Low Oil Prices Impose Difficult Choices in Uganda

This article originally appeared in Uganda's New Vision newspaper on 4 June 2015. This version replaces a previous reference to 6.5 billion barrels of estimated oil inventory with another figure: recoverable reserves of 1.4 billion barrels.

Uganda's Ministry of Energy and Mineral Development (PEPD) recently extended the deadline for firms to submit bids in its first-ever round of licensing for six oil blocks in the Albertine Graben. The extension is intended to encourage more companies to apply, after the ministry received a disappointing collection of bids in the first go-round. This struggle to find appropriate investors is the latest consequence for the country of the sharp fall in global oil prices.

Exploration for hydrocarbons in Uganda gained momentum as oil prices were rising in the early 2000s. The first licenses were awarded between 2001 and 2005, during which time the price of oil doubled from $20 to $40 per barrel. The first commercially viable discoveries were made in 2006 and 2007, while prices were on their way up to over $100 a barrel. Prices dropped during the financial crisis of late 2008 but quickly rebounded to remain above $100 for the better part of the last five years.

Development of Ugandas oil sector

During that period, as the projects were being developed, the government invested in passing laws (Petroleum Bills, Public Finance Bill), developing regulations and training its workforce. But recently, just as everyone thought actual production of the 1.4 billion barrel recoverable reserves was only a few years away, prices have dropped—by more than 40 percent over the last year. Current prices are dangerously close to the break-even point for Ugandan oil fields. (The break-even is the minimum price of oil at which a given project is economically viable, estimated in Uganda to be between $50 and $60 per barrel.) If prices remain at current levels, investors interest in Ugandan oil could be jeopardized.

Description: Crude Oil (petroleum), simple average of three spot prices; Dated Brent, West Texas Intermediate, and the Dubai Fateh, US Dollars per Barrel
Source: http://www.indexmundi.com/

Did Uganda miss an opportunity? Not really. It merely reacted to the whims of the commodity price cycle. Uganda became an attractive oil territory when oil prices, and oil companies exploration budgets, were on the rise. Because there was no history of oil production in the country, time was needed to prepare the ground for an operational oil-producing field. And more time will be needed to develop the infrastructure necessary to refine part of that oil into gasoline, and export the rest to the coast of Kenya, 1,300km away. By the time Uganda is finally able to sell its oil, we dont know what the price of oil will be, though few analysts still believe it will rise to $100 any time soon.

The nascent Ugandan oil industry is currently experiencing its first shock; the three international companies involved in oil production have respectively cut their investment budgets by between 20 and 30 percent, including downsizing of their staff in Uganda. Uncertainty over future prices is prevailing. As Prof. Emmanuel Tumusiime-Mutebile of the Bank of Uganda described during a multi-stakeholder dialogue in February, this means that investors will delay major investments until prices rise sustainably over break-even points. These delays will likely impact the countrys plans for a $4 billion oil refinery and a $3.5 billion pipeline. The 2018 target for oil production has been abandoned, with a consensus forming around 2020 at the earliest.

Oil revenues were expected to be an increasingly important source of financing for public investment. Using long-term real prices of $75 per barrel, we estimated last year that annual government revenues from oil could reach up to $3.3 billion at peak production, twice the international assistance received in 2012 and more than half the current national budget. Postponing the receipt of these revenues will have implications for future investment plans in the country.

For example, consider a number of planned infrastructure developments that were to be funded primarily through external debt. These include the construction of a railway, estimated to cost about $8 billion, linking the country to both Rwanda and Kenya; a new bridge over the Nile; the Karuma and Isimba hydropower dams; an expressway from Kampala to Entebbe airport; and a proposed expansion of the international airport itself. Although these loans are not directly linked to oil revenues, any delay in oil production will make it harder for the government to meet its repayment schedule. The recent experience of Ghana should certainly serve as a caution in favour of fiscal restraint when oil is discovered.

On the positive side, the delay in oil production provides an opportunity for the government to further strengthen its legal and institutional framework, including the development of a national oil company, and make sure the right infrastructure is in place to benefit from domestic refining of crude oil. Additional efforts at governance reforms could also make the government more accountable to Ugandan citizens regarding choices are made in the natural resource sectors, and current public spending decisions. Demand for information is prevalent among the media, civil society and the wider population, amid increasing use of social media. And Uganda has yet to sign up to the Extractive Industries Transparency Initiative, publish its oil and mining contracts, or join the Open Government Partnership.

Decreasing the focus on oil production may also help Uganda develop other, more labour-intensive sectors of its economy, a need highlighted recently by DfID (UK) chief economist Stefan Dercon. Financing will be a challenge. The same scarce capital is needed to finance both oil-related infrastructure and social and economic investments that will promote diversification. The seeming abundance of loans from Chinese banks can appear like a way out of such difficult choices, but it could also leave the country saddled with debt if oil revenues do not materialize.

Some commentators are seeing the glass half-empty. We dont; we believe that Uganda can come out of the current period of low oil prices with a growing economy and healthy finances, by setting up systematic processes to ensure transparent budgetary choices today, and embracing, on its own terms, international initiatives that provide platforms and support to undertake accountability reforms.

Paul Bagabo is a Uganda-based consultant with the Natural Resource Governance Institute (NRGI). Thomas Lassourd is a senior economic analyst at NRGI.