The Risks that will shape the Monetisation Strategy for Uganda’s Oil Assets
By James Reginald Karama
Posted: 28th October 2014 09:02Now that Uganda has confirmed oil reserves, the focus moves to the monetisation strategy. Initial estimates indicate that the project will require over USD 10 billion; a significant investment for Uganda by any measure. Oil investments are long term, and project sponsors will require a higher level of political and economic stability. The key project sponsors (government, oil companies and their financial backers) will need to assess the potential uncertainties and establish appropriate de-risking strategies.
According to David and Wood Associates, risk and opportunity management is the systematic application of management policies, processes and procedures to the task of identifying, analysing, evaluating, mitigating, exploiting and monitoring risk and opportunity. They also warn that one should not lose sight of the opportunities by focusing on the risks! Through the process of risk and opportunity management business managers are able to separate acceptable from unacceptable risks and meaningful from insignificant opportunities, establish their potential values and develop effective risk & opportunity management strategies.
The main purpose of the above process is to ensure that risks and opportunities are identified and evaluated in a systematic and consistent way and significant risks are mitigated and opportunities are exploited without delay.
The project sponsors will assess various oil price risks. The world price of oil has been characterised by booms and recessions, this volatility is partially a result of the strategic nature of oil, which unlike other commodities has cartels that seek to control its price. The oil historian Francisco Parra in his book ‘Oil Politics – a modern history of petroleum’ documented the chronology of how increases in the price of oil spurred the development of new fields. Oil prices are influenced by a range of factors including: huge demand from emerging markets, energy efficient technologies, conflict in some oil producing countries and the US domestic energy boom as a result of the development of shale gas. The US Energy and Administration reports indicate that the 2012 US imports from Nigeria of Crude Oil and Petroleum products dropped by 48% compared to 2011 and for first seven months of 2013, imports dropped by 19% compared to the first seven months of 2012. Over time a balance has been created where low cost producers sell their oil at artificially high prices, which benefits the high cost producers, who otherwise would have been out competed. This implies that below a certain price level, it will not be viable to develop Uganda’s oil.
The investors will also be interested in how prices will be determined. They will need assurances that all concerned parties will respect the sanctity of free market economics. In this case the investors will be keen to use the free on board (FOB) Mombasa price to determine their appetite for the project. The advantage of Uganda’s oil project is it comprises of both a refinery and pipeline, so the investment models will be able to factor in both international and domestic sales prices.
The main question will then be; what volume of crude needs to be pumped per day and for what period of time? It is not uncommon for oil producers to control production in order to benefit from the oil for a longer period. Over the history of oil production, nations have introduced ‘depletion policies’ to control production and ensure that economic activities around the oil are sustainable
The risks around local participation are akin to a hydra headed challenge, failure to provide a proper solution can lead to unnecessary losses. In May 2012 villagers in Mtwara, Tanzania rioted, they were angry that the gas reserves in their village were going to be piped to Dar es Salaam for processing. They wanted the gas processed in Mtwara. They set government buildings and vehicles on fire, causing damages worth USD 1million. This sad episode demonstrates the risks around local participation. The need for local participation is as old as oil production, for instance in the 1970s Norway made a considerable effort to support its fledgling national oil company. According to Francisco Parra, as a matter of national pride Norway was not about to stand aside and let what was clearly to become its major industry be run entirely by foreign oil companies. Uganda too has made a brave decision to legislate for local participation.
The location of Uganda’s oil and the evacuation route exposes it to unique cross border risks. For instance, the Albertine graben is close to Eastern Congo, while the oil has to be evacuated through Kenya. There is no clear formula for dealing with cross border political and security risks, the key concern being the sometimes rapid shifts in political and security circumstances. Over the last few years the East African states have had to deal with security challenges as a result of insurgents operating outside their borders. The strength and brotherhood of the East African Community will help to mitigate any such risks.
Being landlocked with the nearest seaport over 1200km away exposes Uganda to infrastructure risks. Evacuating the oil will require an increase in both the oil and non-oil infrastructure like harbours, roads, airports, power, health and safety facilities, pipelines, processing plants, storage tanks and terminals. A key point of concern will be the overall safety infrastructure. A recent fire at a major regional airport aptly demonstrated this risk; it is said that the water hydrants failed to work. It is exciting to see that the Presidents of Uganda, Kenya and Rwanda are working together to address the regional infrastructure challenges.
