Valuing the UK Continental Shelf s Oil and Gas Reserves

Transcription

1 Valuing the UK Continental Shelf s Oil and Gas Reserves Frederick Foxton Office for National Statistics Summary This paper sets out the methodology and sources of data used to estimate the monetary value of oil and gas reserves existing within the UK Continental Shelf (UKCS). The monetary balance sheet in this report is restricted to oil and gas reserves which are found within the UKCS. Introduction The System of National Accounts (SNA) is an internationally agreed framework for compiling measures of economic activity within strict accordance of accounting conventions based on economic principles. However, these accounts are widely regarded as limited in their treatment of environment assets (UN, 2008a). Recognising this, the System of Integrated Environmental and Economic Accounts (SEEA) has been developed to provide a framework to bring together economic and environmental information in a common framework to measure the contribution of the environment to the economy and the impact of the economy on the environment. The SEEA provides the methodological framework for the UK Environmental Accounts and therefore guides the approaches adopted in this paper. The Environmental Accounts comprises four categories of accounts: Flow accounts for pollution, energy and materials Environmental protection and resource management expenditure accounts Valuation of non-market flow and environmentally adjusted aggregates Natural resource asset accounts. This paper contributes the last of the accounts, in particular the paper describes the methodology and sources of data used to estimate the monetary value of oil and gas reserves existing within the UK Continental Shelf (UKCS) 1. The paper is divided into ¹The UK continental shelf is the region of waters surrounding the UK Isles, from which the UK claims mineral rights and which is governed by the Department for Energy and Climate Change (DECC), who award licences for exploration of a specific area over a predetermined periods of time. 1

2 five sections. The first section contains a brief description of the information about oil and gas reserves currently published by ONS followed by an explanation of why a review of this material was necessary. The next section considers some of the methods available for valuing assets and resources. The paper then moves on to examine the assumptions made in valuing the UKCS oil and gas reserves such as the rate of extraction, calculation of the resource rent and how decommissioning costs have been incorporated. The paper then presents results obtained using the preferred valuation method. The final section of the paper identifies further work that could be done in this area. Current Information on Oil and Gas Reserves ONS currently produces physical and monetary accounts for the oil and gas reserves existing within the UKCS, disaggregating between the two resources, along with a breakdown of changes that occurred between years. The balance sheets of subsoil assets form part of the economy s non-financial balance sheets which distinguishes between produced and non-produced assets (UN, 2008b). By integrating subsoil assets into the non-financial balance sheets they provide a more complete view of the monetary value of non-financial assets in the UK, allowing for comparison with other non-environmental assets and determining their contributions to national wealth. Their creation also provides additional data that would otherwise be unavailable in the formation and implementation of related environmental policies. Why Review Now? In 2009, the monetary account for UKCS oil and gas reserves was suspended pending review because a key data source (Digest of UK Energy Statistics (DUKES) Table F.6) had been discontinued and over time the estimation process no longer being considered fit for purpose. Methodology This section sets out the new set of methodology implemented in creating the improved monetary estimations for UKCS oil and gas reserves. The first part, Valuation Methodology, describes a number of key methods used throughout environmental and national accounts to measure assets and resources. The basic 2

3 approach of each method is described and reviewed. The second part, Applied Methodology, covers a number of key areas addressed and recommended methodology implemented alongside the recommended Net Present Value methodology to derive estimates of oil and gas reserves. Valuation Methodology In estimating the monetary value of resources there are four approaches highlighted within the SEEA and SNA: Market Price Method Net Price or Hotelling Model El Serafy or User Cost Method Net Present Value Method This section considers the use of each of these approaches in turn before discussing in detail ONS application of the recommended method. Market Price Method The SNA recommends using the market price method to value an asset whenever practical (SEEA, 2003a). The Market Price Method (MPM) estimates the economic value of assets or services that are bought and sold in markets. It uses standard economic techniques for measuring the economic benefits from marketed goods based on the quantity people purchase at different prices, and the quantity supplied at different prices. The market price represents the value of an additional unit of that good/service assuming that it is sold in a perfectly competitive market. Application of the MPM requires both time series data on the quantity demanded and data on the variable costs of production and revenues received using this, the total net economic benefit/economic surplus can be obtained. This method has several advantages over most valuation methods. First it uses standard and accepted economic techniques. Second the data required (quantity, price and cost) are relatively easy to obtain. Third, the Market Price Method uses observed data on actual consumer preferences as well as individual s willingness to 3

