* UK government review into North Sea oil out this month
* Production down 40 percent since 2010
* UK seen taking bigger role to recover hard-to-extract oil
By Stephen Eisenhammer and Claire Milhench
LONDON, Feb 14 (Reuters) - Britain is likely to have toditch its hands-off approach to the oil industry for a mix ofregulation, tax breaks and investment if it is to reap thebenefits of the billions of barrels of hard-to-extract oilremaining under the North Sea.
Changing the way an industry has worked for decades will beno easy feat. It could involve costly legal disputes overexisting contracts, and a long-term commitment from a governmentfocused on the short-term goal of cutting its deficit.
But with many North Sea oil platforms and pipelines comingto the end of their working lives, time is running out to get atthe oil, putting pressure on a government review of the industry- due to be published this month - to deliver a plan of action.
"This is urgent. It's not a problem we can see happening inthe next decade, it's a problem now," said David Bamford, aformer head of exploration at oil firm BP, who now runshis own consultancy and sits on the board of Tullow Oil.
Production from UK waters fell by about 40 percent between2010 and 2013 to the lowest level since the 1970s, according toindustry group Oil and Gas UK. Exploration has also tapered off,with consultancy Deloitte reporting last month that only 47 testwells were drilled last year - the lowest level since 2003.
That is bad news for a cash-strapped government which infiscal 2012-13 still relied on the oil industry for over 15percent of all corporate taxes.
It's not that North Sea oil is running out.
An interim report from the government's review - chaired byindustry veteran Ian Wood - estimated as much as 24 billionbarrels of oil could still be produced, worth about $2.6trillion at current prices.
But the oil is getting harder and more expensive to recover.And many of the firms with the skills to do so complain theycan't get access to the infrastructure they need because it isowned by major oil companies that are focused elsewhere in theworld and see little benefit from helping competitors.
High costs, including wages and taxes, are also making oilfirms think twice about the North Sea. In November, for example,Chevron cast doubt over its Rosebank project in theregion, estimated to have cost $8 billion, saying it did notcurrently offer "economic value".
There is also political uncertainty, with BP warning thismonth that the industry could face extra costs if Scotland votesfor independence in a referendum in September.
NO EASY ANSWERS
The interim report from the Wood Review in Novembersuggested the government should set up a stronger regulator forthe industry to ensure companies work together in a way that"maximises economic recovery" of oil in British waters.
That could follow the model of Norway, where the NPDregulator is mandated both to drive cooperation between oilfirms and to impose Norwegian law - which requires thatresources are developed optimally.
The NPD, however, has been operating for around forty yearsand employs about 200 highly-skilled people with an in-depthknowledge of the North Sea, something which industry watcherssay will not be easy to replicate in a short space of time.
"Decent, experienced people in the oil industry can earn afortune," said Judith Aldersey-Williams, partner at law firmCMS. "They will be difficult to recruit and it's going to beexpensive."
The regulation itself could also be deeply contentious,particularly if the government tries to change existingcontracts in order to enforce cooperation between companies -something that may be needed given the ageing infrastructure.
"The government can change the terms of licences goingforwards, but changing the terms of licences which already existis tricky without primary legislation," Aldersey-Williams said.
Major oil companies such as BP and Shell havewelcomed the Wood Review, saying they support moves to maximiseproduction from the North Sea.
But some in the industry think they will put up a fight ifthe government tries to force them to maintain expensiveinfrastructure for longer than they had planned - particularlyif they are also asked to help fund the cost of a new regulator.
If major oil firms are to be won over, they are likely towant tax breaks - something outside the Wood Review's remit.
Other parties may also be reluctant to cooperate.
"We need to collaborate more, but my contention is that ifyou try and tell your kids to play nicely together they look atyou and it's like 'Why should I?'," said Paul Griffin, managingdirector for the UK at Dana Petroleum, which produces 70 percentof its oil from the North Sea.
For ex-BP man Bamford, the government may need to considermore radical solutions with regards to North Sea infrastructure.
"I don't know if it's that you do something like therailways with the infrastructure," he said, referring to thesplit in Britain between a state-owned railway network operatorand mostly privately-owned train companies.
"I hate the idea of it being nationalised, but control ofthe infrastructure in the North Sea is key."
For Dana's Griffin, a better solution would be the emergenceof independent infrastructure owners.
Such companies have grown up in the U.S. Gulf of Mexico. Butit is unclear whether infrastructure investors would be preparedto put their money in ageing North Sea assets, or whether theexisting owners would be prepared to sell.
The government might have to act as a broker in any suchdeals, possibly taking stakes in the resulting businesses. Thatwould be a big bet given the price of oil has fluctuated from aslow as $10 to as high as $147 a barrel over the past 20 years.