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14 April 2015, Gateway House

The United Kingdom of Oil

UK may be on its way to becoming a petro state, again, on back of an oil discovery that may be a whopping 100 billion barrels. The world is awash with cheap energy, and Indian companies need to seize the opportunity to acquire upstream energy assets.

Fellow, Energy & Environment Studies Programme

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A little known company – UK Oil & Gas Investments (UKOG), on Thursday announced that it had made a major oil discovery under the Gatwick Airport – about 30 miles from Central London. In a detailed release to the exchanges, the company has said this field called Horse-Hill, spread over a 55 square mile area, may have oil in place (a technical term for total hydrocarbon present) of 158 million barrels per square mile. In its filing the company has also said that the basin could be considerably larger than 55 square miles. This means the discovery could be of up to 100 billion barrels of oil. UKOG expects 5-15% of this oil to be recoverable. At the higher end of the scale, this discovery will be 1% of current known petroleum reserves. The stock price of UKOG tripled on Thursday, after the discovery was announced to the financial markets.

If these estimates are correct, this means the UK’s existing oil reserves of 3 billion barrels are set to increase manifold. UK has been a major oil producer in the past – till 2002, UK produced more oil than Kuwait – largely from North Sea. However, the North Sea fields are old and production has been falling – UK’s current oil production is less than 900,000 barrels per day – one third of the peak during 1990s and early 2000s. A large discovery such as Horse Hill can reverse the trend and take British oil production back up again.

This discovery has two positive spinoffs for India. Fresh oil coming into the world market will create more stability and reduce chances of sudden, sharp spikes. Predictability is good for large energy importers such as India. The discovery in the UK comes just days after news of a possible deal between Iran and world powers on the nuclear issue. Iran’s return to the oil markets could mean an additional 0.76 million barrels per day in the short term, and 2-3 million barrels a day over the next several years. These additional quantities are significant, considering global oil demand is approximately 86 million barrels per day; it means that the moderation in energy prices may sustain for longer.

During FY14, India spent $167 billion on oil imports. With oil prices down by over 50%, the lower oil import bill will improve India’s trade balance. Companies such as Indian Oil, Bharat Petroleum and Hindustan Petroleum were earlier struggling as prices of key products such as diesel and petrol were below cost – due to high cost of crude oil. All of these companies are now profitable and the government doesn’t need to subsidize them. New sources of oil such as Iran and the UK means the low-prices run can last longer.

Secondly, lower prices offers Indian companies an extended window during which to grow by acquisition. Gateway House suggested in the past that ONGC acquire a stake in Rosneft. The price drop is hurting everyone: global oil majors such as ExxonMobil and BP, which are both cutting back spending on exploration, and smaller energy firms, whose valuations have fallen by up to 70% in the past year, making them takeover targets. For instance, UK headquartered Tullow Oil, which made major oil discoveries in Uganda, has seen market value fall by over 60% in the past 12 months. The market value of US based SandRidge Energy, which produced 29 million barrels of oil in 2014, has eroded seen almost 70% during the same period.

The time to buy an asset is when the price is down. The proposed $70 billion acquisition of British Gas by Shell is a case in the point. Leveraged firms will find it difficult to sustain operations and there will be distress sales. India’s public sector oil firms – financially sound and with low or manageable debt levels – should take advantage of this opportunity. These companies have been trying to buy energy assets for over a decade.

Now that prices have fallen, they should pursue such opportunities more aggressively.

Amit Bhandari is Fellow, Energy & Environment Studies, Gateway House.

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