4 pay for costs and benefits of that good/service. However this method does have a crucial shortcoming when applied to creating monetary values for oil and gas reserves. While market price is the preferred method for valuing assets, in the case of environmental assets the required data is often not available. Being rarely sold in total there aren t enough transactions carried out to establish their respective market prices and what does exist of any market price may not be accurate in reflecting true economic values due to them being traded in a non-perfectly competitive market. Net Price or Hotelling Model An alternative method is the Net Price Method based on the Hotelling Model (SEEA, 2003b). This model assumes that under certain market conditions there exists a simple linear relationship, between price/value and stock/reserves. It states that in efficient exploration of a non-renewable or non-augmentable resource (oil and gas); the percentage change in net-price per unit should equal the discount rate. As the supply declines the price of the asset will rise causing the resource rent to increase precisely inline with the discount rate, meaning there is no need to discount future resource income. So the value of the resource stock can be calculated simply as the current rent per unit of resource multiplied by the size of the stock (Landefeld and Hines, 1985). While the Hotelling Method is a simple approach in revealing an asset or stocks resource rent, it has been shown both theoretically and empirically to greatly overvalue the reserves in question. Work by both Cairns and Davis (1998, 1999) and Davis and Moore (1998) demonstrated that asset values calculated using the Hotelling Method, tended to produce estimates up to twice their market values. World prices for Oil and Gas are not created under perfect competition and similarly the UK is a relatively small producer and is a price-taker in a market in which price-makers exist. El Serafy or User Cost Method The El Serafy method values an asset by disaggregating the resource rent into its true income and the costs associated with the depletion of the resource. Defining true income as the amount of income that would be sustained indefinitely, regardless of 4

5 the actual finite lifetime of the asset, by suitably investing a portion of the gross receipts generated which can be the depletion cost. This is also referred to as the user cost. The income element has to be such that the net present value of X over an infinite period has to be the same as the net present value of the resource. To achieve this, part of the resource rent is put aside and reinvested at interest rate (r) to sustain future income at the same level as the estimated income (X) of the current year (El Serafy, 2002), this is the residual number when subtracting the true income from the resource rent (RR-X). RR RR-X= n + 1 (1 + r) The method, however, has several shortcomings. First, the El Serafy method assumes that the level of receipts is constant over the lifetime of the resource, thereby ignoring the influences of changes in the resources prices. Secondly, it also assumes that the rate of extraction is also held constant until the resource is exhausted. Identified as one of the key issues in producing a monetary valuation, the impact of this assumption on overall estimation is explained later in this paper Net Present Value In absence of market prices the Net Present Value (NPV) method has been identified as being the preferred valuation method for energy resources (SEEA, 2008). The net present value method predicts the net income flows of an asset over its entire economic life. This is achieved by forecasting the flow of all future net revenues (incomes gained and cost incurred) generated from the resource if it where exploited optimally and until depletion and is then discounted using suitable rates and costs of capital. The aggregate of these discounted net revenues, under certain conditions such as the absence of taxation, will then equal the resources market value at the current time. The net present value approach assumes that all yearly income from the extraction of oil and gas reserves is received at the end of the year. The NPV approach has several advantages over other methods for valuing an asset or investment. By discounting any future net revenues, NPV recognises money has 5

