcity and three U.K. tax increases in the past three years threaten to make the area less competitive.

Some 27 billion BOE of resources remain to be recovered, the UKOOA estimates. Hannon Westwood estimates that $2.4 billion will be spent in 2006-07 for about 55 exploration and appraisal wells per year, between farm-ins and joint-venture wells.

Some 145 companies now hold offshore licenses despite that the North Sea is still dominated by majors and the larger independents. A flurry of start-ups and foreign companies have entered during the past three years as the U.K. government stepped up its campaign to attract more drilling activity. (For more on this, see "Independents in the North Sea," Oil and Gas Investor, July 2004.)

"The exploration and drilling market is buoyant. We see no end to the farm-in activity in the next two or three years," says Hannon. "The geotechnical talent is there and we see a swell of small companies that need quality financing, the kind of backing that lasts for 10 years or so-in other words, not fickle money."

The firm estimates some 600 million BOE have been found this year to date by 25 exploration and appraisal wells (including appraisals in older, fallow fields). Hannon Westwood believes operators plan at least 135 wells on the UKCS in the next two years, with more to come, but the available rig fleet is capable of drilling only around 55 wells per year and there could be additional pressure on this from development projects.

Jackup dayrates range from $200,000 to $250,000 on new contracts and standard semisubmersibles command $335,000 and up.

New ventures

Now that a flood of capital has entered the E&P space, U.S. institutional money is finding the North Sea more interesting.

"We've been looking for a North Sea investment opportunity for a long time. We've done our share of Gulf of Mexico deals, so we're not afraid to go offshore," says Robb Turner, a principal of ArcLight Capital Partners, a New York private-equity firm. "One, we like the fundamentals of the U.K. and European gas markets. And two, we think ownership of North Sea reserves will be changing hands and there will be lots of opportunities for small and midsize independents. There should be good deal flow.

"We view this as a longer-term play."

ArcLight closed its third fund in March 2006 with $2.1 billion. But just before that, and from its second fund, ArcLight led a group of North American investors in a new joint venture called North Sea Gas Partners, which in turn formed a 50-50 partnership with Venture Production Plc, a rising U.K. independent. Compass Advisers LLP advised on the deal.

North Sea Gas Partners will have an initial commitment of $300 million and will invest alongside Venture to acquire and develop North Sea assets, which Venture would operate.

Venture, an Aberdeen firm that went public in 2002, has been growing through drilling and acquisitions. Its total production for the first five months of 2006 averaged 44,500 BOE per day, more than double the same period in 2005. Production is growing still, since in August it acquired CH4 Energy Ltd. for $224 million, gaining 184 billion cubic feet equivalent (Bcfe) of proved and probable reserves. Several of the acquired fields will come onstream shortly or in 2007, tripling CH4's production.

ArcLight's Turner says Venture had a lot of development opportunities on its plate, so the new joint venture is a way for it to do even more, yet retain the upside, without having any single opportunity be outsized to the company's capabilities. "We're excited to be teaming up with Venture, which is very good on the operating side. They are very acquisitive and have a lot of drilling and service capabilities lined up. We like their market knowledge."

Another relatively young venture focused on the North Sea is Houston-based Endeavour International Corp. After getting started two years ago, and assembling leases, seismic data and personnel, it is about to get busier than ever.

"This October, Endeavour kicks off an exploration program that goes into 2007 and early 2008, that shows a maturing of our business," says Bill Transier, chairman, chief executive officer and president of the company. It just secured a harsh-environment, heavy-duty rig from GlobalSantaFe and drilling slots on some other rigs as well. The Columbus prospect will be drilled by an Ensco International rig starting in October.

The company is a partner in Gaz de France's Cygnus discovery well in the Southern Gas Basin that has tapped an estimated 300 billion cubic feet of gas. Development plans are under way for an application to U.K. authorities and first production is anticipated in 2008.

But four straight dry holes operated by Endeavour in 2005 left the market plenty disappointed. Management is undeterred. "We were unhappy about those dry holes too-which by the way found hydrocarbons, but were non-commercial. We're impatient. But I think we don't get enough credit for gearing up this company as fast as we have," Transier says.

"From a standing start in 2004, we now have 65 people-two-thirds geological and geophysical. We have amassed 1.8 million acres offshore the U.K. and Norway, and we have an inventory of 40 prospects. That exposes us to 1 billion BOE of potential. Our goal is to eventually have 80,000 BOE of daily production there. That would be 1% of total North Sea daily production."

In August, Endeavour was granted a new frontier exploration license offshore Ireland in the Donegal Basin on the Atlantic Margin. But Endeavour's recent $414-million acquisition of interests in seven producing North Sea fields from Talisman is the greater deal in the near term. It will provide cash flow to fund the exploration effort. The deal added 18 million BOE of proved and probable reserves.

"Neither Bill nor I foresaw $70 oil and that made it challenging to make an acquisition," says Endeavour vice-chairman John Seitz. "We would have preferred that the acquisition occur earlier in the life of the company-it took two and a half years. But we are well-positioned. This is still like the Gulf of Mexico was 20 years ago in terms of its potential."

Based on its long-term relationships with U.S. offshore rig contractors, Endeavour has been able to secure rig slots to drill five wells offshore the U.K. and one well offshore Norway in 2007.

Tors development

Houston-based ATP Oil & Gas Corp., which set up its U.K. office in 2000, achieved a milestone this spring when first gas production began at its Tors development in Kilmar Field at the K-1 well. The K-2 was being drilled at press time. ATP operates with 85% working interest and Japanese firm Sojitz Energy Project Ltd. is the partner. In December 2005, a third-party engineering report estimated Tors has 73 Bcfe of net proved reserves and 42 Bcfe of net probable reserves.

ATP chief executive T. Paul Bulmahn points out that operations in the North Sea typically are measured in years, and are thus slower than investors have come to expect in the Gulf of Mexico where ATP also is quite active. But first production at Tors came nine months after the company received development approval from U.K. authorities.

When fully developed, Tors will add net production of at least 50 million cubic feet per day from Carboniferous and Rotliegend zones.

This year, ATP will get about 26% of its total production from the North Sea, 36% from Gulf of Mexico oil and 38% Gulf of Mexico gas, but as North Sea production ratchets up in 2007 and 2008, it will be half of the company's production, Bulmahn says. He expects to book additional proved North Sea reserves this December.

"We have a rig engaged for five consecutive wells, and we're negotiating for other rigs now. The Garrow G1 well, also part of Tors, will spud right after we finish the K-2," he says. "Later, we'll know if a second Garrow well is appropriate or a third well at Kilmar. Our 100%-owned Wenlock project will see initial production in 2007. The platform was installed in September and we'll drill two wells there next year."

ATP did not participate in the latest bid round. "We looked at a couple of things, but they did not make the cut, and...we have a high activity level already," he says.

Of the U.K.'s recent tax increases, Bulmahn diplomatically says, "We like to put a positive view on these kinds of changes. We certainly hope that because of this, opportunities will fall out of other companies' portfolios that would be appropriate for ATP. But obviously when something is taxed more heavily, the economics are not as good.

"The North Sea will be a major production-growth area for us without any acquisitions because of the projects we already have under development, and we are pleased with what we are accomplishing."

With near-month U.K. gas prices at about $8 and the 12-month strip at about $11, and many fallow acreage blocks set to expire, it looks as though plenty of drilling and farm-in opportunities remain. The alarming production-decline rate seen between 2000 and 2005 appears to have flattened, so the increased activity promoted by the DTI seems to be working.