Gloom for Uganda as oil prices dip

Even before Uganda starts to pump her first barrel of oil, the drastic fall in prices of crude oil on the world market is bad news for a country that is at a critical stage of undertaking the development of the resource.

The sense of gloom and panic that is currently being experienced in most oil-producing countries has seen currencies tumble, and economic collapse for countries as big as Russia, Venezuela and others which heavily rely on oil.

Crude oil prices fell by over 50 percent in 2014 and are still falling. The decline is attributed to excess production that was not being matched by corresponding demand as manufacturing in China started to decline compared to previous years.

Geopolitical rivalries between Saudi-Arabia and Iran are also said to have led Saudi to decline to an OPEC proposal to cut production so as to boost prices.

Saudi-Arabia, which is ruled by Sunni Muslims, experts have pointed out, believes that low oil prices will weaken her Shiite Muslim rivals in Iran and Syria and hence stop their growing influence in the region that has risen, thanks to the recent oil boom.

Besides, the growing share of Shale oil, a competitor but more costly alternative for crude, in the US, had many crude producers worried of losing their market share to the new alternative source of energy.

In its effort to become energy dependent, the US has become the world’s biggest producer of oil and therefore imports less.

While it is difficult to get a real feel of the likely impact of plummeting oil prices on Uganda because of the deep secrecy surrounding oil developments in the country, world events are definitely impacting on Uganda.

More importantly perhaps, the collapse of the world oil market has come at a particularly crucial moment for Uganda for three main reasons; the way Uganda’s oil sharing agreements were structured, the pending award of the oil refinery contract and the allocation of new exploration licenses.

Bad agreements

If global prices do not rise in the foreseeable future, Uganda will suffer a disproportionate blow to her much-anticipated earnings from the resource, according to an analysis carried out by PLATFORM, a UK-based international group on transparency of natural resource contracts.

In its 2010 report titled: Uganda’s Oil Agreements Place Profit Before People, PLATFORM noted Uganda’s model Production Sharing Agreements (PSAs) were structured in a way that the proportion of earnings accruing to the Ugandan government would considerably fall by up to 47% with lower oil prices.

The PLATFORM report cites an analyst report produced by Credit Suisse, a European Investment Bank on Heritage Oil PSA that provided an estimate of “government take rising from 55% at $30 oil to 67% at $70 oil, based on a minimum 600mmboe reserves scenario”.

PLATFORM found out that lower oil prices, smaller fields and higher development costs such as the planned development of the oil pipeline, would lead to government receiving a lower proportion of revenues, compared to less stable countries.

“In a context of low oil prices ($30), the proportion of revenues going to the Ugandan government could crash to 47.4%. As the oil price rises, government take rises, before reaching a plateau of around 73% (incorporating the pipeline) or 76% (ignoring the pipeline).

PLATFORM added: “At a very low oil price of $30 per barrel, Tullow will still make a strong [rate of] return on its investment of almost 13%. However, at this price, the state is only receiving 61.6% of total revenues. This means that most of the price risk is held by the Ugandan state rather than Tullow, fir instance Uganda carries the ‘downside’ that comes with low prices. Uganda will receive less than 75% of total revenues unless the average oil price remains above $122 per barrel throughout production.”

At 2014 oil prices of US$ 115 per barrel, it was anticipated Uganda would earn about US$2.5b from oil every year, almost a half of Uganda’s total tax collections.

At the current price of US$ 53 per barrel of brent crude, it means that if Uganda’s oil was on market already, the country would most likely be in economic turmoil. In Nigeria for example, which gets 70% of her revenues from oil, some regional governments have failed to pay salaries to their employees.

Pending refinery contract

After nearly a year of trying to get a partner to build the oil refinery in Hoima, government said last year it was set to reveal the winner of the multi-billion dollar bid before the end of 2014.

Government had zeroed in on two players, South Korea’s SK group and Russia’s RT Global Resources, as the companies that were asked to submit final bids for consideration.

However, the plan was to have the investor inject own capital in the hope that they recoup their investment by selling part of the oil.

A decline in prices at this time, appears to have been affected by the sharp fall in prices of crude. This would significantly alter the negotiations between the bidding companies and the government of Uganda as the company would want to hedge its risks against lower prices.

Even if the two parties would agree to share the oil on percentage terms, lower oil prices mean it would take much longer for it to recover its investments but also that it would want to look for more lucrative options elsewhere such as failing national oil companies in countries like Venezuela.

Uganda’s plan was to have a 60,000 barrels-a-day refinery installed at Kabaale in Buseruka at an estimated cost of US$3b.

The fall in world oil prices means that the winner of the tender would need more time to recoup her investment at lower prices than the case was in 2014.

The fall in oil prices has dealt a major blow to Russia’s economy as well as her own companies that now face a harder task of accessing capital not only to invest in new projects but also to pay off old debts.

Last month, the US Treasury Department extended sanctions on Rostec, which is RT Global Resources parent company and Russia’s major arms conglomerate.

The sanctions effectively cut Rostec from accessing debt financing from America’s financial system, which presents a competitive disadvantage to the Russian RT company as well as a difficult choice for Ugandan leaders who now see fewer options and therefore the possibility of having to accept unfavourable terms.

Wrong time to license?

The fall in global prices at this time when Uganda is preparing to license new oil fields presents another set of misfortunes for a government that was so optimistic about using oil revenues to transform the economy from a peasant to a middle-income country.

Whereas the country now has better knowledge and expertise on the status of its reserves, the sharp fall in prices means that the resource is no longer as lucrative as it was a few years ago.

This means that the interest that had been generated in the country’s oil potential by big companies such as Exxon Mobile, is likely to dissipate.

Silver lining

They say there is a silver lining to even the darkest cloud. The current fall in prices lend credibility to calls for better oil revenue management so as to avoid the effects of boom and burst economics as is being experienced in many oil producing countries.

More importantly perhaps is the need to put in place a system of greater transparency and accountability before, during and after the production of oil.

Absence of transparency, as the case has been in Uganda, creates problems such as not knowing at which price oil is a viable option, as opposed to tourism or agriculture.

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