6 time value (time preference) in that income received today has a higher value than an equal sum received in a year s time. Similarly, risk can be incorporated into the valuation using discount rates. The use of NPV also allows for flexibility adjustments in reaction to inflation rates and for testing other scenarios and alternative assumptions. Finally, while not without its fault, NPVs are regularly used in numerous real world situations to evaluate a firm s value and performance or appraise a proposed investment. However, similar to all other valuation measures of resources, NPV has some limitations. As a tool to calculate the profitability of an asset it is assumed that if the result from an NPV is positive the investment is worthwhile and should be adopted. This is regardless of factors such as the investments capital requirements, which in the real world is ultimately limited with individual access dependent on current performance. While a project may have a positive value this value may not be realised, as its associated capital requirement is too high. Any such projects would be included in ONS s overall estimations, while in truth such a NPV would be foregone, ultimately overvaluing the oil and gas reserves. Similarly the capital requirements for the project may change over time altering its associated risk however NPV does not allow for any future changes, using only information known at the time of the valuation. Both of these can be significant in the valuation of oil and gas due to their relatively large capital requirements and the assets long lifespan. In determining the NPV of an asset, both a discount rate and rate of return on capital are required. The discount rate takes into account the producers time preference of income today over income in the future as well as accounting for the risk linked to future expected returns from the asset such as price changes and future extraction rates. With the Return on Capital there are two schools of thought. It is either viewed as the opportunity cost of investment in the capital assets, taking into account the average return possible if the same sum was invested elsewhere in the economy; or as the cost needed to cover the purchase of the capital stock. In aid of creating data more appropriate for international comparison ONS adopted recommended rates. For the discount rate, with individual rates varying between countries (UK 3.5 per cent) (HM Treasury, 2003), the rate of 4 per cent was used in this paper. A recommendation made by Eurostat, the discount rate of 4 per cent is an approximation of average government bonds rates. As for the Return on Capital, 6

7 ONS again followed the Eurostat recommendation, adopting a rate of 8 per cent which is derived from the industries profitability across the EU. As part of this paper, later on these assumptions will undergo some sensitivity analysis, showing changes that occur when they are altered. In line with international recommendations, this paper applies the Net Present Value method to value the UKCS oil and gas reserves. Applied Methodology The first stage is to recognise that while there are some fields that solely produce gas or oil, the vast majority of the reserves extracted are sourced from fields that yield both. This presents a difficulty for the valuation of the two assets since typically no separate data for the individual resources extraction costs exists. 2 The main source of data used by this paper are the Income from Expenditure on UK Continental Shelf Exploration, Development and Operating Activities available on the DECC Oil and Gas website. This, however, does not offer a break down of costs between oil and gas. The method adopted between 2004 and 2007 was to allocate weights to the reserves based on oil equivalents of total quantity produced which allowed for the data to be disaggregated, splitting total operating costs. However, the resulting data failed to match the historical cost data from before and in the absence of collaborative data the weights where believed too arbitrary. As previously highlighted, as the purpose of these accounts being to produce the most accurate monetary estimates for the UKCS oil and gas reserves, the best approach was to create a joint account. While creating a joint monetary account would produce a more limited dataset and possibly reduced analytical usefulness fears are that any form of disaggregating, without appropriate data, would produce inaccurate and irrelevant estimates. One source existed prior to Published by the Department of Energy and Climate Change (DECC), table F.6 ² within the Digest of UK Energy Statistics (DUKES) provided a disaggregated split between the sales and expenditure of oil and gas. This source, however, was discontinued due to a greater proportion of gas production on the UKCS being produced in association with oil and condensates. The expenditure for gas could no longer be reliably separated from expenditure for oil which led to the two being given jointly from 2001 onwards (DTI, 2004). 7

8 Physical Accounts With a joint account now being produced and all aspects of the accounts needing to be aggregated, difficulties arose in aggregating the physical accounts. Due to the heterogeneous nature of oil and gas, as well as geographical and the field s project status, the UKCS reserves for oil and gas are broken down into classes depending upon their commercial attraction to be extracted: Proven: Reserves which on the available evidence are virtually certain to be technically and commercially producible, i.e. have a better than 90 per cent chance of being produced. Probable: Reserves which are not yet proven, but which are estimated to have a better than 50 per cent chance of being technically and commercially producible. Possible: Reserves which at present cannot be regarded as probable, but which are estimated to have a significant but less than 50 per cent chance of being technically and commercially producible. In addition to these three classes which relate to known deposits of gas and oil, also included are so-called potential deposits of resources. Estimated on the basis of very preliminary exploration studies they are broken down into lower, middle and higher range estimates. For this paper the figures used to best demonstrate those resources within UKCS that are economically viable and profitable to extract were the aggregate of both proven and probable as well as the lower range estimate of undiscovered oil and gas reserves with data regarding the physical reserves for oil and gas being sourced from DECC. An additional difficulty in forming a joint physical account arises because the resources being produced are quantified in different units; oil in millions of tonnes and gas in billions of cubic metres. There are few common units of measure for both oil and gas. Following consultation with involved bodies the recommendation taken forward was the use of Tonnes of Oil Equivalent (TOE) for a common unit in creating a joint physical account. Using a ratio of million TOE per million tonne of oil and million TOE per billion cubic metres of gas. 8

