Uganda oil refinery unfeasible: Tullow, Total, CNOOC not interested

By Andrew M. Mwenda

Dr Duncan Clarke, author of the `Crude continent: The struggle for Africa’s Oil Prize’ and CEO of Global Pacific & Partners spoke to The Independent’s Andrew Mwenda.

Assuming president Museveni called you and said look, Duncan I want you to be my advisor, how do I maximize the benefits to this economy from this oil?

Local content is often paraded as an excuse for protectionism in a form of allocation of resources at a higher cost to efficiency. In Nigeria in 2005, they tried two local content vehicles and local content requirements that had a form of about 5 pages that said tick off the boxes what percentage of nuts and bolts would come from Nigeria and what percentage from Korea and this thing fell over in the water because the bureaucracy involved. There will not be good margins for ever. This is a cyclical game – crude prices come up and down. I believe the real local content will happen organically. It is not in the interest of an operator with the biggest investment in the country; whether Uganda or anywhere, to import everything. If they can get local supply, if they can employ locally; that is going to lower their cost structure.

With CNOOC bringing in Chinese companies to supply almost everything?

That is a slightly different game because we have seen them all over Africa and all over the world. They have typically two levels; one is a government to government channel and the other is a private – a whole mix of little shops which you see on the road to Entebbe.

So you believe if local content clauses are an unnecessary inconvenience to the few operations of market dynamics?

What I am talking about are these graduated higher level local content strategies that seek to ring-fence a country or its environment or yield protectionism, indigenisation laws.

If I am president Museveni and I said Duncan: advise me; would you say you won’t have local content – it’s unnecessary?

Let’s not make it choice between extreme A and extreme B. I am just saying it is not in their interest not to have local people (and they have employed plenty); may be not the Chinese.

Tullow don’t have expatriates here; they have only three or four everybody is Ugandan. But our president loves the Chinese. The Chinese are taking a much more nationalistic political line.

I agree with that. It’s a fact elsewhere. The reason they can get away with it, is that some sort of political deal was done with them.

But I think there is some ideological affinity between our president and the Chinese. He thinks the Chinese have a Ugandan interest at heart more than the west. The west has always been exploitative, you know these assumptions.

The biggest investors in Africa are still not Chinese. They are the old OECD-country interests that command the majority of the FDI stock and investment flow and trade. And that’s a fact.

But remember that Chinese investment into this region has also grown.

There is nothing wrong with having an open trading system. I would say look everywhere.

What else can the state do to increase the benefits coming to Uganda`s economy. Because your approach is that marketing dynamics will solve all these things.

Not simply that. The more one leans to the market, the better off because it is more adaptive. All this state control over the market has always underperformed, come short. But the market will always change your direction; it will shift your path.

When you look at these African oil exporters do you think they have negotiated well with the oil companies especially the big boys like Nigeria and Equatorial Guinea and the rest?

There is one myth that is often presented and handed out religiously by the Norwegians that the pool of the African countries are hard to negotiate their share, they are so backward, and this is rubbish. We have met, over the years, very tough capable set of African bureaucrats, technicians, geologists, people at negotiations even if they haven’t got all that they can get and acquire and buy the best advice from the law firms or anybody else. We think of the Algerians, the Libyans before the whole place fell apart, the Egyptians, and Angola. But the risk is that the state institutions, the pathways to resource nationalism which is what you see with these retrospective taxes and capital gains taxes demand for tougher terms in a market. The small companies are having a tough right now. They are cutting back exploration budgets and this is going to play out in the next few years in terms of pickup of acreage, offers of bonuses, and bid rounds, all the competition that normally takes place. So the key lesson for any country is to stay highly competitive.

Is revenue share, therefore, not the most important thing?

The government is interested in the country getting maximum benefits, but they tend to see it in terms of the state take – that is the share that over the lifecycle of the project and particularly the field basin and corporate investment given, that reflects the revenues coming to the state; that is taxes royalties, fees etc. Typically in Uganda it is around 80%. So these are clear financial benefits but at the same time they are not all the benefits that come from portfolio investment in oil and gas industry. They are much wider if you look at the indirect benefit. If you take the multipliers on the economy, the employment growth, the formation of companies, the effects on the balance of payments on the trade account on the strengthening of the economy, of a whole range of ancillary value supply chain suppliers and local firms and services that emerge as consequences of the development from the discoveries. So government should be looking at this from a macroeconomic point of view not merely from a cheesy financial point of view.

