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North Sea energy transition enters choppy waters

STATE OF TRANSITION: Wind cancellations and upstream capital flight loom large over beleaguered North Sea supply chains, but mature province offers enduring appeal to investors.

Storm clouds are brewing over the UK’s offshore energy industry. Severe cost inflation and project cancellations have rocked the offshore wind boat. In upstream oil and gas, operators warn of capital flight and job losses from the ‘windfall tax’. With supply chains in mature segments struggling for profitability, the Herculean task of scaling up clean hydrogen and carbon capture and storage becomes that much harder. But there remains a high-level political consensus around decarbonisation, centred on the enduring appeal of the North Sea. Can established and nascent technologies navigate today’s turbulence to meet sky-high policy ambition and keep the ageing basin relevant in the quest for net zero?

The North Sea energy transition is entering a pocket of turbulence. Spiralling materials and capital costs scuppered both Equinor’s Trollvind and Vattenfall’s Norfolk Boreas offshore wind farm projects. These moves crystalised long-simmering fears over the economic trajectory of the sector, a flag-bearer for the UK government’s wider North Sea decarbonisation push. Vattenfall’s review of the entire Norfolk Zone wind area set the tone for a summer of disquieting headlines.

Siemens Energy launched a strategic review of its wind power business in August after booking a €4.5 billion hit from onshore turbine defects and cost- and ramp-up challenges in its offshore segment. The German OEM is said to be delaying turbine deliveries from its troubled 5.X platform to buy time while it steadies the ship.

Offshore wind’s failure to bid in the fifth Contracts for Difference (CfD) allocation round is symptomatic of a global problem. 

Inflationary pressures are crushing capital-intensive projects the world over, with almost 10GW of offshore wind believed to be at risk globally. Power purchase agreements (PPAs) underpinning US projects are being cancelled and renegotiated at higher rates in the hope of passing the pain through to offtakers and consumers. US state regulators are resisting, saying developers entered these agreements in full knowledge of the risks they entailed.

Here in the UK, the CfD regime does not allow for strike price renegotiation, so there is no mechanism to pass through costs – meaning they must be absorbed along the supply chain. But turbine OEMs such as GE, Siemens and Vestas have for too long been sustaining heavy losses while ramping up delivery, prompting an ‘arms race’ for ever-larger turbine capacities in a desperate bid to lower per-unit costs. This strategy was never likely to succeed and now it is unravelling before our eyes.

Row over regulatory reform

Developers will not pursue projects that hold no hope of generating adequate returns. So without an outlet to release the cost pressure, cancellations – and auction flops – become inevitable. The deteriorating investment climate, combined with the rigidity of CfD strike prices and delivery deadlines, is prompting calls for a swift shakeup of the support regime before there are other high-profile casualties. 

Regulatory interventions are strewn with risks, not least the very real possibility of exacerbating an investment hiatus while new rules are designed, consulted upon and implemented. This is arguably the worst possible outcome since it guarantees a fallow period for under-utilised supply chain capacity without any guarantee that the new regime will be any better than what it is replacing.

There is a need to tread carefully; the CfD leveraged project finance into 20GW of operational and forthcoming offshore wind capacity so surgical tweaks could be advisable rather than wholesale regime changes. But revolutionary changes are still being contemplated, both within the CfD regime itself and across the wider UK electricity sector. The big question now is, how to strike the right balance to avoid throwing the baby out with the bathwater?

Fickle fiscal framework for fossils

Stuttering investment is already a gloomy reality for the North Sea oil and gas industry. Following a volley of changes to UK tax regulations and an ongoing fiscal review, a new set of risks and uncertainties must be navigated to achieve final investment decisions (FIDs) or allocate capital to pre-FID developments.

Leading independent offshore operators such as Ithaca Energy blame the Energy Profits Levy –the much-maligned windfall tax – for the deferral or cancellation of investment in major untapped North Sea discoveries. And while the introduction of a price floor offsets some of the theoretical risk of excessive taxation in the face of a commodities slump, the reality is that markets are not expected to dip below the threshold to deactivate the windfall tax before it is due to expire in 2028.