9 Extraction Rate To form estimates for the monetary value of oil and gas reserves there need to be projections for yearly extraction rates. Until 1997, the conventional assumption was that extraction rates were constant for assets such as oil and gas. Conceptually, this meant an equal slice of the reserves would be extracted each year until the reserves had been exhausted. This method was deemed viable as the accounts where recalculated annually and any changes in extraction where reported separately in the accounts balance sheet. However this theory, as mentioned earlier in discussing the El Serafy Method, came under scrutiny due to two major drawbacks. Firstly extraction is not only linked to the level of available reserves but is also influenced by demand for the resource and supply conditions such as ease of extraction or quality of the supply. Secondly, as time passes and a resource becomes scarcer, natural constraints will present difficulties, leading extraction rates to fall and associated costs to rise (resources become hard to reach and newer technology is needed). So with future extractions discounted over time, the path of potential extraction has a large impact on reserves NPV and the assumption of a constant rate perhaps wasn t the most realistic representation for extraction of oil and gas reserves. Therefore, in 1998, the method of determining the extraction rate of resources lifespan was modified. This took into account the fact that for a proportion of its life, a constant extraction rate could be maintained but that it would then begin to decline. In the 1998 Hybrid model the resource is extracted at a constant rate for four years which then decreases at a constant rate which then decreases at a constant rate. These two models not only differ in terms of their concept of subsoil extraction paths but also have an empirical effect. By taking the same levels of resources, the modern method caused substantial increases in the lifespan of the reserves of oil and gas. Resource Rent The resource rent (RR) is the net income from extraction i.e. the total revenue from sales less all costs incurred in the extraction process including user cost of produced capital. Thus, the resource rent represents the returns from the resource only. There are three ways of determining the resource rent for oil and gas: Appropriations Method 9

10 Resource rent derived form Capital Service Flow Calculations Resource rent derived from PIM Calculations Appropriation Method Using the Appropriation Method the resource rent of an asset is determined by the sum of all observed receipts that comes about from the extraction. In many countries the government is the primary owner of its nation s resources. The theory of Appropriation Method is that governments could then collect the entirety of the resource rent through fees, royalties and specific taxes, which are charged to the extraction companies, and their aggregates would form the asset s resource rent. However, in practise taxes, fees, etc tend to understate the assets resource rents. Governments may only be able to acquire most of the resource rent; with it possible any rates or fees are set artificially low as a result of governments having other priorities such as implicit price subsidies to the extractors or to encourage further growth in the industry. Similarly, with the market for oil and gas being highly volatile, it could be assumed any rates or fees would not follow inline with the associated market prices and those resource rents would escape appropriations. Similarly there could be difficulties as government s revenue earned from a resource such as oil and gas not only consists of specific taxes but also non-specific taxes such as corporate tax. Resource rent derived form Capital Service Flow Calculations This method considers the decline in the service provided by the asset over its life rather than the decline in price, assuming that while an asset may see its value decline as it ages the asset could still be as productive. Such types of flows are used in productivity studies as well as in the calculation of net income flows. The value of the capital service flows (CS) derived from the stock of capital is subtracted from the total economic rent (GOS) to give the assets resource rent (RR). RR = GOS-CS Resource rent derived form Perpetual Inventory Model The Perpetual Inventory Model (PIM) calculates the net operating surplus (NOS) of an asset by subtracting the relative consumption of fixed capital (CFC) from gross operating surplus (GOS). The return to produced capital is taken by multiplying the produced capital stock at the start of the year (V) by the discount rate (r), which then can be deducted from the NOS to give the resource rent (RR). 10

