ONS 2004 – The Story’s the Same, But the Faces are Changing

Published Aug 16, 2004
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Offshore Northern Seas in Stavanger this August will see for the first time a targeted marketing effort to promote entry into the Norwegian Continental Shelf (NCS), as the Norwegian Petroleum Directorate (NPD) campaign to promote the Norwegian sector to new entrant E&P firms gathers pace. Building on the success of the UK Department of Trade and Industry’s efforts to attract new players to the UK Continental Shelf (UKCS), the Norwegian authorities are progressing a similar, targeted approach to attract North American firms that have recently entered the UK, such CNR, EnCana, Apache, and Petrocanada.

Though generally a less mature province, like the pattern of activity in the UKCS, Norwegian oil production is nearing peak and new discoveries are far smaller than those currently in production. In the UK sector much relies on the independent E&P operators as a key component of the future of the region. For Norway to best exploit its reserves, calls are being made for a more competitive system to be put in place to attract new companies and additional investment. With numerous production and exploration opportunities in the sector, the Norwegian authorities are keen to attract “firms of substance” who have the ability and the appropriate focus to invest.

Ownership Situation
The NCS has been relatively closed since the inception of the industry, with major players such as Total, Exxon Mobil, ConocoPhillips and Shell effectively being bit-players in the region as the majority of reserves are owned by the state enterprise Petoro, complimented by very strong positions of Statoil and Norsk Hydro who collectively operate 80 percent of production. Although the NCS is very much a core area for both Statoil and Norsk Hydro, with expected production in 2004 of one million boe/day and 500,000 boe/day respectively, the majority of both firms future growth is expected to come from international plays. The oil ministry has also taken steps to change the historical dominant position of these companies through partial privatisation and more openness in licensing rounds, which is tempting the entry of independent E&P firms keen to exploit mature assets and expose themselves to exploration opportunities.

Talisman, Anadarko, Paladin, and BG have all been awarded operator licences in 2003, while CNR International and Acorn Oil and Gas are completing their pre-qualification process. The arrival of the independent community suggests that attempts by the Norwegian petroleum ministry are working to attract new players. Overall, this should benefit the whole North Sea if new companies can be attracted to the North Sea region. A natural step for operators in the UK would be to expand into the Norwegian sector, and vice versa.

Entry Strategies
For companies seeking to access the wealth that exists in the NCS, a range of entry strategies are available. Possible options range from acquiring exploration licences, buying shares in discoveries to be developed, or the purchase of shares in producing fields. While the purchase of producing assets has been the historical entry method to the NCS, it is no longer necessary to buy producing assets for tax purposes prior to initiating large scale exploration activities. Exploration costs can now be carried forward and offset against future net income. Additionally, a firm that has incurred losses through exploration can sell these losses to third parties. Thus, we may witness increased entry into the NCS through licensing rounds and other exploration led activities.

Exploration Plays
Norwegian exploration policy has favoured a gradual opening of exploration areas through licensing rounds, offering opportunities for majors and independents to establish a balanced portfolio of acreage in mature, frontier, and virgin areas. This has been highlighted by the increased interest that has been shown in the 18th Licensing Round for frontier areas in the North Sea and the Norwegian Sea. The Norwegian Authorities believe there are major undiscovered hydrocarbon reserves on the unexplored areas of the NCS. Therefore there is an emphasis on applicants to undertake rapid and efficient exploration. To date, some 18 companies have applied for blocks, eight more companies than participated in the 17th round. These are; Amerada Hess, BG, ChevronTexaco, DNO, DONG, ENI, ExxonMobil, Gas de France, Idemitsu, Marathon, Norsk Hydro, Paladin, Pertra, Revus, RWE-DEA, Shell, Statoil and Total. The Ministry of Petroleum and Energy aims to award new production licenses in the second quarter of 2004.

However, the choice between buying production relative to other entry methods will depend on several factors in relation to the overall corporate strategy of the firm. Elements such as the required rate of return, the likelihood of having to sell losses at a discount, or the ability to raise capital and operate with losses over a time period until they can be utilised, will all affect the entry strategy to be adopted.

Corporate Activity
Independent E&P firms continued to strengthen their presence in the UKCS in 2003, acquiring an additional 574 million boe of commercial reserves from the majors. In all, 400 million barrels of oil were transferred in addition to 1 trillion cubic feet of gas. Independent E&P firms and new start-ups were involved in 27 of the 28 corporate deals – which amounted to just under US$2 billion of commercial reserves being traded.