When you look at the Production Sharing Agreements of Uganda, Ghana, say, Nigeria, Angola, Equatorial Guinea, which country do you think negotiated best?

They are quite different because you know the old, established, more mature countries like Angola and Nigeria are not like Uganda. You are just having a discovery; they have been having them for 50 years, they are mature, this is a frontier, this is a land locked country, this is a rift valley clay that wasn’t even opened up until 2006 for the first discoveries, they have been producing in Algeria since 1956 and in Ghana very soon after. They have got large very petroliferous duress basins with enormous potential offshore and onshore in case of Nigeria and Angola. If you are a frontier, you are a new player, it’s not the same.

What is the average for a frontier and where do you place Uganda?

It varies enormously; 50, 60, 70, Uganda is at the upper end of it because now you have got reserves in the discovery but you have to be careful because this is a global game. This is about global opportunity and choice. The companies can go anywhere, they can decide to shift their portfolio to Brazil, Colombia, Indonesia, Vietnam; you name it. So the thing for a country over time is to check the maximum Foreign Direct Investment. That helps grow the local industry too because you don’t have Ugandan upstream companies – you have got little ones looking to start to come in but they don’t have the capital or technical management experience and backgrounds.

You are looking at huge potential in this country – up to 2 billion barrels to be realised and developed and it’s a capital markets issue. People have to raise funds for it. No exploration is funded by anything other than risk capital. You are not going to get a bank to finance deep exploration because that is not what they do. But if reserves are found and development can take place then you can get reserve backed financing.

Negotiation of oil refinery takes years in Uganda. Meanwhile, as an oil company, I have my billions sunk in there and I am not getting a return, but in Ghana it has taken me four years. What happens?

Companies dilute their portfolios to other countries. They will sit on their reserves in the hope that they can somehow monetise and get a return, they will farm down, they will bring in other partners to share the risk.

But what does this delay do to the reputation of Uganda as a destination for oil investment?

I don’t think it’s positive although you got a wider spectrum of companies interested. They will still want to try Uganda. Tullow is already looking to dilute its equity interest here. They have put in over a billion dollars and they haven’t seen any dollar back; they can’t keep doing that. So that’s partly reflected in their share price that was up to £15 and now is down to £8.5. So that creates a lot of problems for the market, for the shareholders, for their status in the business.

So the danger is really to the company not to the country?

The danger is for the country because also you delayed production, lost time value of money, and benefits that could have come quickly and better and more. You have also put the market down to the effect that there is a bit of a risk involved and people are perceptive about this risk. If you look at the drilling success rates that have been achieved by Energy Africa which is 84% in Uganda, it is very high. (But) It doesn’t mean that the next basins and blocks will run at 80% success. To be honest, it’s a risk.

Why do you think Uganda, which is a frontier country, was able to negotiate such good PSA`s?

I think it was seen at the time as an open environment and they had very few people knocking on the door. The ones that came were willing to take risks. They were actually companies that had a lot of background and experiences in Africa and in East Africa and understood the situation, the right geosciences and that was to the benefit of Uganda obviously.

Ghana is said to be facing problems of very badly signed contracts. Do you know anything about that?

That’s rubbish, complete absolute rubbish. It wouldn’t have gone with the deal in the first place if terms hadn’t been as they were. What they typically do is revise according to the new status of the country and Ghana is now an offshore producer. At least they are producing, they are delivering crude to the market, they have gas going on, so there is a revenue flow to the government, and the benefits on the macroeconomics are evident. Uganda you have got nothing. It’s is going to change because now you have got FIB kick-off with its new producer arrangement. It will come but it is slow and time is money; simple.

Beyond the government share of oil through royalties, taxes…, how do Ugandan oil policies and institutions ensure a greater diffusion of benefits from this industry to develop the economy? Is it right to have a refinery or export crude?