Planners have to deal with the technical risks, first at the point of extraction then at the refining, transportation and storage phases. At the point of extraction there will be hundreds of wells, so the engineers will have to figure out a way to link all these wells to both the pipeline and the refinery. The other challenge will be building a pipeline over a diverse and challenging terrain, with special attention around the massive rift valley escarpments. Uganda’s oil is solid at room temperature, so the designers have to decide how they will handle the waxy nature of the oil. However, it is important to note that the three key investors in the Albert basin have the combined knowledge and experience to overcome the technical challenges.
Environmental risks will have a significant influence on the investment decision. The oil wells are located within a very sensitive ecosystem and this will be a key issue for the investors. Providers of project finance now apply the Equator principles and other international environmental standards. Potential financiers will be keen to ensure that they do not run afoul of any environmental standards and the exploration companies will be keen not to tarnish their reputations through environmental disasters. In this regard the oil explorers have embraced the environmental complexity of the Albertine basin. According to various press stories one of the leading exploration companies is using 3D seismic, cableless technology that is harmless to the environment (for the first time onshore in Africa).
Funding risks will also be atop every investor’s agenda, assuming that the key sponsors have to choose between multiple projects. Uganda’s return on investment will have to be compared against a range of other investment options and a rational decision will be made on where to allocate scarce capital. The funding options will depend on the overall risk profile and tenor of the project. On a positive note, the ‘finding cost’ for Uganda’s oil is one of the lowest in the world which will increase the return on investment.
It is now an accepted practice that international financing decisions are influenced by the credit rating of a country. Credit rating agencies such Fitch, S & P and Moody’s, periodically assess a country’s risk and issue a rating. Country risk refers to the economic, political and business risks that are unique to a specific country, and that might result in unexpected investment losses. Political risks may include; civil or regional wars, civil unrests, terrorism, unfair contracts, onerous social and environmental obligations, restrictions on movement of capital, politically motivated justice systems, the nature of political opposition, length of time of the government in power, democratic systems, ethnic tension, quality of life, regional relations, corruption and organised crime. Insurance firms have developed products to cover some of the political risks. However these policies drive up the costs of a project.
Generally the development and execution of large mega projects is fraught with a lot of risks. The oil and gas sector is distinguished among other sectors by lengthy overruns and arrant overspend on its bigger projects, according to Tim Haidar, of the Oil & Gas IQ newsletter - the question is whether these projects can be kept within the bounds of profit and operational acceptability. There are now established methodologies for identifying and isolating the different risks and measuring their impact on the overall project risk profile. Oil investors can obtain business advisory services from banks and consultancy firms. These expert advisers will help them to strike the right balance between risk and opportunity
James Reginald Karama joined Stanbic Uganda in March 2008 as a Senior Relationship Manager responsible for Multinationals. Prior to joining the Stanbic he worked with PostBank Uganda as the Executive Director in charge of operations. James is a member of the Association of Chartered Certified Accountants of the UK and a holder of an MBA from Oxford Brookes University –UK.
He served as the Manager Country Strategy and Investor Relations from 2010-2013, in this role he supported the Banks Country Exco and the Board to develop and implement Stanbic’s strategic plan. He is currently responsible for the implementation of Stanbic Uganda’s Oil & Gas strategy.
The writer is the Sector Head, Oil & Gas Coverage – Corporate & Investment Banking, Stanbic Uganda. – firstname.lastname@example.org
The Corporate & Investment Banking Division is one of the business units within Stanbic Bank Uganda. This division looks after the bank’s business relationship with large corporate organisations such as multinationals, regional corporates and large local Corporates. It is also responsible for the bank’s relationship with International development organisations, Government and Non-Bank Financial Institutions. The business is built around three key products namely Transactional Products & Services (TPS), Global Markets (GM) and Investment Banking (IB). Relationships with our customers are built around a “One Stop Shop Model” whereby every customer has a Relationship Manager who is the main contact point on all issues relating to the Bank’s delivery of products and services. The three product Teams are designed to be centres of excellence with respect to delivering relevant solutions to individual customers.