11 RR = (GOS-CFC)-rV In theory, the latter two should produce the same resource rent. This is based on the assumption that for a pattern in the decline in the service flow of an asset is matched by the decline in price of the asset however this match is not always obvious. This paper uses resource rents derived them from the Perpetual Inventory Model or PIM, as figures for these are the most readily available and are used within ONS to estimate gross capital stock, consumption of fixed capital and net capital stocks for the UK National Accounts (Dey-Chowdhury, 2008). Unit Resource Rent The Unit Resource Rent (URR) is the net income received from each individual unit, which is derived by dividing the RR earned in a given year by the rate of extraction for the same year. Relative to other resources, the prices associated with oil and gas are volatile with no foreseeable trend or long-term forecast. The difficultly caused by this is that estimations for the oil and gas reserves are price sensitive, with any volatility in price reflected in the Unit Resource Rents (URR), which is in turn reflected in the overall end balance for that year. So as to reduce the price sensitivity of the URR, averages are taken to lessen the distorting effect of any one year. While there are a number of methods which could be used the approach adopted in this paper a 3 year weighted average, as recommended by the SEEA London Group. 3-yr weighted average =.2URR + 0.3URR + 0.5URRt 1 0 t 1 t + This requires an estimate of forecast unit resource rent (URR t+1 ). This is done first by forming an aggregate of the current actual URR and the unit cost of the previous year. A forecast EA Price is then calculated by multiplying the current year EA Price by the change in the resource prices from the current and previous year (e.g.2009 price/2008 price). Then the forecast actual URR is determined by multiplying the current year unit cost by the change in the deflator (2009/2008) and subtracting this from the forecast EA Price. Decommissioning Cost 11

12 Over time an asset s value will fall relative its original value. This decline is referred to as the consumption of fixed capital (CFC) and shows the difference between the values of the capital service flows rendered and the income element which arises in the same period. For the majority of assets as they reach the end of their life there will either be a residual/scrap value or a value of zero. However, at the end of certain assets lives additional costs know as terminal and remedial costs or decommissioning costs are incurred and if these decommissioning costs aren t taken into account, any associated consumption of fixed capital will be too low and their respective net operating surplus will be too high. (SEEA, 2003c) Terminal Costs are similar to capital formation costs in that they should be covered by income that the asset generates over its lifetime in production. If this is not done during the asset s life these large costs may be treated as intermediate costs at a time when there is no longer any income being generated from production leading to negative value added. Alternatively, they are recorded as capital formation but instead of the costs being recovered from value added, these costs are written off in the other changes in the volume of assets account. This procedure omits from the macroeconomic aggregates a legitimate cost to business and so overstates gross and net domestic product over a period of years. (UN, 2008c) The SEEA recommends treating terminal costs as positive capital formation, with the view it is an improvement to the site where the asset to be decommissioned is situated, which is written of immediately in consumption of fixed capital. However, forming estimates for decommissioning costs is difficult because of the uncertainty regarding the total costs. Many platforms and associated facilities are at least a decade away from being decommissioned which inevitably carries substantial contingent technical, commercial and project uncertainties (Oil & Gas UK 2010 Economic Report). Similarly very few examples of UKCS based offshore platform decommissioning exists from which accurate predictions can be drawn from. Even areas where much larger scale of decommissioning has taken place, such as the Gulf of Mexico, offer little guidance due to the difference in platforms style and build. 12

13 This paper has incorporated these costs by distributing forecasted total decommissioning costs over the lifespan of the asset. In recent years, Oil & Gas UK has published figures for the total decommissioning expenditure for across the UKCS which are, based on the latest data supplied by all the leading exploration and production companies operating in the UK (Oil & Gas UK, 2010 Oil & Gas UK Activity Survey, p.1) and are annually up-dated within their Activity Survey. Ultimately, however, these figures are approximations. While picking up all the major fields currently producing, the data aren t comprehensive. There could be an underestimation in their value by not accounting for as yet undiscovered fields and associated developments or they may be overvaluing the costs by being unable to capture the impact of efficiency improvements and the development of newer technologies. To then create an average yearly decommissioning cost, the total decommissioning expenditure is divided by the remaining number of years left in the resources lifespan. The year s value is then aggregated with the other costs incurred in the same year (operating costs, capital consumption and return on net fixed capital) and subtracted from the total income to form that year s Resource Rent. By doing this, the costs are spread over the asset s life while still generating income. This approach is consistent with the recommendations of SEEA regarding the treatment of terminal cost. Results By applying the NPV method under the following assumptions; Three year weighted average unit resource rent, Decreasing rate of extraction, Rate of return on capital of 8 per cent, Social discount rate of 4 per cent, 22.5bn total decommissioning expenditure payable over the life of the reserves, The UKCS oil and gas stock is estimated to be worth 170,465 million in 2009, a decrease of 2.8 per cent on the value in 2008 of 175,430 million. Sensitivity Analysis 13