By comparison, the Norwegian market, despite the oil Ministry’s efforts, remains less liquid regarding asset deals. In 2003 some 32 transactions were announced, and of these, only four deals were for producing assets, the balance being licence deals. Given the dominance of Statoil and Norsk Hydro on the NCS it is interesting to note that only eight deals that occurred in 2003 included the two companies.

That said, according to Wood Mackenzie, corporate activity in 2003 displayed a continued trend of increasing involvement of both new and independent E&P players. Statoil sold its interests in two production licences in the central North Sea to Paladin, while Talisman Energy added to its growing portfolio with a purchase of BP’s interest in the Gyda field. ConocoPhillips sold its 15 percent stake in the Njord field to Ruhrgas marking their entry into the NCS.

While the UK sector still has a potential 22 to 34 billion barrels of oil equivalent (boe) of remaining reserves, the Norwegian oil and gas sector is undoubtedly the most significant in Europe. Since 1966 some 1063 exploration wells have been drilled, proving 60 billion boe of recoverable reserves. Undiscovered resources are thought to be 21 billion boe recoverable, equivalent to the quantity that has been produced to date. With oil production exceeding three million barrels per day and net gas production over 2.5 tcf a year, Norway ranks as the world’s third largest exporter of oil and gas behind the Russian Federation and Saudi Arabia.

At present, oil production dominates the shelf, however this relationship is expected to change as the region develops. The mix of gas to oil currently stands at 27 percent, which is expected to reverse to 77 percent gas by 2050. Estimates indicate that Norway has oil for 50 years and gas for a further 100 years. Although the region has yet to go into decline like its British neighbour, there is a realisation that the NCS will follow a similar path into maturity – which is expected to occur, for oil at least, in 2006.

Sector Issues
While issues have been raised regarding access to infrastructure in the UK sector, the Norwegian government has been keen to open up the pipeline system – particularly for gas, to all participants on non-discriminatory, objective and clear terms. Its gas pipelines are operated by Gassco, an independent company. Overall, there is a “regulated and clear access regime” where Standard Terms and Conditions apply to all holders of capacity. Tariffs for the use of the upstream pipeline network are stipulated by regulation and are readily available. Regulated transportation costs and equal rights of access ensure appropriate incentives for exploration, field development and marginal production.

Similar to the UK, the Norwegian North Sea is littered with numerous large production platforms, some truly massive in scale. In the future, there will be similar issues regarding the decommissioning of this infrastructure, which may attract higher liabilities than the UK. Decommissioning has been a major issue for independent E&P operators on the UKCS as the liabilities erode balance sheets and constrain access to appropriate finance for smaller investors. Given the scale of some of the offshore platforms in the Norwegian sector, it may be hard for the independents to enter the region through production-based acquisitions.

Taxing Times
In March 2004, the Norwegian Ministry of Finance proposed various changes to the Norwegian tax regime that should make Norway a more attractive place to do business. The proposals, if approved by the Norwegian parliament, will be effective from 26 March 2004, and are more sweeping than the reform of the UK system that has taken place over the last few years. Not only will gains realised on the sale of shares by companies be exempt from taxation, but also dividends received by companies will no longer be liable to tax. The UK introduced an exemption for gains in 2002, but still taxes dividends received from non-resident companies. Moreover, the UK has detailed rules that require to be met to qualify for the exemption, whereas the indications are that the Norwegian proposals have no minimum holding period or minimum percentage ownership requirements.

In addition to these current changes, the Norwegian industry group Kon-Kraft is lobbying for further change in acknowledgment of the maturing environment. Their report published in August 2003 recommends that oil and gas taxation levels need to be lowered to attract new investment creating a win-win for industry and government as lower taxation stimulates increased E&P activity, and overall higher tax receipts. The current regime imposes 28 percent corporation tax, with a supplementary 50 percent rate for oil and gas activity. The study suggests that lowering this supplementary rate to 10 to 25 percent is needed to ensure long-term sustainability of the nation’s industry.

In response to these calls, the Norwegian government issued a white paper in the spring of 2004. The white paper included a number of proposals to amend the country’s petroleum tax system but stopped short of the rate cuts called for. However, the Norwegian Oil Industry Association (OLF) has described the proposed measures as “completely inadequate” and continues to lobby parliament for what it believes to be more effective changes. It remains to be seen how this situation will develop.

Overall, the Norwegian oil and gas sector may be seen as a good opportunity for E&P companies seeking to invest. Although the resource situation is significant, there are still hurdles to overcome. The efforts of Norwegian stakeholders to make the province more attractive to inward investment will take time to realise. Yet it is encouraging that the sector has recognised the need to change, and that inward investment will be key to the success of the region. Lets hope this momentum builds to the benefit of the Norwegian sector, and the benefit of the North Sea as a whole.

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