The two views; the company view and the governments are the same. I think they should have gone for the crude oil production pipeline export as quickly as they could have. Government`s interest in the refinery is sort of cozy nationalist presumption that an own refinery is somehow beneficial. But refineries can also be operated on weak margins or negative margins. They involve a set of different operators, players and risks. In the end, refineries are particularly vulnerable due to shifts in the market, distribution, questions to pricing. So you need a different class of investors and that won’t be an upstream company like Tullow. On the other hand, the two other bigger partners, Total and CNOOC are integrated companies. They could pull in some of the expertise, but I don’t see them at this point willing to invest as a refinery operator. But governments, whether it is Uganda or a combine of Uganda and Kenya, are not specialists in refineries and Africa is littered with poor refineries, uneconomic refineries.

If you are President Museveni, would you insist on a refinery?

No, I wouldn’t. It is possible you might find some sort of argument for a small topping refinery – may be 20,000-30,000 barrels a day. I think this was the initial proposal. The way the paradigm is shaping looks like this is just a step on another step to a long term 180,000 barrel day refinery. If you look at refineries across Africa, almost all the inland refineries have been closed, are just industrial west lands. Take the Feruka refinery in Zimbabwe for instance which closed years, and basically turned into a storage tank if you like. The KPR (in Mombasa) is bedeviled by problems, Essar took it over, the government now trying to buy it back at US$3million. If you are going to have a refinery, it would make potentially more sense on the coast because you can export products into the other markets in the other countries. The other problem is that you need an investor to own and operate it. Countries in the gulf; in particular the Saudi, Iran and others, need to export and they can discount or they can do term dues. That is why the super mergers, and many of the bigger companies are bailing out of the refinery businesses and selling them off, or they are splitting their refinery divisions from their upstream. A new refinery in Uganda for this little petrol would be competing against what would be imported. The unit cost, which is the key thing, would be much high. And then they also have got to resolve some of the issues you mention; the markets in eastern Congo, Rwanda, Burundi and south Sudan, each of those has got different currencies, you have got currency risk, you have got cross-border transport linkages, and I don’t care about what everybody tells me about the EAC and how wonderful everything is coming in COMESA – it isn’t.

I was involved with the very first trade missions to set up the Preferential Trade Area of East and Southern Africa in 1979-1980 and it was a wonderful idea but it hasn’t achieved its main objective. Look at the border queues, look at smuggling, look at issues to do with corruption; you look at the tariff structures, the fact that for instance even in the EAC local content is an unresolved question. Uganda wants local content, but if a Kenyan comes, that is not considered local.

Are there other external benefits that come from a refinery, for example, other products you are producing  from oil, people you are employing, taxes being paid, the investments – do those other benefits exceed higher unit cost?

You need a more detailed evaluation but in general terms I think it is a higher risk to take a refinery dream strategy than to go for the crude option because you are involving a lot more complexity and risks.

There is a book I read called `Untapped, the scramble for Africa`s oil’, it’s a doomsday story of how Africa has been cheated by these big oil companies it’s been shortchanged.

It’s better off knowing what happened or that it could have happened in a very different way. But the bigger problem is the idea that use of the word exploitation is a bad thing. Countries that haven’t been exploited are the worst off. So Uganda – you are telling me, would be better off if Tullow and all the people wouldn’t have come here, and discovered all that reserve of petroleum?

Some people think Uganda got a very good deal, somebody was telling me that in Nigeria Abacha signed an agreement with some oil companies that they would be buying oil for some years at US$10 a barrel?

Let us go back in time because there was a time when the crude price was US$10 a barrel so these one line throw a ways don’t mean anything.

But that he signed it over a period of years so up to now companies are still paying US$10 dollars a barrel

No, I don’t believe that. Number two, Nigeria as a particular country case, is a land of no tomorrow and you know the acute scandals and recently with Sanusi, the governor of the central bank being fired by president Goodluck Jonathan for instance for pointing out that NAPC; the state oil company, has not delivered US$20 billion worth of revenue to the state as it should have. That money is gone somewhere; it has not gone into the central bank.