What impact is Brexit likely to have on the UK’s oil and gas industry?

Introduction

Most commentators believe that Brexit, in isolation, is unlikely to have a material effect on the regulation of the UK’s oil and gas industry, including its UK Continental Shelf (UKCS) activities. This is largely due to the fact that the UK Government has always retained control over its energy policy, including the development of oil and gas reserves . Key policy matters such as licensing and taxation of oil and gas exploration, appraisal, development and production activities have always been, and continue to be, determined by the UK Government, although aspects of the industry have been influenced by the EU. However, other significant changes have been triggered by the referendum and these may have a major impact on the UK’s oil and gas and broader energy industry for the reasons discussed below.

Does European Law still apply? Will the existing legal and regulatory regime change when withdrawal from the EU is complete?

The pre-referendum legal and regulatory regime governed by the Petroleum Act 1998 has not materially changed since its inception and nor is it likely to for some time. According to David Davis, the Secretary of State for Exiting the European Union, formal notice to withdraw from the EU will be served by the UK no later than end of March 2017¹, and for now the Government is holding this position, regardless of the recent High Court decision concerning giving notice under Article 50 of the Treaty of the European Union (TEU) (see below). Service of this notice starts the clocking ticking on a two year window for exit negotiations (which are unlikely to be concluded in a shorter time frame and may be extended only with unanimous agreement from all member States), giving a degree of certainty that the existing legislation applicable to UK oil and gas activities (including legislation which is derived from EU law) is likely to remain in place (or be implemented in the UK where it would otherwise cease to have direct effect) until at least March 2019. Furthermore, with the Prime Minister Theresa May’s proposal to introduce a Great Repeal Bill which will take, as a starting point, a continuation of the existing regime, any changes are likely to be introduced gradually and only following parliamentary debate. David Davis confirmed this in a recent speech², saying “The Great Repeal Act will convert existing EU law into domestic law, wherever practical. That will provide for a calm and orderly exit and give as much certainty as possible to employers, investors, consumers and workers.”

What will happen when the UK finally withdraws?

The prevailing opinion is that the existing legal and regulatory regime for oil and gas will not materially change following withdrawal from the EU. As was confirmed by an independent review of the UK offshore oil and gas regulatory regime conducted after the 2010 tragic events in the Gulf of Mexico, it is largely fit for purpose. The UKCS oil and gas industry operates to world-class standards, and has set the bar, contributing to raising operating standards worldwide. To take an example, the EU Offshore Safety Directive which was issued in 2013 was largely based on the existing UKCS health and safety case regime. As the overall legal and regulatory regime (including North Sea regulations which are derived from directives issued from the EU) works very well, and is one of the leading regimes operating around the world, it seems unlikely that there will be major changes post-Brexit and we do not envisage this becoming a target for lobbying by industry stakeholders, who are keen to protect the North Sea’s reputation for high standards.

What effect will the Government’s reorganisation have?

The immediate fallout from the Brexit referendum has seen the appointment of Theresa May as the UK’s new Prime Minister, a dramatic merger of the Department for Energy and Climate Change (DECC) with the Department for Business, Innovation and Skills to create a new Department of Business, Energy and Industrial Strategy (BEIS), and a cabinet reshuffle with Greg Clark assuming the role of Secretary of State for Business, Energy and Industrial Strategy. So what may be behind these significant changes and why the formation of this link between business, energy and industrial strategy?

As the UK starts to step-out from the EU, and negotiate its own international trade deals, many UK businesses would like a sound energy strategy, including a secure and cost competitive energy supply, to help them succeed. With recent reports suggesting that “manufacturing output is still almost 10 per cent below where it was when the Great Recession began in 2008, and the UK is running a balance of payments deficit unmatched in its peacetime history”³, the UK could perhaps be better placed at the current time. The changes to Government may be a precursor to more active Government involvement, shaping a new energy strategy for the UK, designed to stimulate the economy and drive business growth. UK oil and gas production has a key role to play in achieving such objectives, and with the right help from the Government, the industry could be a cornerstone to support future growth of the economy. Low oil and gas prices and depleting UKCS reserves have long given rise to difficult challenges for the North Sea oil and gas industry, and it is against this backdrop that the new Government needs to carefully consider the future of the industry. The right strategy is required to continue to attract and retain investors in the sector. After operators and their co-venturers have taken a decision to cease production and decommission infrastructure, there will be no going back; any related reserves are likely to remain in the ground forever, notwithstanding future advances in technology, given that future extraction would become uneconomic once fields have been permanently shut-in and infrastructure decommissioned.

Industry can, of course, also try to help itself. PwC has recently published a report into the state of the North Sea oil and gas industry, based on numerous interviews with senior stakeholders from the UK, the Netherlands and Norway (available to download here. The report concluded that “the general consensus is that the North Sea does have a future. However, a number of fundamental issues will need to be addressed in the next 24 months if the basin is to avoid a rapid and premature decline”. Amongst its recommendations are the formation of a “super joint venture” amongst offshore operators to maximise efficiency savings – enabling companies to share risk as well as return, secure coordination of activities for smaller fields and fragmented assets as equipment ages, and to apply similar joint approaches to securing funding as access to capital becomes increasingly difficult. The report also calls for strong and decisive leadership, which is both hoped and anticipated to come from the newly created regulatory body, the Oil and Gas Authority (OGA).

