Local participation is a very crucial aspect of oil production
Posted Wednesday, October 16 2013 at 01:18
According to 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.
In this second and final article on the key risks around Uganda’s oil project, I would like to reiterate the fact that oil production is a long-term project so the key sponsors (the government, oil companies and their financial backers) will require a certain level of stability. They will have to assess the potential uncertainties and establish appropriate de-risking strategies.
The world price for oil will influence their appetite for investment. 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 the huge demand from emerging markets, energy efficient technologies, conflict in some oil-producing countries and the fact that USA is enjoying a domestic energy boom due to the development of shale gas. 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 Mombasa price to determine their appetite for the project. The advantage of Uganda’s oil project is that 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 damage worth $1 million. 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 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 moved 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 unique security challenges as a result of insurgents operating outside their borders. The strength and brotherhood of the East African Community will mitigate any such risks.
There are now established methodologies for identifying and isolating the different risks and measuring their impact on the overall project risk profile. Insurance firms have also developed some products to cover some of the investment risks. Oil investors can obtain business advisory services from banks and consultancy firms. These expert advisers can help them to strike the right balance between risk and opportunity.
Mr Karama coordinates the oil and gas strategy at Stanbic Bank Uganda. email@example.com