Westwood: UK’s windfall tax puts oil & gas investments at risk, with domino effect on North Sea rig demand

After the UK made changes to the UK Energy Profits Levy (EPL), increasing it to 75 per cent for oil and gas producers, many operators, including oil majors, have pointed out that this has the potential to drive out investments in the UK’s oil and gas sector. In line with this, Westwood Global Energy highlights that these tax changes could amplify the mass departure of rigs from the North Sea, which is already in full swing. Is this the point of no return for North Sea rigs?

The government made a move to hike its windfall tax to a further 10 per cent and delayed the closing date until 2028 to raise cash to aid the UK’s cost of living support programmes. However, as pointed out by Teresa Wilkie, Research Director – RigLogix, the tax changes appear to have backfired due to the backlash, as many claim that the increase in windfall tax will drive away investment “at a time when energy security is more crucial than ever.”

Following the windfall tax hike, Offshore Energies UK (OEUK) underscored that the UK offshore industry would be “hit hard” by these tax changes on oil and gas production, which threaten to drive out investors and drive up imports, leaving consumers increasingly exposed to global shortages.

In addition, oil majors, mid-sized operators and smaller independents have all voiced concern regarding the new fiscal environment with TotalEnergies, Equinor, Shell and EnQuest, among others, revealing plans to reduce UK spending this year, while Harbour Energy blamed the tax changes on its recent job cuts.

According to Westwood, new reports also indicate that some of the planned greenfield projects, such as Ithaca Energy’s West of Shetland Cambo development, may now be in jeopardy of reaching a final investment decision (FID) due to the tax hike.

Wilkie underlines that RigLogix solution currently shows a total of 5,403 days, or 14.8 rig years, of jack-up and semi-submersible demand with a 2023 or 2024 start date and already in the tender or pre-tender/enquiry stage, including new greenfield projects, as well as brownfield and decommissioning or plug and abandonment work, which are a mixture of short-term and multi-year duration.

Westwood emphasises that several of these planned projects may now be at risk and the outlook could change drastically if operators decide their projects are no longer feasible in the current financial climate.

Furthermore, Wilkie expects this to have a knock-on effect on “already anaemic” North Sea rig demand, as highlighted recently by Apache’s early contract termination of Diamond Offshore’s Ocean Patriot. The rig is now set to become available in July 2023, over 400 days earlier than planned and Apache stated that the cancellation was off the back of the changes to the EPL.

Moreover, a letter of intent (LOI) awarded to a sixth-generation semi-submersible by a UK operator, which could have seen the rig fixed until 2030 if all options were taken up, has also been cancelled following a re-jig of the company’s UK drilling plans. The rig will now be available upon completion of its current UK drilling campaign in mid-2024.

The North Sea Chapter of the International Association of Drilling Contractors (IADC) recently sent a letter to 650 UK MPs and 129 MSPs warning that further harsh-environment rigs could be “lost for good” due to the windfall tax changes while explaining that rigs are just the “tip of the spear” for further oil and gas production.

The organisation says rigs are “vital” for decommissioning hundreds of North Sea wells, as well as playing a “critical role in meeting net-zero” through facilitating carbon capture utilisation and storage (CCUS) projects. The letter states that the reduction in the available fleet size will “severely hamper all of the above.”

Based on Westwood’s data, the total rig supply in the North Sea has continued to fall since 2017 and is currently 40 per cent leaner than it was in March of that year. In the past two years alone, 13 rigs have left the region, either for work elsewhere or through retirement, and two more – Hercules and Deepsea Mira – are already confirmed for relocation later this year to Canada and Namibia.

Wilkie underscores that the supply has wilted due to a lack of demand for rigs in the region, which is mostly made up of the UK, Norway, the Netherlands and Denmark. In a previous piece, published in late November 2022, Westwood shared that despite improving North Sea rig market fundamentals last year, rigs were being enticed abroad by jobs with longer durations and higher day rates.

According to Wilkie, this appears to be a trend that will persist this year, “especially with the additional dampening of demand appetite” because of the amended UK fiscal regime, while Norwegian drilling campaigns also look few and far between. An improvement in development drilling demand off the Scandinavian country had initially been expected to improve during the second half of this year, but now an uptick off the back of the Norwegian tax incentives does not expect to materialise until mid-2024 at least.

When it comes to the North Sea, Westwood elaborates that there are currently four cold-stacked rigs – three semi-subs and one jack-up – and nine warm-stacked rigs (five semi-subs and four jack-ups). Wilkie confirms that only three of the latter have future work in place and two of those will be outside of the region. Additionally, there are 15 further rigs that could roll off the contract before the end of this year if follow-on work is not found or if options are not declared.

Wilkie further hammers home the rig exodus by disclosing that industry sources indicate at least two – but potentially more – North Sea semi-subs will likely be confirmed for contracts outside of the region this year. During its 4Q 2022 results call, Jeremy Thigpen, Transocean CEO, stated: “We anticipate at least two additional semi-subs will leave Norway in the next 12 months potentially for opportunities in Australia. If this happens, we believe there will be a supply deficit in Norway in 2024.”

Westwood further points out that another high-specification, harsh-environment semi-sub currently based in the North Sea could be in line to drill in the eastern Mediterranean later this year, which will mean another unit exiting the region for at least a few months. To make matters more dire, Wilkie claims that multiple North Sea semi-sub contractors have confirmed to RigLogix that they are now bidding their assets for work in areas such as West Africa, Asia Pacific and the Mediterranean due to “paltry demand” in the region.

Meanwhile, Westwood says that there is a similar sentiment from jack-up rig owners, as highlighted by Valaris recently confirming that it will preservation stack the Valaris Viking as a cost-reducing measure. The company says it does not see sufficient work in the region to keep all three of its harsh-environment rigs working due to “softening North Sea demand” from “the uncertainty created by changes to fiscal policy related to windfall taxes”.

Based on Wilkie’s statement, market sources indicate that further North Sea jack-ups are also being bid on projects outside of the region due to “a lack of near-term opportunities.” Over the past year alone, six units have left for work in the Middle East, Mexico and West Africa.

Westwood’s latest insights point to a concern in the market, which indicates that once rigs exit the region, they may not return, given the high mobilisation costs incurred with the initial relocation as well as attractive contract terms and day rates in other areas of the globe such as the Golden Triangle (U.S. Gulf of Mexico, South America and West Africa), the Middle East or Australasia.

“A knock-on effect from a continued North Sea rig exodus would be a smaller pool of rigs within the region, meaning less choice and subsequently higher day rates for those operators that do wish to press ahead with campaigns in the next few years,” stated Wilkie.

While some improvements have been seen before the coronavirus pandemic in 2019, rig demand in the North Sea has struggled to recover since the oil price crash in 2014. Therefore, Westwood concludes that the added fiscal volatility from the UK will further challenge any previously anticipated recovery expected from the rising commodity prices, as has been the case in many other areas of the world that have seen increased rig demand, utilisation and day rates.