14 Table 1 shows how the valuation estimates change when the discount rate or return on capital is changed. While holding everything else constant, using the HM Treasury Green Book s recommended discount rate of 3.5 per cent the estimate of oil and gas reserves decreased by around 10,848 million. A decrease of a full percentage point to 3 per cent would lead to a decrease of 31,630 million. On the other hand, when the discount rate was raised by a percentage point to 5 per cent the estimate of oil and gas reserves rose by 5,820 million. Similar tests were carried out on the rate of return on capital, altering by a percentage point either side of SEEA s recommendation of 8 per cent. Again this caused changes to the estimate of oil and gas reserves but in the reverse directions, with 7 per cent seeing a fall of around 5,345 million and 9 per cent causing the 2009 value to rise to 5,346 million. Table 1 Estimates of UKCS Oil & Gas Reserves, 2009 Discount Rate (per cent) Rate of Return on Capital (per cent) Oil & Gas End Balance ( millions) , , , , , ,119 Another area of analysis was carried out on the smoothing of the URR. As noted earlier the volatility of the resources market prices could obscure any real changes, with individual years causing dramatic movements. Figure 1 shows the effects of changes to the average resource rents. As would be expected, by taking an average of a greater number of years the estimate of oil and gas reserves time series smoothes out, showing a more general trend and dampening the effect of individual years. 14

15 Figure 1 Unit Resource Rent averaging results, million 300, , , , ,000 50, Year Future URR equal to 3yr weighted average URR Future URR equal to past 3yr URR average Future URR equal to last years URR Future URR equal to 3yr centred URR average Table 2 Estimates of UKCS Oil & Gas Reserves, 2009 Year 1 years average resource rent ( million) 3 year average resource rent ( million) 3 year centred resource rent ( million) 3 year weighted resource rent ( million) ,664 72, , , ,754 98, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,465 Table 3 shows how these estimates change when costs for decommissioning are distributed differently. The method used within this paper splits decommissioning costs based on a time period approach, allocating an equal proportion of the total decommissioning expenditure to each year until 2040, however this is not a perfect reflection of actual distribution of decommissioning expenditure. Instead of 15

16 distributing costs on a time period basing an alternative approach is to allocate costs on production basis. By summing the present value of year by year decommissioning costs, and using a discount rate of 4 per cent, this in turn can be divided by estimated ultimate recovery of both oil and gas reserves to produce a decommissioning cost to each unit of production. To then arrive at the decommissioning cost associated with future production the decommissioning cost per TOE is multiplied by the closing stock of reserves or future production, taken from the physical account. This is then deducted from the value of remaining production to arrive at a decommissioning cost adjusted value. When adopted instead of the time period approach the monetary estimates for oil and gas reserves increase by 3,123 million to 173,588 million, which is 4,191 million less than when no allowance is made for decommissioning cost. Table 3 Estimates of UKCS Oil & Gas Reserves, 2009 Approach in Allocating Decommissioning Cost Oil & Gas End Balance ( millions) No Allocation 177,779 Time Period 170,465 Unit of Production 173,588 Data Analysis Figure 2 shows the end of year monetary balance for the UKCS Joint Oil and Gas, as well as the annual change in unit resource rent from 1995 to The prices shown are deflated to 2006 prices. The figure illustrates that the end of year balance of the UKCS Oil and Gas reserves increased by 88,316 million from 82,149 million in 1995 to 170,465 million in The increase in the value of the UKCS Oil and Gas reserves has primarily been the result of changes in income from sales and not changes in reserve volume which, over the same period, saw a decrease of 1,163 million TOE. 16

