By James Paton, ADIL The global oil industry is evolving; increasing hydrocarbon demand necessitates quick replacement of reserves while managing rapidly escalating production costs in aging basins. New discoveries, in combination with EOR and improved production efficiency, are key to ensuring a continued secure supply, particularly in the UK Continental Shelf (UKCS) where production volumes have been dropping since the late 1990s. As a result, and driven by a high oil price, the independent sector has in recent years become the vibrant and fast-moving face of exploration and production. However, the vital role that these companies play in stimulating exploration activity and growing the industry is under threat due to a lack of available funding. Small and mid-cap companies operate in a dynamic, fast-moving environment, which allows them to excel at exploiting new regions while also delivering additional value from more mature areas. Numerous independents are making discoveries in areas that have traditionally been ignored by the majors and super majors. As Guy Chazan, energy editor at the Financial Times, pointed out the major oil companies spend billions of dollars each year on exploration yet have still have a poor record of finding new reserves, largely due to being unwilling to take a risk on new, untapped basins. For me, independent oil companies have become the lifeblood of our industry, playing a vital role in stimulating regional exploration activity. As Chazan argues, the major oil companies retreat from exploring for and discovering oil created a vacuum which independent oil companies filled, with many going on to eclipse the more established and much larger companies through their nimble approach. As developers, the independents play a similarly important role; their smaller size allows for a flexibility that permits them to effectively develop marginally economic fields. The ability to create value in challenging assets means established provinces are more fully exploited, thereby making a vital contribution to the continued growth of the UKCS. As such they have been more successful than the majors in producing these smaller, stranded, geologically complex or end of life fields through their use of novel technology and innovative solutions. The problem is that they are now struggling to fund their operations. For companies focused on exploration activities a supportive fiscal regime is a critical factor in planning future activity. A strong fiscal stimulus drives down the effective cost of appraisal projects attracting investment and maximising exploitation of the region, something the UKCS has yet to achieve and an important challenge for government to address. The challenge for independents is accessing the funding necessary to carry out exploration and development activities or to acquire a stake in a producing asset, exacerbated by ever increasing operating costs in mature areas like the North Sea. Risk prone small companies are currently out of favor with the investors resulting in either regression or them being forced to divest. These companies simply don’t have access to funding in the same way that a major oil company does and are currently unlikely to receive funding for anything other than exploration activity. This approach from the investment community is a threat, not only to these companies but to the overall growth of the oil industry. The lack of financial investment affects the independents’ ability to undertake E&P activities, resulting in under exploitation of mature basins and new frontiers being slower to open. Limited access to funding means most independents are forced to farm down on assets they aspired to develop themselves, or perhaps even sell the whole company. The acquisition of independents by the majors has short-term benefits by way of increasing reserve portfolios, but in the longer term reduces the front-end exploration needed to replenish new opportunities. Additionally a decrease in the presence of smaller companies risks a loss of innovation, and subsequently leads to the surrendering of marginal fields in which larger companies cannot envisage ways to extract value. In the current economic market the provision of accessible funding is not likely in the short term, meaning the alternative approach is to reduce risks and project costs, decreasing the amount of capital needed to unlock assets. One way to achieve this is to increase the collaboration between independents to allow discoveries to be more effectively developed. In the case of small, stranded assets value can be greatly increased through the use of shared infrastructure, which dramatically reduces the development costs associated with each field. Across the industry smaller companies are generally better at collaboration however in the UK our record has so far been poor in comparison to global operations. The key is to widen collaboration between these smaller companies as far as possible. By collaborating and working together these companies can benefit by having the same economies of scale and large acreage as major oil companies while maintaining their flexible and entrepreneurial approach. This collaboration may also make the companies involved a more attractive proposition for the investment community who will see investment in a portfolio of companies as a far less risky strategy than investment in a single company. The independent’s rapid and risk prone E&P activity is imperative to feeding the opportunity funnel on which big oil relies. The future of regions such as the UKCS will be determined by the ability to extract maximum value from existing assets, add new opportunities, and quickly explore untapped plays. Creating security in aging basins is therefore reliant on an economic environment in which the independents can excel at these activities, with an emphasis on stimulating collaboration to fully exploit future production potential. James Paton is managing director at ADIL. He will be chairing a speaker forum titled “The Independent Oil Company – mighty oaks from little acorns grow” at Offshore Europe 2013 in Aberdeen on Sept. 4.
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