In the immediate aftermath of the referendum result, the previous Chancellor of the Exchequer George Osborne announced that he would consider cutting corporation tax to 15 per cent, or “preferably lower”, to galvanise the economy. In his own words, “What stronger message could we send that Britain is open to business?” However, in September his replacement, Philip Hammond, confirmed to EU finance ministers that he would stick to the UK Government's plan to cut this rate to 17 per cent by April 2020 (from the current rate of 20 per cent, which is still much lower than the EU average of around 24 per cent). What additional changes are to be made to the fiscal regime for oil and gas developments specifically remains to be seen. A raft of measures were announced in April 2016 to boost the UK oil and gas industry including reducing Petroleum Revenue Tax (PRT) to zero, reducing the supplementary charge from 20 per cent to 10 per cent and granting relief on decommissioning costs to field participants where they retain liability for those costs when they dispose of an interest in a field. See our client briefing here for further details.

Will Brexit galvanise the UK shale industry into action?

With security of energy supply being a key concern, particularly as traditional ties with the EU are broken, and with declining North Sea production, the UK Government may seek to promote the development of domestic shale oil and shale gas resources. Indeed the communities secretary, Sajid Javid, only last month overturned Lancashire county council’s rejection of Cuadrilla’s application to frack for shale gas at Preston New Road, paving the way for Cuadrilla to drill in the county next year. In explaining its reasoning behind the decision, the Government stated it considered the existing regulatory regime was sufficiently effective to control emissions, and further concluded there would be no health impacts arising from potential exposure to air and water pollutants.

Some of the more optimistic news reports suggest that the move marks “a major step up in the scale of exploratory fracking in the UK”⁴, as it green lights four wells, compared to Third Energy’s single well approved for fracking in North Yorkshire earlier this year (although that decision, along with the decision on iGas’s application to drill near Doncaster, has been delayed into 2017 due to legal challenges to both applications by the non-governmental organisation Friends of the Earth). However, as has been the case for a number of years, the successful development of shale oil and shale gas reserves in the UK will largely rest on two key issues: economic viability and local community engagement and buy-in, including comfort as to its safety (regardless of the reassurances from Government that public concerns about health carried “little weight in the planning balance”⁵). Those same concerns will remain at the top of the agenda in a post-Brexit environment.

Will the fall in value of the pound help or hinder investment in the North Sea?

If the pound remains devalued (recently it fell to a 31 year low against the US dollar as a result of the Brexit referendum), this may encourage international investors to invest in the UK, as UK assets and companies become instantly cheaper. However, the results of the most recent North Sea licensing round are not encouraging – only 29 applications were made this year, compared to over 170 in the previous 2014 round. The numbers are no doubt in part influenced by Brexit but given the global nature of the oil and gas business, the key driver is more likely to be the current oil price set against a background of Brexit-related uncertainty. The recent High Court ruling, confirming that the Government cannot trigger Article 50 TEU without parliamentary approval may have given heart to those hoping for a “soft” Brexit and caused a slight rally in the value of sterling, but in practical terms there will continue to be uncertainty around doing business in the UK.

Conclusion

At present, the UK sources around 43 per cent of its demand for gas from the North Sea and 13 per cent from LNG imports, with the remainder being imported through the gas interconnectors which link the UK gas network to Europe (via Belgium, the Netherlands and Ireland). The three existing LNG import terminals are hugely under-utilised. If they were all used at full capacity they could deliver 50 per cent of the UK’s gas needs. It will be interesting to see how the current gas demand situation and sources of supply change over time.

The vote to “Brexit”, coupled with the fall in the oil price, have together undoubtedly brought to the fore the need for change. The North Sea is a mature basin with many fields at or nearing their end-of-life cycle. Such change was already afoot following the publication of the Wood Report in 2011 and the consequential creation of the new Oil and Gas Authority, whose primary aim is to maximise economic recovery from the UK. But there are now additional drivers for change, and hopefully Government and industry can live up to the challenge. The overarching belief is that this change will come through innovation and collaboration and early indicators are positive. It would be good to think that the merger of DECC into BEIS will trigger a new lease of life for the industry and help to maintain UKCS oil and gas production, incentivise the development of new fields and encourage the continuation of production from fields nearing the end of field-life, thereby slowing-down increased dependence on imports of hydrocarbons and the potential negative impact this may have on UK businesses. The Government, following Brexit, is increasingly motivated to ensure that the UK oil and gas sector is attractive and competitive to safeguard its survival and stem the flow of decommissioning, and the industry itself seems to be galvanising and collaborating in new and innovative ways.

As the current post-referendum turmoil subsides, we predict that Brexit will lead to the new Government creating a more attractive investment climate for oil and gas investors; one that we hope will see the emergence of a sensible and balanced long-term energy strategy for the UK, which:

1. includes an attractive and stable environment for oil and gas investors;
2. offers a secure and cost competitive source of energy for UK businesses; and
3. creates employment opportunities in the UK’s oil and gas industry.