Warning: North Sea drilling ban would hit renewables sector

Political parties appear to be hedging their positions ahead of elections at Westminster and Holyrood in coming months. However, the Labour party looks set to enter the UK general election campaign with a manifesto that includes curbs on North Sea drilling, which could help capture the green vote. In June Keir Starmer said Labour would not grant licences to explore new fields.

In the draft energy strategy published in February, the Scottish Government said there should be a presumption against exploration in the North Sea.

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It is not clear if the SNP-led administration wants curbs in new areas only or a total ban, which would mean no drilling would be allowed on existing licences as well.

Sector watchers fear a total ban would have alarming implications.

James Reid, senior research analyst at Wood Mackenzie, says there are still finds to be made in areas such as West of Shetland.

The latest North Sea exploration licensing round won a strong response from the industry. On Monday the North Sea Transition Authority announced that it had offered 27 licences offered covering areas the regulator reckons could go into production faster than others.

The round attracted 115 applications from 76 companies, the highest participation rate for six years.

“There’s still a fair bit in the yet to find bucket,” says Mr Reid, adding: “If they did do a complete blanket ban on exploration it would probably change a lot of companies’ view on the UK.”

Noting the windfall tax and related changes have caused instability, Mr Reid cautions: “If you were to layer on top of that a ban on exploration it would make it much harder to attract capital and new companies into the UK … it would very much be seen as if it’s on a far quicker glidepath to ceasing [production].”

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Industry body OEUK is also worried about what a ban on exploration would mean.

“For as long as we need oil and gas in the UK we think we should be producing that locally,” insists fiscal and investor relations manager Francesca Bell.

“There’s currently around 283 producing oil and gas fields in the UK by 2030 that goes to 180, so we need to top up.”

Ms Bell warns: “That idea of banning exploration really, really worries investors about what that means for the UK … it then pushes them out of the UK to other regions.”

She worries that cuts in investment by operators could lead supply chain firms to shift their focus overseas. That could mean the UK loses the skills that will be needed to develop offshore renewables assets and carbon capture, storage and usage facilities.

“At a corporate level it’s one thing. [As it’s] the people sitting in those businesses who will be pivotal to delivering CCUS and offshore wind and hydrogen making sure we can make the UK an attractive place for that next generation of the workforce is also fundamental too.”

Ms Bell says firms across the oil and gas supply chain are very active in renewables.

While OEUK has claimed the windfall tax could hammer the North Sea industry, oil and gas activity seems to have held up better than expected despite displays of anger from some heavyweights.

Harbour Energy, TotalEnergies and Apache have all announced cuts in activity.

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“There is still a fairly healthy pipeline of projects in the North Sea,” notes Wood Mackenzie’s Mr Reid.

He highlights the importance of the investment allowance introduced alongside the windfall tax, or Energy Profits Levy. The allowance lets firms set qualifying spending against the levy.

Environmentalists say the allowance subsidises polluting activity on a huge scale and want it scrapped. Labour leaders have called for a “proper” windfall tax to be imposed.

Mr Reid says the impact of the windfall varies markedly between firms in growth mode and those that are trying to maximise the profits generated from existing assets.

“Companies such as Harbour were hit pretty hard because it was pretty much in harvest mode,” he observes, adding: “Companies that were going through a heavy investment cycle, they were still hit by the tax but they were able to somewhat offset that with the investment incentives.”

Mr Reid highlights the decision by Norway’s Equinor and Israeli-owned Ithaca Energy to approve the giant Rosebank development West of Shetland.

However, while the Rosebank decision may make Ithaca more optimistic about the outlook for the North Sea it may not increase the likelihood of the firm approving plans to develop the giant Cambo find. Cambo could require years of planning. It might not come onstream before the expected end date for the windfall tax and related investment allowance in 2028.

“They will need to find a farm-in partner first and foremost, which I believe is Ithaca’s main focus just now,” says Mr Reid.

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OEUK’s Ms Bell notes: “It’s only one project and we definitely need more than Rosebank to move forwards.”

She says firms may be reluctant to make decisions until they have digested the full implications of the series of windfall tax related changes made since the EPL was introduced in May last year.

Uncertainty about the political situation given where we are in the electoral cycle may weigh on activity. The fallout from the terrible events in Gaza could lead to major economic disruption.

Oil prices surged before the crisis erupted, after Saudi Arabia cut production to support the market. Following the cuts, analysts said Brent could hit $100/bbl this year.

Mr Reid observes that a range of firms are working on smaller subsea tiebacks in the North Sea and what are called infrastructure-led projects close to existing platforms.

In its latest well survey, the North Sea Transition Authority found exploration and appraisal activity had fallen recently but operators expected it to increase.

Some companies still look keen to increase exposure to North Sea. Prax has underlined its appetite for more acquisitions after buying West of Shetland-focused Hurricane Energy for £250 million in June.

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Further tax changes could have a big influence on companies’ thinking.

OEUK is awaiting the outcome of a review of the fiscal regime launched by the UK Government. The result is expected to be announced by the end of 2023.

The Conservative Government has said it wants to max out the North Sea’s reserves.

OEUK appears to have toned down its rhetoric about the windfall tax.

However, Ms Bell is adamant that firms are no longer generating the kind of profits they did after Russia’s war on Ukraine triggered dramatic increases in oil and gas prices, so can’t be said to be enjoying a windfall.

Mr Reid believes the Government could use a royalty system to benefit from price rises in a more flexible way than tax changes entail.

“We would abolish the EPL as it sits now and replace it with a high price royalty. That would extract a share of windfall revenues if prices increase rapidly but then if prices fall back down the royalty would cease to apply.”

With parties of all hues keen to encourage renewables investment, OEUK also fears the windfall tax imposed on renewable energy generators could deter investors.

Ms Bell claims the fact offshore windfarm developers boycotted the latest official funding round spoke volumes.

Noting that countries such as the US are offering generous tax breaks for renewables investors, she concludes: “It’s a global race for capital, the UK is just a small dot on the global map.”