Uganda’s Oil Projects Still Attractive for Investment Amidst Falling Oil Prices
I am prompted to offer an opinion on issues raised in the article “Experts call for caution on oil investments” written by David Mugabe which appeared in the New Vision. The caution revolved around the falling oil prices and therefore the ability to raise financing for Uganda’s oil projects. It is important that Ugandans are informed and better appreciate the investment climate in Uganda’s oil and gas sector.
The major financing needs in Uganda’s oil and gas sector currently include; i) the development of the 17 oil fields estimated at $10billion, this is a responsibility of the licensees to raise, however, the Production Sharing Agreements (PSAs) provide flexibility in financing options; ii) development of a 60,000 barrels per day greenfield refinery which includes a 205 kilometers products pipeline estimated in excess of $4billion; and iii) development of a crude oil Export Pipeline so far estimated at over $6billion.
There is no doubt the crude oil price is a key driver of profitability and therefore the capacity to raise financing. It is also important to note that although the oil industry is a long term one, the prevailing oil price has among other things an important bearing on the final investment decisions and hence the importance of knowledge of the movements of the same.
It is further important to note that the oil prices have been improving progressively since January 2015 although not enough to conclude that a nearly year-old slump will end any time soon. Experts in the oil markets including Wood Mackenzie predict a moderate recovery of the oil price to over US$70/barrel in the second half of 2016, due to oil demand growth that will be faster than that of supply from mid-2015 onwards.
Major international oil industry costs have also been observed to follow crude oil prices as they fluctuate – albeit with a time lag. A sustained period of low oil prices will therefore lower costs of development and production and therefore restore profitability of the projects.
Like most oil producers, Uganda will be a price taker for its crude oil and so all is being done to achieve the lowest breakeven price possible (currently estimated in the range $30 - $60 per barrel). Some of the cost saving initiatives being considered include, integrated development planning of the fields for sharing of facilities, design optimization at Front End Engineering Design (FEED), operating cost minimization together with early project execution among others. In addition, considerations are being made to ensure that the fiscal system specifically the rules on Value Added Tax (VAT), Withholding tax on imports and thin capitalization among others do not add to the capital expenditure.
The article highlights the need to apply prudence and pragmatism in structuring some of the projects specifically the export pipeline. This is indeed important to achieve optimality especially for such a project that is intended to enhance upstream production. Given the nature of Uganda’s crude oil (being waxy and therefore solidifying at room temperature) the proposed pipeline will be relatively expensive to operate and knowing that the economics of the pipeline are mainly hinged on the throughput (capacity), there is therefore a size below which the export pipeline would not make economic sense. The sizing of the pipeline will be determined based on the available daily production less the volumes consumed by the refinery.
The article also mentions the country’s location as adding to the complexity of the projects and therefore one of the things that would keep away investors and banks who prefer projects with better cash flows. This is not entirely correct because some of the projects like the proposed refinery are very robust with above industry average margins because of the pricing of the feedstock (which is based on export parity) and the pricing of products (which is based on import parity). The projected cash flows are therefore good enough to support reasonable debt equity ratios for project financing.
In conclusion, the oil and gas projects in Uganda are still robust amidst the oil slump and several measures are being put in place to ensure that timely and positive Final Investment Decisions are made.
Senior Petroleum Economist
Ministry of Energy and Mineral Development
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