ICIS VIEW: UKCS investment remains sluggish despite high prices

LONDON (ICIS)– Despite seemingly positive signals for North Sea energy development from gas prices at nearly double long-term averages, UK investment remains sluggish at best and long-term decline seems to be on the cards.

The ICIS NBP Month +1 contract has halved since the explosion on the Nord Stream pipeline in September 2022, mainly due to steady British LNG imports along with a strong storage buildout on the continent.

UK gas production also peaked in 2022 off the back of record-high gas prices alongside an easing of maintenance and restrictions on production.

Gas prices remain structurally high because of a fundamental mismatch between supply and demand, which, in theory, should act as an incentive for UK North Sea producers.

DEVELOPMENT OF NEW FIELDS

While on the face of it the UK seems to be steadily expanding production within the North Sea, with the potential to add around 48.2mcm/day to the UK gas system by the end of the decade, the supply situation looks more precarious when placed under the microscope.

Only three new fields gained development approval last year (Jackdaw, Abigail and Tommeliten A), with these projects containing over 12bcm of discoverable gas reserves. While this may seem like a sizeable addition for the UK, this is around a fraction of the 67.5bcm discovered in the previous decade.

There are also ten projects under review by the UK government which could add around 97.5bcm to the UK energy balance.

However, investment appetite for long-term, costly oil and gas fields may be under threat with two of Britain’s recent additions (Cambo and Rosebank) continually delaying their final investment decisions because of uncertainty around economic conditions and taxes.

This has been mainly evidenced in a significant reduction in capital expenditure on the UK continental shelf (UKCS) since the beginning of 2010. Investment in the North Sea reached an all-time peak of £16.2bn in 2014 and has now more than halved to £4.7bn in 2022.

Capital expenditure is set to reduce even further over the next decade, falling to a projected low of £2.5bn.

COMPANIES FACING HEADWINDS

The current high-price environment should in theory incentivise continued investment in the UK’s North Sea to capture this high value.

However, the introduction of the Energy Profits Levy in 2022 has caused significant turmoil in the UK’s upstream process, and has discouraged investment and raised costs for many producers.

A recent business outlook report from trade association Offshore Energies UK estimated around 500mn barrels of oil had been wiped off the UK North Sea’s balance sheets owing to risks associated with investment.

To go one step further, the gradual erosion of the UKCS, along with unfavourable investment conditions, will force the Britain back into the global gas market and leave it increasingly exposed to developments worldwide.

Indeed, the OEUK estimated that imports cost the UK £117bn in 2022, compared with £54bn in the previous year.

In 2022, the UK imported around 60% of its gas needs, with production taking up 40%.

However, forecasts suggest the UK will need to import 85% of the oil and gas it requires within a decade, this sets up a sore sight for the UK consumer.

GLOBAL GAS PRICE ALIGNMENT

While the UK has access to multiple sources of flexible gas supply (Norway, Belgium/the Netherlands and LNG volumes), this reliance on imports has left the British gas market exposed to high prices and extreme volatility as it links the NBP to international price movements.

The correlation of front-month contracts at the British NBP to the equivalent contract at the US Henry Hub (HH) and ICIS East Asian Index (EAX) have all significantly increased in recent years.

The relationship between the NBP and EAX has strengthened by 39 percentage points since 2018, with a similar movement between the NBP and HH at 35 percentage points.

The Russian invasion of Ukraine, and the subsequent loss in eastern piped gas volumes, accelerated this trend in globalised gas markets and has only served to strengthen the NBP’s interrelated relationship with the rest of the world.

For example, an explosion last summer at the Freeport LNG terminal, one of the US’ largest such plants, caused several NBP near-curve contracts to soar.

Looking towards the current forward curve, prices are set to remain two-three times above the historical norm seen between 2010-2021 until new global supply comes online.

Even then, contracts remain above €15/MWh, which shows elevated prices could be the new normal for some time to come.

Britain’s exposure to global gas price movements is only set to strengthen as supplies will remain constrained in the foreseeable future along with a particular dependence on the premium fuel of choice, LNG.