Equinor and Shell’s neat UK combo offers a step towards an exit

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Conditions for oil and gas companies in the UK North Sea over the past 18 months have become as hostile and unpredictable as the weather off Scotland’s north-east coast.

It was already a mature basin with declining production and relatively high costs, but the introduction from May 2022 of the UK’s “energy profits levy” — a “windfall” tax that has since been raised and extended several times — has made operating in the region harder than ever.

Companies with assets in UK waters now face one of three choices: get out, diversify to reduce North Sea exposure, or consolidate to unlock savings.

On the face of it, oil majors Equinor and Shell are plucking for option three, by pouring their UK North Sea assets into a new jointly-owned company that will become the region’s biggest independent producer — and “self-funded”. Ultimately, though, this neat tie-up looks an attempt to find their way to option one.

There are several attractions to the deal. First, Equinor has big tax losses in the UK — £6bn according to Barclays’ Lydia Rainforth and Matthew Cooper. But at 38,000 barrels of oil equivalent (boe) per day, it has relatively modest current production. Adding Shell’s UK production means the new joint company would produce about 140,000 boe per day in 2025, allowing it to make use of those tax losses much earlier and more efficiently.

Second, the combined company will have a more attractive production timeline. Shell has more near-term production. But Equinor’s $3.8bn Rosebank scheme 80 miles north-west of the Shetlands — if allowed to proceed — would contribute production up to 2050.

For both companies, it also means the capital expenditure required by the UK assets will be off their respective group balance sheets. For Equinor, which is on the hook for 80 per cent of Rosebank’s capex, this is also sharing the burden.

On the downside, other savings are likely to be limited, says Stifel’s Chris Wheaton. Equinor’s UK business in 2022 had administrative expenses of just £80.2mn. Assuming those costs could be knocked out through the combination, it would equate to savings of just $2/barrel.

The real prize here is optionality. A bigger, stronger business might prove more attractive to any future buyers of stakes — or the company — who still believe in the merits of cash-generative UK fossil fuel production. No doubt this will not be lost on other UK operators who are considering their limited choices.

Already, London-listed Ithaca Energy and Italian major Eni have struck a deal over the latter’s UK assets. More such tie-ups should follow.

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