In the wake of Gordon Brown’s steal-from-the-poor-to-give-to-the-rich budget, it was reported that what had changed the Chancellor’s borrowing forecast was the decline in revenues from North Sea oil. “What has changed our forecast is what happened to North Sea revenues.” Mr Brown said North Sea oil revenues would be £5.5bn lower than expected for 2007/08 but argued that the reduction was due to factors outside the government’s control. “That’s no fault of the government. It’s lower production from the North Sea. We have to take that into account,” Mr Brown told the BBC’s Today programme. That the electorate might reasonably expect the government to factor in the rapid depletion in North Sea oil reserves to their financial forecasting seemed to be beyond him. “The chancellor is becoming as bad at forecasting oil and gas revenues as he is at estimating the cost of the London Olympics,” commented SNP leader Alex Salmond. Reserve depletion fed into a 9% decline in production last year. When the UK government can’t even make a realistic short term assessment of declining UK production it is perhaps unsurprisingly they appear guiless in the face of the global situation.

It’s salutary to note the U.S. DOE/EIA optimistic forecasts for oil production from the North Sea in their 1999 International Energy Outlook forseeing U.K.and Norwegian production increasing significantly from 6.2 million barrels oil per day (mbd) in 1998 to a peak in 2006 above 8 mbd (all liquids). They projected a decline rate of about 2% per year, after the peak to 2020. In reality, North Sea crude oil and liquids production peaked in 2000 at 5.9 mbd, following production grow of 55% over a decade from 3.8 mbd in 1991. U.K. North Sea oil production peaked in 1999 at 2.72 . It took 25 years for the first 100 fields to be brought on-line but only 6 years to bring the second 100 fields on-line. Because individual oil companies are tempted to keep a high production rate as long as possible, instead of planning to smooth the future decline, mature oil provinces exploited with the best technology are likely to see steady production growth followed by very steep decline. The opposite therefore of what a reasoned approach to the problem of oil depletion would seek to achieve. By 2005 the UK produced 1.7 million mbd and the UK became a net oil importer, five years before the EIA predicted. In 2006 an average of 1.65 mbd was produced compared to 1.7 mbd consumption. The days of the UK being a net oil exporter for longer than a few months are over. In February the FT reported:

“Fears for North Sea output grow”

Oil and gas production in the North Sea is now expected to be about 10 per cent lower over the next few years than previously thought, according to the leading survey of the state of the industry.

The faster than expected decline in production is bad news for Britain’s energy security, increasing the country’s dependence on imported oil and gas, and also for the exchequer.

The latest annual survey from the UK Offshore Operators’ Association, the trade body which gives the most authoritative assessment of the health of the North Sea, also shows a steep increase in costs and an expected decline in investment over the next couple of years.

Malcolm Webb, the association’s chief executive, said: “There are signs of a struggle for competitiveness here: issues that the industry and the government need to address, and without too much delay.”

High prices for oil and gas have led to a surge of interest in exploring the North Sea: most of it from smaller companies.

At the beginning of the month Alistair Darling, the trade and industry secretary, declared that 2006 was the best year for new finds of oil and gas for five years. There is still an estimated 16bn-25bn barrels of oil equivalent in oil and gas left to be extracted.

But old wells that are running dry and new wells that are generally very small cast a shadow over the outlook for the North Sea.

Last year’s production of oil and gas was down 9 per cent at 2.9m boe a day, according to the association. That is already a steep fall from the peak in 1999 of 4.5m boe/d in 1999, and the lowest level since 1992.

By 2010 production is expected to be down to just 2.6m boe/d.

The main reason, ominously, is described as “poor reservoir performance”: in other words, wells not yielding as much oil and gas as had been hoped. But also an increasing amount of resources has been diverted to maintenance on the ageing infrastructure of the North Sea, some of which dates back to the first oil rush of the 1970s.

Capital investment last year of £5.6bn was the highest since 1998. But much of the increase seems to reflect higher costs rather than increased activity. Investment is expected to fall this year by 20 per cent or more, to £4bn-£4.5bn.

Demand for equipment and skilled staff has sent costs soaring worldwide, but the North Sea seems particularly badly affected. The cost of developing and operating a project rose by 45 per cent on average last year, from $15 per barrel of oil equivalent extracted to $22. During the next couple of years it is expected to rise again, to $25.

Nor is the apparent good news about discoveries quite what it seems. The 2006 figure of 500m boe being found included one big find of about 175m boe. Typically, recent discoveries have only been of about 10m boe. The biggest oil finds in the world – the ones that get people excited – run into the billions of barrels.

This comes at a time when oil prices, although still relatively high by historical standards at about $58 a barrel, are well down from last year’s peak.

The gas price is almost equally important because gas now provides about 45 per cent of the North Sea’s production, and the UK spot price has fallen about 70 per cent from its peak last year.

If falling prices put pressure on international oil companies to cut their investment, they will cut first in high-cost areas.

The industry is still smarting from Gordon Brown’s increases in taxation and points out that the worse outlook for the industry has already prompted the Treasury to revise down sharply its forecasts of future North Sea tax revenues in last year’s pre-Budget report.

It is also worried about the looming bill for decommissioning the infrastructure of the industry when it is no longer viable. Uncertainty over the tax treatment of decommissioning costs, and the concern of companies not to get landed with large liabilities, is preventing assets being traded and new investment coming in, says the association.

If those issues were addressed by the government, the decline of the North Sea could perhaps be slowed. However, there is nothing the government can do to undo the forces of geology and history that have made the North Sea such a difficult environment in which to work.

• Project costs for oil and gas companies have risen by 32 per cent in the past year, according to a new measure complied by two leading consultancies.

The figures illustrate the pressures energy companies are under in their struggle to increase production.

IHS and Cambridge Energy Research Associates, have compiled the index based on a “basket” of costs for oil and gas capital projects. From November 2005 to May 2006, costs rose by 17 per cent; in the subsequent six months, they rose by 13 per cent.

Daniel Yergin, chairman of Cera, said there was a “double bubble” pushing costs up: the shortage of equipment such as drilling rigs and skilled staff in the oil and gas industry, and the general strength of the world economy pushing up prices for commmodities such as steel and facilities such as slots at ports.

By Ed Crooks, Energy Editor Published: February 13 2007