With a general election highly likely in 2024, the prospect of an incoming Labour administration brings fresh uncertainty. The party’s promise to end new oil and gas licences puts a potential long-stop date on unsanctioned discoveries, quelling M&A activity in the basin. Shell’s protracted effort to offload its interest in the Cambo oil field is a case in point.Regardless of any changes at 10 Downing Street, a straitened Treasury grappling with soaring UK borrowing costs and weak post-Brexit economic productivity will have no real room for fiscal leniency towards North Sea operators. An extension of the windfall tax beyond 2028 is entirely conceivable given the enduring political sensitivities around oil and gas taxation and Labour’s proposal to hike the overall tax rate to 78%, in line with Norway.

Oil, tax and decarbonisation

Fiscal uncertainty can have multifaceted effects in mature hydrocarbons provinces such as the North Sea. Hesitation to commit to large capital investments for fear of punitive future taxation can intersect with decarbonisation objectives in a number of ways.

The most obvious of these is the impact on supply chains. Offshore oil and gas projects contribute to local economies through job creation and revenue generation. Investment cancellations lead to job losses and economic downturns in regions dependent on the industry, potentially making a swift energy transition more challenging – especially where sector coupling technologies such as hydrogen and carbon capture and storage (CCUS) are viewed as key enablers for net zero.

To the extent that new field developments adopt cleaner technologies to reduce upstream emissions, cancellations hinder technological progress – for example, by squandering opportunities to deploy carbon capture or electrification via subsea connections to nearby wind farms.

North Sea leaders and laggards

The UK North Sea industry has work to do to make this argument with conviction. While British oil and gas is generally cleaner than imports from North Africa or North America, it is significantly more emissions-intensive than neighbouring Norway, where tighter regulations implemented over many years are now delivering environmental dividends.

Emissions from Norwegian petroleum activities are regulated through several acts, including the Petroleum Act, the CO2 Tax Act on Petroleum Activities, the Sales Tax Act, the Greenhouse Gas Emission Trading Act and the Pollution Control Act. This suite of rules and protocols has forced the industry to pioneer the deployment of upstream emissions-reduction technologies and procedures.

For example, routine gas flaring has been outlawed since production began on the Norwegian Continental Shelf, and as a result Norway’s flaring intensity of >1 cubic metre per barrel is “dramatically lower” than the UK’s ~2.5 cubic metres per barrel, according to flare monitoring experts Capterio. “[T]he difference is largely attributable to government commitment, leadership and investment,” Capterio says.

In a decarbonising global economy, the case must be made for the cleanest barrels to be the last to be shut-in. Therefore, the onus is on government and industry to work together to achieve rapid and sustained reductions in Scope 1 and 2 emissions in order to mount a compelling counter-argument in the face of resistance to tax exemptions or new licence awards.

Going beyond the regulator’s stewardship expectations will be key to demonstrating that new developments are enabling capacity building in transition-critical technologies, such as flare mitigation, platform electrification and carbon sequestration. Future-proofing projects as ‘transition-ready’ is no longer enough – North Sea oil and gas must take the initiative and earn its decarbonisation stripes.

An ocean of enduring opportunity

There is a silver lining to the current malaise. Lack of progress means the UK North Sea still offers a wealth of opportunities to decarbonise new and existing infrastructure, to scale up offshore wind and other clean power sources, and to pioneer new business models that breathe life into next-generation hydrogen and carbon storage ventures.

Looking beyond electioneering squabbles, there remains a strong cross-party political consensus that the North Sea should remain at the very heart of the UK’s energy transition. This aspiration was enshrined in the North Sea Transition Deal in 2021, with greater detail and ambition set out in the British Energy Security Strategy (BESS) last year.

All of this is embedded in an overall supportive policy environment in an advanced industrial economy with an enviable track record in technological and regulatory innovation. As investment conditions go, the North Sea is a world class destination for energy transition capital.

Ambition overdrive

The BESS increased the UK’s 2030 energy transition targets across the board: it upped offshore wind to 50GW, set a goal to deploy four CCS clusters capturing 20-30 million tonnes of CO2 per year, aims to deploy up to 10GW of ‘blue’ and ‘green’ hydrogen production capacity, and envisages a halving in upstream oil and gas production emissions.