17 Figure 2 also shows the effect of various years, visible in both sets of figures, where highly volatile market factors come through. Between 1996 and 1999, and to a lesser extent 2001 to 2004 and 2008 to 2009, the end balance of UKCS Oil and Gas reserves decreased. Around 1998 there was a substantial fall in the value of UKCS oil and gas which coincided with a worldwide fall in oil prices, per barrel prices falling by one-third. Similarly gas prices also fell but at a much smaller rate, 2.9 per cent. As for the decline in the few years following 2001, these likely came about by the UK oil and gas industry seeing continuous declines in their level of production, the UK becoming a net importer of oil and gas in the wake of the millennium. The recovery following can probably be attributed to price changes outstripping the negative effect of production, with both oil and gas seeing their prices rise by about 11 per cent and 16 per cent respectively. The final discrepancy comes about in the last couple of observations in the data. The valuation of the UKCS oil and gas reserves decreased from 215,744 million in 2007 to 170,465 million in 2009 with 40,314 million of the 45,280 million decrease occurring between 2007 and This decrease in the UKCS oil and gas valuation between 2007 and 2009 has come about because of several factors. Highlighted with the account in 2008 the change in resource rent turned negative decreasing the overall closing balance of that year by 40,314 million. First, in 2008 demand for oil began to decline with the positive effect of developing countries wearing away and the global economy falling deeper into recession causing oil price to move from $ to $44.57 Q Q With average annual prices dropping by over one-third to $62.39 per barrel it had an adverse effect on total income for Similarly, during 2007 oil price rose, driven by weakening of the US dollar ($), with oil prices coming close to $130 per barrel. 17

18 Figure 2 Year End Balance Annual Change of Rent for Oil and Gas, millions 225, , , , , ,000 75,000 50,000 25, , ,000 Year Change in Rent End balance Figure 3, along with Annex 1 and Annex 2, show the comparisons between the results formed by the methodology put forward through this paper and that which was previously used in estimating the monetary value for oil and gas reserves. To allow a comparison, the previously split oil and gas monetary estimates have been aggregated together to form what is referred to in Figure 3 and the Annexes as End Balance for Previous Oil and Gas Account. Figure 3 illustrates a comparison between the end balances in current prices. In general, the two methods are similar with a general trend of the end balances from the method described in this paper, being slightly less than those from ONS s previous method. However, also highlighted is a divergence of estimates between the methods from 2004/05 onwards. While this difference is increased by the new method accounting for decommissioning costs from 2006 onwards, the majority can be attributed to the adoption of weighting used to disaggregate costs between oil and gas which, unable to account for changes in production as more gas production became attributable to field that produced both oil and gas. Annexe 1 and Annexe 2 provide a more detailed breakdown, highlighting end balance estimates as well as distribution of the annual change. 18

19 Figure 3 Comparison of Total End Balances for Previous and New Oil and Gas Account, million 250, , , , , , ,000 75,000 50,000 25, End Balance for Previous Oil and Gas Account Year End Balance for Updated Oil and Gas Account Comparison with other countries With a focus on international comparability many of the recommendations made by bodies such as Eurostat, SEEA and SNA have been adopted by most countries as their primary method of measuring their reserves of oil and gas so as to include them within their national accounts. The key dissimilarity is the overall output. For example, some countries those such as the Netherlands and Canada produce split monetary account for oil and gas. However, these estimations have associated faults. Similar to the split previously available in the UK, assumptions are made about the split between production values. While these can bias the estimations due to the make up of volumes and field compilation, such effects are minimised. Nonetheless, work is underway to produce a more accurate split for costs and revenues associated with oil and gas production. A leader in this field is the Netherlands, splitting operating costs through the use of production values. Limitations As noted in the methodology section, this approach does have some weaknesses. These measures are affected by the chosen rate for discounting and return on capital as well as the way by which an average unit resource rent is taken. Similarly this approach only values those reserves deemed advantageous to extract (estimated to have a better than 50 per cent chance of being technically and commercially 19

