Viewpoint: More changes ahead for North Sea benchmark
London, 9 January (Argus) — North Sea production is likely to remain relatively stable in 2018 but calls for changes to the benchmark are likely to grow, particularly after a recent outage to Forties production highlighted its failings.
When North Sea production dropped below 3mn b/d for the first time in 2012, there were concerns the region's long-term decline would accelerate — particularly when investment levels dropped following the price crash of 2014. But output ultimately fell no lower than 2.57mn b/d and stabilised at 2.7mn-2.8mn b/d in the past three years.
Expectations of a rapid return to long-term decline have been largely shelved. Opec recently revised its medium and long-term production forecasts higher for Norway and the UK. Opec does not expect any significant declines in North Sea production until 2021 and even then the decline is forecast to be far slower than previously expected.
This stability has been driven by the regular start-up of new fields in the last few years, which has offset the declines recorded by the region's mature assets. Production rates will benefit from the start-up of the Kraken, Maria, Catcher and Gina Krog fields in recent months, and 2018 should see the start-up of Liberator, Mariner and Harrier.
North Sea production has benefited from a continued focus on costs, allowing new developments to go ahead and existing fields to continue producing profitably. Development costs of the first phase of Norway's 2bn-3bn bl of oil equivalent (boe) Johan Sverdrup field have declined by 25pc since approval in 2015. This focus has masked the effect of lower investment levels in the region. Maria started up in December, 10 months ahead of schedule and 20pc below initial cost estimates.
But most of the crude from new start-ups does not join the volumes underpinning the North Sea benchmark. North Sea Dated and Platts' equivalent Dated Brent are based on the value of five grades — Brent, Forties, Oseberg, Ekofisk and Troll. It is these volumes, rather than North Sea production as a whole, which are a cause for concern.
Production of the five grades averaged just 1.06mn b/d in 2017, compared with 1.37mn b/d in 2010, accounting for just 39pc of the region's total production. As recently as 2014, the five grades accounted for 43pc of North Sea production.
And production of the five benchmark grades could decline further in 2018. January's loadings of Brent crude are forecast to be the lowest in decades at just 58,000 b/d; Troll loadings will drop to a five-year low of 162,000 b/d.
Forties production appears to be declining sharply as well, driven by a slowdown at the grade's largest contributing field Buzzard. Forecasts from FPS operator Ineos suggest Forties production will average around 374,000 b/d in the first quarter, down from 440,000 b/d in the first three months of 2017. Buzzard production peaked at 218,000 b/d in 2009 but the field continued producing almost 200,000 b/d until 2013. Output has declined since then and that decline looks to be accelerating. In 2016, Buzzard output was 8pc lower than in the previous year, while in 2017 production was down a further 4pc even before the field was shut in on 11 December.
Ineos forecasts suggest first-quarter Buzzard production will decline by 20pc from the same period of 2017.
December's three-week unplanned Forties outage — caused by a small crack on an onshore pipeline — highlighted the vulnerabilities of a benchmark backed by so little physical volume. The benchmark's mechanisms were designed to protect against any spikes in the price of a single grade. Should Forties or Brent move sharply higher, for example, then one of the other three grades would set the benchmark and this would limit the exposure of North Sea Dated to supply disruptions.
But December's experience makes clear that the mechanisms do not protect against a slump in the price of any one grade. Forties buyers stayed away in December amid scepticism that scheduled loadings would go ahead. As a result, relatively low offers failed to generate interest and Forties values weakened. As the lowest priced of the five benchmark grades, Forties set the Dated benchmark for seven consecutive days — despite the absence of any actual Forties production.
The absence of Forties crude in December also highlighted how little physical crude underpins the benchmark. The addition of Troll to the basket of crudes supporting Dated last year was intended to bolster the benchmark. But Troll trades at a significant premium to the other four grades and never sets the benchmark as the lowest–priced crude. It is never used to settle North Sea forward contracts. That could change with the addition of a quality premium (QP) — something that has made Oseberg and particularly Ekofisk more relevant in recent years. The addition of a QP for Troll is likely to be the first adopted change to the benchmark this year.
Even if Troll does gain relevance, there are likely to be calls for further changes. A move to a delivered-northwest Europe benchmark is one possibility. If Dated were to move to a cif basis rather than a fob basis, grades from outside the region could theoretically be added. There are signs such a move could be underway — trading firm Vitol has made a number of bids for Forties crude on a cfr Rotterdam basis in early January, although as yet no deals have been heard.
A move to a delivered basis would enable the addition of other North Sea grades, such as Statfjord and Gullfaks, to the benchmark. The addition of grades from outside the region — Russian Urals, Algerian Saharan Blend or even Nigerian Qua Iboe — could be more problematic, given the difference in quality and loading periods. But some such moves may need to come sooner rather than later, if the North Sea is to remain the location of the globe's crude benchmark.