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Derek Leith, UK head of oil and gas taxation at EY writes about the future of the Scottish oil and gas sector, in the new edition of World Class Scotland 2015.

Oil rig platform

Scotland’s oil and gas sector has been an outstanding success for many decades, but as the North Sea works through its mature stage, it faces huge new challenges and major opportunities

The past 12 months have seen a dramatic fall in the oil price and a very slow recovery. The uncertainty surrounding the short term price has brought the industry’s underlying problems into greater focus, starting with a significant reduction in the capital expenditure budgets of oil companies both big and small.

It is estimated that $120 billion of projects have been cancelled or deferred. Although some commentators believe such cuts in investment will have an impact on oversupply only in the short term, others are more pessimistic, not in the least because of the prospect of increased supply from Iran if sanctions are lifted.

In many ways, the Scottish oil industry has been a victim of its own success. Fields which were originally scheduled to be decommissioned in the 1990s have confounded expectations and still produce oil today, but the ageing underlying infrastructure has meant the fixed costs of such fields have increased dramatically.

Access to a well-developed supply chain has encouraged continued investment offshore while a highly developed regulatory regime and non-interventionist state have proved very attractive compared with many developing oil and gas basins; that investment peaked in 2012-2014 as large capital projects were undertaken, which in turn has driven cost inflation.

The high cost base and falling production efficiency of the older assets began to sound warning bells in government and Sir Ian Wood was commissioned to undertake a review in the second half of 2013. Its findings were published in 2014, closely followed by a Scottish Government Expert Commission and a Fiscal Review by HM Treasury.

Future of oil and gas

“There is a lot of scope for improved discipline in cost control and project execution, the introduction of new technology, collaboration across the supply chain and new working methods. Companies with clear focus and strong leadership will seize the opportunity and transform their businesses.”

Derek Leith, UK head of oil and gas taxation, Ernst & Young

These studies highlighted that the North Sea cost base had to be addressed: companies needed to collaborate to a much greater degree; a new regulator with greater resources and powers was needed to proactively oversee the sector; and that the fiscal regime needed to be simplified and tax rates lowered.

The industry has been greatly reassured that its contribution, particularly that of the predominantly Scotland-based supply chain, is valued and that the government is committed to maximising the economic benefit of the significant reserves that remain to be gained from the UK Continental Shelf (UKCS).

Against that backdrop, it is inevitable there will be a significant shake-up in the companies investing in the UKCS. Many of the supermajors are likely to continue to move their focus on core assets and there will be opportunities for the mid-tier and smaller companies to take control of assets, perhaps in some cases with the supermajors remaining responsible for decommissioning at the end of field life.

There is evidence that the region is attracting attention from private equity funds and state oil companies and there will no doubt be deals announced in the second half of 2015.

Opportunity also abounds for the supply chain. The volume of demand in recent years and a high oil price has reduced the effectiveness of both the upstream companies and the supply chain, and parts of the industry have seen a slump in operational efficiency. There is a lot of scope for improved discipline in cost control and project execution, the introduction of new technology, collaboration across the supply chain and new working methods. Companies with clear focus and strong leadership will seize the opportunity and transform their businesses.

The Scottish oil and gas sector has been a huge success story for decades. The introduction of a new regulator, a commitment to a simpler lower rate tax system which will be competitive internationally, and the deployment of the skills, expertise, innovation and energy of the workforce will ensure that the oil industry will continue to prosper and leave the legacy of a supply chain rooted in Scotland and operating in every corner of the globe.

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