20 producible), however, certain fields classification may change overtime perhaps as a result of technological development. As well as this, with these accounts now incorporate decommissioning expenditure the current figures available are forecasted approximations which are susceptible to change in value and lifespan. Further work An appropriate split could be incorporated into the costs associated with these resources. As mentioned earlier in the paper, while aggregating the accounts would produce a more accurate estimate for the reserves, ideally separate monetary accounts would be available to improve their analytical usefulness with users. Future work could incorporate a more appropriate split between the associated costs of oil and gas when the required data becomes available. As highlighted within the paper, the inclusion of decommissioning costs is new to these accounts. By including them they portray a truer estimate for reserves value. However, further work should be carried out to determine the most suitable way for these costs to be accounted for. Experimental Statistics The estimates within this paper for the Monetary Value of Oil and Gas reserves are designated as experimental statistics because they use new methods which are still subject to testing and could be subject to modification in the light of user feedback. Further information on experimental statistics can be found on the National Statistics website at: Acknowledgements The author would like to thank Donna Livesey, Richard Jones, Valerie Fender, Mavis Anagboso and Mike Earp for their helpful comments and suggestions on this paper. 20

21 Annexe 1 New methodology oil and gas monetary balance sheet Current Prices million Opening stocks¹ 41,975 80,964 98,977 98, , , ,864 Extraction² -5,373-11,134-11,293-14,022-17,348-17,451-21,972 Revaluation due to time passing 3,210 4,987 4,752 6,216 8,262 8,344 11,143 Other volume changes -1, ,686 6,801-2,004 13,953 2,570 Change in Extraction 1, ,417-3,234-5,340-5,044-3,187 Change in Rent 23,955 24,437 2,857 35,600 48,752 17,819 56,492 Sum of Change in 't' 21,718 17, ,361 32,321 17,620 45,046 Closing stocks 63,692 98,891 98, , , , ,910 New methodology oil and gas monetary balance sheet Constant Prices million Opening stocks¹ 55,859 95, , , , , ,150 Extraction² -6,930-12,885-12,091-14,615-17,594-17,285-21,076 Revaluation due to time passing 4,140 5,771 5,087 6,479 8,379 8,264 10,689 Other volume changes -1, ,017 7,089-2,032 13,820 2,465 Change in Extraction 1, ,517-3,371-5,416-4,996-3,057 Change in Rent 29,175 26, ,310 45,792 13,804 48,574 Sum of Change in 't' 26,289 19,339-3,478 29,892 29,129 13,607 37,594 Closing stocks 82, , , , , , ,744 1 The estimated opening and closing stock values are based on the present value method -see Environmental Accounts on the National Statistics website for more detailed descriptions of the methodology used. The estimates are extremely sensitive to the estimated return to capital and to assumptions about future unit resource rents. 2 Negative extraction is shown here for the purpose of the calculation only. Of itself, extraction should be considered as a positive value. 21

22 Annexe 2 Old methodology oil and gas monetary balance sheet Current Prices million Opening stocks¹ 41,589 77,459 97,448 97, , , ,361 Extraction² -5,257-11,100-11,145-13,892-17,656-18,287-23,693 Revaluation due to time passing 2,675 4,878 4,689 6,168 8,423 8,764 12,125 Other volume changes -1, ,661 7,127-1,888 14,666 2,877 Change in Extraction 1, ,328-3,325-5,400-4,941-1,972 Change in Rent 22,968 24, ,484 49,925 20,297 61,044 Sum of Change in 't' 20,029 18,229-3,167 29,563 33,403 20,500 50,381 Closing stocks 62,712 96,623 97, , , , ,231 Old methodology oil and gas monetary balance sheet Constant Prices million Opening stocks¹ 52,116 85, ,462 97, , , ,080 Extraction² -6,419-12,039-11,145-13,553-16,847-17,011-21,422 Revaluation due to time passing 3,266 5,291 4,689 6,017 8,037 8,152 10,963 Other volume changes -1, ,661 6,953-1,802 13,643 2,601 Change in Extraction 1, ,328-3,244-5,153-4,596-1,783 Change in Rent 28,044 26, ,668 47,638 18,881 55,193 Sum of Change in 't' 24,456 19,771-3,167 28,842 31,873 19,070 45,552 Closing stocks 76, ,797 97, , , , ,632 1 The estimated opening and closing stock values are based on the present value method -see Environmental Accounts on the National Statistics website for more detailed descriptions of the methodology used. The estimates are extremely sensitive to the estimated return to capital and to assumptions about future unit resource rents. 2 Negative extraction is shown here for the purpose of the calculation only. Of itself, extraction should be considered as a positive value. 22

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