Governments need to adapt to the oil price too

The oil price is having a huge effect. Falling cash generation means oil companies are cutting capital expenditure to balance the books. Not even this is enough – many IOCs are paying dividends out of debt.

In this environment, exploration has been hard hit and we have seen a huge fall off in exploration wells drilled in the last 18 months.

Global exploration wells Source: 1Derrick

Governments need to adjust
The Brent forward curve implies a muted recovery. While service costs continue to adjust, companies are unlikely to invest in exploration unless returns improve. Governments have a role to play in this. Just as they increased fiscal take in the upswing, they should be prepared to reduce the tax burden in the downswing.

We believe that Côte D’Ivoire is showing the way in this respect. The recent deal announced by African Petroleum in its farm-out with Ophir Energy includes a revision to the PSC in Côte D’Ivoire that reflects “the current commodity price environment and outlook for development of the deepwater prospects”.

Ceteris paribus, this flexibility in approach means that exploration is more likely to happen in Côte D’Ivoire than in other countries. This means that Côte D’Ivoire could see increased investment and better long-term prospects when/if oil prices recover – even if this process is many years, or decades away, those countries that are not looking to incentivise exploration now will suffer in future.

Importantly, with the benefit of hindsight of the rise in oil prices from 2004-2008, it should be possible for countries to facilitate exploration in lower oil price environments while retaining the economic rent of higher prices. Effective incentivisation to explore by governments in exploration in the short term should pay long-term dividends.

The effect of fiscal adjustment to boost exploration is very clear when looking at the tax rebate system introduced by Norway in 2005. The number of exploration wells increased materially, and production from the NCS has benefited as a result.

Source: NPD, Edison