Alexander Le Grys
In the past two months, there has been a certain buoyancy in the oil market. Brent crude oil prices reached below the $70 mark for much of January. As a result, 2018 looked to be a promising year for many oil-producing countries, particularly those that are not members of the Organisation of the Petroleum Exporting Countries (OPEC), like the UK and the USA. However, oil prices fell to their lowest in six weeks on Thursday 8th February, reaching $64.14 with a downward trend gravitating towards $60 looking very plausible for the remainder of the year.
Before the downward shift in the oil markets, the UK’s oil industry operating from the North Sea was optimistic. New fields had started production and large-scale projects were being written up, with Shell giving the green light to redevelop its Penguin field, its largest investment in the North Sea for over six years. In addition, costs have fallen with inefficiencies being ironed out. As prices are expected to remain around $70 for 2018 from the extension of OPEC cuts in 2017, the Treasury has predicted over £1 billion in tax contributions for this year. But, with the sudden turnaround in oil this year, will the UK and its oil industry see further pain that has been experienced ever since the huge price fall in 2014?
With the US aggressively drilling for shale over the past 6 months, the supply lag has caught up, thus counteracting OPEC’s supply cuts. Coinciding with this, a strong US dollar has also put downward pressure on oil because of the selling off effect on commodities it brings as a consequence. This has caused a realistic recognition that a resurgence in the British oil industry is unlikely due to the financial constraints on production preventing it from being economically viable. The trade body Oil and Gas UK predicts by 2025, 98 platforms will have been removed and more than 1,600 wells plugged. More worryingly, with an industry that experiences external economies of scale such as oil extraction, a ‘domino effect’ is always plausible. That is, when one company exits operating in the North Sea, leaving the incumbent firms to share a greater part of the cost of maintaining infrastructure, encouraging more firms to leave the North Sea.
With the supply dynamics still working against this market, and a constant underestimation of US output, crude oil looks very unlikely to replicate January’s movements. John Kilduff, a partner at energy fund Again Capital, has called for crude oil to pull back to $60 a barrel for the lion’s share of 2018. If this is the case, expanding output and investment in the North Sea will not be economically viable for UK firms. Nevertheless, last week BP announced the discovery of two oil and gas fields in the North Sea. In addition, there is almost half of original reserves left intact enhancing that investment in the long run is still wise providing the price of the commodity rises. For those that can manage production at $60 a barrel it is business as usual. However, it would seem foolish for the UK and its firms to expand and contribute to a bearish global oil market, for now at least.