Bruised but unbowed, the UK oil and gas industry has emerged from three years of job losses, rock bottom oil prices, increased global competition, and the lowest exploration levels since the 1970s.

Cautious optimism is the new byword on the UK Continental Shelf (UKCS) following the release of trade body Oil & Gas UK’s annual Economic Report. Forensic cost-cutting, a marked uptick in M&A activity and a new cohort of private equity-backed businesses is breathing new life into the basin.

But for how long? According to Deloitte senior partner Graham Hollis, the offshore industry cannot afford to be complacent if the potential £40bn worth of developments in companies’ business plans is to be realised – and the UKCS is to compete from a position of strength on the international stage.

“There are many positives that the Oil & Gas UK Economic Report calls out,” he states. “Increased production levels and M&A activity, more use of technology, and signs that behaviour is changing in both the upstream and downstream sectors; all these point to confidence returning after a couple of very challenging years.

“New regulatory body the Oil and Gas Authority and the recently launched Oil and Gas Technology Centre and its Innovation Hub in Aberdeen have achieved a great deal in a short space of time.

“However, what also comes out of the report is the need to guard against complacency. The UKCS remains challenging and is still a mature basin to do business in. As an industry, we need to focus on making further improvements if the North Sea is to continue to thrive and be sustainable long term.”

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Efficiency drive: cost-cutting, technology and the talent pool

Reducing unit operating costs by $14 per barrel on average in 2017 has been central to the recovery of the UKCS. Oil and gas companies have pared expenditure down to the bone to attract investment.

“The UKCS is competing for investment in a global market and high operating costs are a deterrent,” says Hollis. “Great progress has been made across the sector, partly through companies driving costs out by challenging the supply chain. However, we’re at the point now where the supply chain is hurting as a result of the downturn and further reductions are not sustainable.

“What is heartening is that the industry is looking away from easy wins in favour of changing their behaviours and operating models with a view to focusing on sustainable increases in efficiency.”

The £180m Oil and Gas Technology Centre and Innovation Hub in Aberdeen have a vital role to play in maximising recovery from the UKCS and anchoring the supply chain in the north-east of Scotland.

“The Oil and Gas Technology Centre is challenging the offshore industry to develop and deploy new technologies in the UKCS,” says Hollis. “There is a realisation in the sector that we need to look at adjacent industries and seek to employ similar technological advances to those that they have made to reduce operating costs.”

Technology will also play a key role in attracting a new generation of talent to the domestic oil and gas industry, which supports more than 300,000 jobs in the UK, a third lower than the peak in 2014.

Oil & Gas UK’s annual report said 60,000 direct and indirect jobs were lost across the industry in 2016, more than the 40,000 it had predicted. The sector could lose another 13,000 jobs in 2017.

“One of the most significant impacts of the downturn of the past few years has been on the talent pool − I see that in Aberdeen on a day-to-day basis,” says Hollis. “

“However, I’m optimistic because the young have a lot to offer around digital innovation. We need to focus on new technology such as artificial intelligence and they are used to the new technology.

“We also need to be mindful of the fact that delivering on the opportunities in the UKCS requires a combination of experienced workers who may be accelerating their retirement because they don’t want to go through another cycle, and the brightest and the best from our universities.”

New blood: M&A activity  and asset transfers

There are tangible signs that the industry’s efforts are working and investor confidence is returning.

The Oil and Gas UK report notes that almost $6bn was invested in the UKCS in the first half of 2017. Hollis also points to the upsurge in M&A activity and asset transfers between large established players such as Shell and a new breed of North Sea players, many of them backed by private equity.

Hollis cites as salient examples Chrysaor’s $3.8bn purchase of assets across seven North Sea projects from Shell and Siccar Point’s strategic acquisition of OMV’s portfolio in the West of Shetlands region.

“Previously, there was a disconnect between the prices at which sellers were willing to pass on their offshore assets and the price that acquisitive companies were willing to pay,” he says. “However, the benchmark for doing deals has been reset and this has driven further significant M&A activity. We now have a new breed of upstream independents operating in the UKCS, a diverse investment group. It’s important that exploration and production is not just in the hands of the majors.”

However, Hollis takes issue with the view that international oil companies (IOCs) are abandoning the UKCS in favour of more cost-competitive play abroad. The evidence, he claims, suggests otherwise.

“There are a number of very large transactions upstream and downstream that would contradict that view,” he says. “For example, Centrica’s recent acquisition of Bayerngas is an indication that a large established player in the UKCS still believes there is value there. BP’s production in the UKCS will be larger than it’s ever been when the large projects it is currently working on come onstream.”

“It is not accurate to suggest that the IOCs are withdrawing completely from the UKCS − they are simply reflecting on their overall portfolio. Part of that process involves a transfer of assets from owners who have been active for years and maybe no longer see those as core assets. That’s natural and not the first time it has happened.

“Similarly, big downstream deals have been done, including the [£2.2bn] takeover of AMEC Foster Wheeler by the Wood Group, which was a real positive for Aberdeen and the offshore sector.”

Subsidising the future: government policy, Brexit and renewables

Looking ahead, is the UK Government is doing enough to aid the recovery on the UKCS, and could continued uncertainty around Brexit negotiations damaging investor confidence?

“A few years ago the industry felt it was being hit very hard and was pointing to several successive fiscal changes that were making the UKCS less competitive,” Hollis says.

“What’s encouraging is that recent budgets have included action to make the tax regime more attractive to potential investors, including a reduction in supplementary corporation tax. In addition,  the introduction of investment allowances, a reduction in the petroleum revenue tax to 0%, and potential tax incentives for late life assets hint at a welcome mindset change from the government.”

“Brexit is no more significant than the other challenges facing the UKCS, but until the negotiations are complete it does equate to uncertainty − and the UCKS does not need more uncertainty.”

Finally, how does Hollis respond to the argument that government subsidies would be better spent on incentivising renewable alternatives to fossil fuels such as offshore and onshore wind, and solar?

“The Oil & Gas UK report forecasts that oil and gas will provide two thirds of our domestic energy in 2035. In addition, global oil and gas demand is predicted to increase by 25% between now and 2035.

“We are seeing an acceleration toward renewables, but we mustn’t lose sight of the fact that oil and gas will continue to play an important part in the UK and global energy mix. We are not in a place where renewables are a direct substitute for the contribution that oil and gas makes presently.”