How sustained is the North Sea's second wind?

It is estimated that there are between 15 billion and 24 billion barrels of oil, or its gas equivalent, left in the North Sea

If you want to get oil and gas out from under the seabed, pressure is very important. And so is a lot of cash.

It's not just operating expenditure, of course, though there's a lot of that. Today's update on the UK's offshore oil and gas industry shows that amounted to £7.7bn last year.

No, it's primarily investment that counts in this business: capital expenditure, and in abundance.

This year, we're seeing a record amount being invested in the sector. Up from the very strong £11.4bn in 2011 to £13.5bn this year.

In real terms, that's more than any year in the 1970s, when the giant oil platforms were being built and pipelines laid. In 1976, though in today's terms, it reached £11bn.

From 1992 to 2008, annual investment never rose above £7bn (at 2012 prices).

Probable and possible

So what we're seeing now is sometimes described as "a second wind" for the North Sea. And there's some truth to that. After those poorer years of investment, it's deemed necessary to extract the hard-to-get reserves of oil and gas. If you don't spend now, the offshore kit won't be there, waiting until the price rises higher.

Having already extracted 42 billion barrels of oil or its gas equivalent (boe), it's reckoned that there are between 15 billion and 24 billion boe left. (You'll note that Scottish ministers always prefer to quote the upper limit.)

If the full potential for extraction is to be reached, then the fields will become more expensive to run

Let's break that down a bit. In its economic impact annual report, Oil and Gas UK sets out that 7.4 billion barrels have already been sanctioned, meaning there's a 90% chance of that being extracted.

"Probable reserves", with a 50%-plus chance of being developed, could mean another 2.5 billion boe of oil and gas. The more marginal "possible" stuff, which is technically difficult and too expensive at current oil and gas prices, could eventually bring another 1.5 billion barrels on stream.

Where does the rest come from? The industry body reckons there are potential additional resources of between one and four billion boe, and yet-to-find resources of between three and nine billion.

Trillion pound bill

So what kind of capital expenditure will be required to extract that? Well, if the 11.4 billion boe in current plans is to go ahead, that'll cost £300bn in today's money; £100bn in investment, £160bn to operate them, and £35-£40bn to decommission them after production has ended. That's more than the total £270bn investment in the UK offshore sector in the past 45 years.

And if the full potential for extraction is to be reached, then the fields become more expensive to develop and run. Oil and Gas UK thinks total expenditure could be between £600bn and £1,000bn, in 2012 money. That's right: a trillion pounds.

If the industry goes ahead with all the investment projects currently sanctioned, that guarantees the industry will be active for another 15 to 20 years. To go beyond 2050 will require other elements to fall into place; price, cost inflation, technical innovation, the right tax policy and the supply chain.

Integrity

You can drill down further into those big numbers, to understand what's going on at present. Large chunks of the 2012 investment was spent on a small number of very expensive projects. Only four fields got 30% of the spend.

That may change, as tax incentives target older oil fields to get incremental gains. A more helpful tax regime is credited by Oil and Gas UK with unlocking quite a bit of this spending, as relations with government have been patched up following the £2bn tax raid in the 2011 Budget.

Money has been invested in safety regimes following the Macondo blow-out in the Gulf of Mexico in 2010

The increase is also explained by renewed confidence in UK waters. While it seemed the oil majors were leaving this mature basin to smaller players, the big companies have come back in. Between 2009 and this year, the amount the majors have invested on the UK sector has trebled. That's just as well, because the credit crunch has made it more difficult for smaller operators to fund operations.

Oil and gas producers have also had to raise their game on safety, following the Macondo blow-out in the Gulf of Mexico in 2010. About £1bn has been spent on "asset integrity" last year, and the same is expected this year.

So while these firms were seeking to reassure us that the safety regime in the North Sea was much better than the American one, and everything would be just fine, they've quietly been spending multiple billions to make sure that it is.

Industry vs planet

So it's with that backdrop of record highs in investment that the industry is watching the decline in production with some alarm.

In 2011 and 2012, it took only a few fields to reduce output by 30%, and not enough new fields were coming on-stream to compensate.

There were lengthy shutdowns on Buzzard, North Morecambe and Brent. Rhum has been closed because of sanctions against its Iranian part-owners.

With the Elgin gas leak last year in the central North Sea, the consequent pipeline closure affecting seven fields accounted for four-tenths of the 14.5% decline between 2011 and 2012.

What this means is that the production at its peak, in 1999, has fallen from more than four million boe per day to only 1.54 million last year. Oil and Gas UK is expecting that to fall by at least a further 8.5% more and perhaps double that decline - to between 1.2 million and 1.4 million boe, for this year and continuing into next year.

What the industry needs is to get more of the potential oil and gas out the ground. Falling from 80% to only 60% in production efficiency in less than eight years is a big challenge to the finance departments. For every one pound sunk in the industry now, it's claimed that the industry is only getting a fifth of the return that it had a decade ago.

And yes, I know what some are thinking: what the oil industry needs is not what the planet needs, and that the best strategy for oil and gas is to keep them safely stored under the seabed.

But governments are hooked on the taxation income it generates, Britain needs it to keep energy imports down, while the public rather likes to avoid further increases in energy bills.

Volatility

And that question of taxation brings us back to the question of how this oil could transform Scotland's economic prospects if it were independent.

What this report underlines is that there is, probably, lots more oil and gas to be extracted from under Scottish waters, if the price and conditions are right to attract a very large amount of investment.

It shows how important oil and gas has been to Britain since the flow started nearly 40 years ago; in jobs (supporting 450,000 of them), in balance of trade (£32bn last year) and in tax revenue (more than £300bn in production tax over the years, £6.5bn of it in 2012-13, or 15% of corporation tax last year).

What it also indicates is that the volatile output of oil and gas has become a lot more volatile than even the industry expected, and it's struggling to see why or what can be done about it.

It also indicates that this "second wind" is going to come at such a cost in tax deductible capital investment, followed by tax deductible decommissioning costs, that the tax revenues coming into the treasury, in either London or Edinburgh, are likely to be very significantly affected, and may look a lot more modest than we've seen recently.