Lessons from Uganda on oil agreements with investors

Saturday, 25 February 2012 10:17

By George Wachira The Citizen Correspondent Nairobi. Earlier this month Uganda announced that it had signed the much delayed oil production agreements with Tullow Oil, the main investor in the upstream oil and gas sector.The agreement details production sharing formulae and applicable taxation regime. The signing now enables Tullow to enter the crucial stage of wells development and production. It also opens the way for a three-way joint venture between Tullow, Total and China National Oil Offshore Company. The latter two will be expected to bring in much needed development capital and technology. What is of interest is the inordinate length of time it has taken to reach this stage. Oil was found in Uganda six years ago, and it may be another four years before the first cash inflows from oil are received, making it nearly 10 years from discovery to resource monetisation. Legal and tax tussles between the government and investors caused much of the delay as Uganda groped for experience in handling a totally new industry. Apparently, the government was also not willing to be rushed into signing deals that would have given the country less value for their oil than is justified by best practices around the world. The lengthy time it took to come up with appropriate sector laws and institutions also caused the delay. For oil and gas policy, which was ready in 2008, the corresponding Bill has just been tabled in parliament this month. The new Bill proposes a National Oil Company and an Authority to independently handle the sector and reduce direct government involvement. The political and civil society groups may also have contributed to delay as they sought accountability and transparency in the management of oil resources Here then lie lessons to be learned by countries aspiring to become oil and gas producers. Updated policies and laws must be in place to guide the management and governance of the upstream oil and gas sector. Presence of an effective sector legal and regulatory framework reduces perceived investor risks and expedites regulatory and investment decisions. It will not be a surprise to see the civil bodies engage the government on transparency and resource accountability as has happened in Uganda. A more independent and emboldened judiciary is likely to be generous in issuing civil injunctions that can slow down resource development. It helps to anticipate these constitutional developments and prepare accordingly so that when oil is discovered delay in development will be minimised. Uganda has also confirmed that they will refine the initial crude oil production, pushing the crude export pipeline option to a later date when more oil is confirmed. The Foster Wheeler feasibility study conducted in 2010 made this recommendation. The study report proposes a two-phase refinery development, with an initial 60,000 barrel per day (bpd) complex those later increases to 120,000 bpd capacity as more oil is confirmed. The initial phase targets demands for Uganda, Rwanda, Burundi, Eastern DRC and South Sudan. Phase two development takes into account demands for western Kenya and northern Tanzania. The report estimates refinery completion by 2017. Expensive option Local refining has always looked sensible due to the difficult physical properties of crude oil, which is waxy, viscous, and with densities ranging from 22 to more than 30 degrees API gravity. An export pipeline to an Indian Ocean location would require heating to keep crude oil fluid enough for pumping , making it a very expensive option. It needs to be noted that all along President Yoweri Museveni has consistently preferred the refinery option to add value to crude oil. The decision to refine in Uganda will definitely introduce new petroleum supply/demand dynamics in the region, a factor that cannot be ignored by any one of the East African Community countries. It will certainly influence future infrastructure investment in the region. For the refinery viability, it can be assumed that Uganda will cost its products so that netback prices anywhere in the region are kept cheaper than alternative offshore imports. They can achieve this by varying crude oil input costs to the refinery to keep products competitive. Raising a consortium of investors for the Uganda refinery is not expected to present problems, because the government can guarantee refining margins that reflect adequate return on investment, by varying refinery crude feed-in costs. However, Ugandans should not ignore the threats posed by other planned regional refineries. South Sudan is planning a refinery; the Lamu project has a refinery component; while plans of a Mombasa refinery upgrade persist. Oil finds in Uganda have catalysed interests in upstream oil and gas exploration in the region. Huge deposits of natural gas discovered in Mozambique and Tanzania have also heightened exploration on the Kenyan continental shelf. The prevailing high global oil prices, which now appear stabilised above $100 a barrel have also encouraged more risk taking in the region previously considered marginal and frontier. All said and done, lessons learned from Ugandan experiences should advise proactive review of existing oil resource laws to ensure that potential conflicts and delay will be manageable .Mr Wachira is the director, Petroleum Focus Consultants. wachira@petroleumfocus.com