Over the same seven-year timeframe, the government hopes to reduce UK natural gas demand by 40% while shoring up domestic production, thus restoring the North Sea as the country’s primary source of gas and cutting the gas/LNG import bill.

 The UK is on a trajectory of rapidly increasingly import dependency, so bending the curve on demand becomes crucial if North Sea supply cannot ramp up to fill the gap.

The trouble is that government aspirations for the North Sea are so ambitious they are bordering on fantasy. Hitting 50GW of offshore wind by 2030 requires annual deployment rates to more than quadruple to 4.5GW every year between now and 2030. Trade body RenewableUK anticipates a shortfall against the 2030 target, with only 40GW forecast to be operational by the end of the decade – and this was before Vattenfall’s Norfolk Boreas bombshell cancellation.

The challenge for wave, tidal, hydrogen and CCUS is even more daunting, since these supply chains must be mobilised from a standing start.

Tidal power is scaling up from demonstrator projects into larger arrays supported by CfDs. Tidal strike prices are generous compared to offshore wind, so officials will want to see sustained cost reductions in exchange for ringfenced funding in future auctions.

The UK’s first hydrogen business model (HBM) allocation round is progressing, albeit with a degree of attrition: 408MW across 20 projects were shortlisted, but three green H2 projects including Orsted’s Gigastack development at the Hornsea 2 offshore wind farm withdrew. There are around 262MW of schemes still in the running, enough to meet the government’s aim to support 250MW by the end of the year.

A second allocation round will aim to award contracts for a further 750MW of hydrogen production capacity in 2025, marking the start of annual tenders under the HBM support mechanism. But even if this timetable is met, it will mean that the 1GW by 2025 target is met only insofar as those projects will be at pre-construction – which would seem to put 10GW by 2030 out of reach. Orsted’s stated reason for shelving Gigastack – inadequate supply chains to deliver such a feat of engineering – is another shot across the bows of the UK’s North Sea energy transition plans.

Capturing the CCUS opportunity

The government’s carbon capture, storage and utilisation (CCUS) programme is finally making progress, with four CCUS clusters now selected under Track 1 and 2 of the CCUS cluster sequencing process after many years of delays and deliberations. The East Coast Cluster in Teesside and Humber, HyNet in Merseyside, Acorn in Grangemouth and Viking in Humber and will now proceed towards negotiations, with each vying for a slice of the £1 billion CCS Infrastructure Fund prize.These clusters, if developed, promise a low-carbon industrial renaissance that could revitalise coastal economies with a flood of fresh investment and thousands of new jobs. Two of the four clusters are targeting subsea storage sites in the southern North Sea, which has been described as a CCS ‘super-basin’ thanks to its ample sandstone reservoirs offering thousands of potentially viable carbon sequestration targets.

But the toughest challenges still lay ahead. The CCUS industrial opportunity will not be realised without a rapid and comprehensive retraining programme to ensure adequate provision of skilled engineers, technicians, operators and construction workers. And just like hydrogen, there is not yet a viable supply chain for sourcing the specialist equipment needed to deliver industrial scale carbon capture projects on time and within budget.

Clamour for clarity

The stage is set for a monumental investment spree between now and 2030 in North Sea energy transition ventures spanning new and conventional energy sources. The single most important factor determining the pace and scale of investment will be certainty of the fiscal and policy environment supporting these initiatives. 

There is palpable enthusiasm across market players around the overall direction of travel, but this is tinged with anxiety in the wake of recent events. Wavering commitments to major project outlays must be nipped in the bud with swift and decisive policy action that prevents a period of turbulence from descending into a full-blown investment hiatus. Above all, the UK cannot afford another handbrake turn in energy policy or a repeat of the White Rose and Peterhead CCS debacle, which abruptly pulled the plug on two advanced projects and severely damaged investor confidence in this sector.

Regardless of the outcome from a 2024 general election, North Sea industry players will be looking to Westminster for stable, consistent messaging around its existing policy commitments. There needs to be a genuine pledge from ministers and policymakers to reform support schemes and fiscal frameworks in a way that strikes the right balance between investment returns, value for money, timeliness and deliverability. Moving at pace with attention to detail is a tough act, and one that government and industry must strive to perfect.

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