East African oil safe from price drop - policies are the problem
06 November 2014, 15:53
Nairobi - Tougher government terms that will squeeze corporate rewards, not the sharp crude price drop, are the more potent threat to east Africa's oil boom.
The 25 percent fall in oil prices to below $85 a barrel from July has rattled high-cost producers, but industry insiders say Kenya and Uganda have enough oil to secure investment.
"These projects are long-term, multi-decade projects and hence short term variations in the oil price don’t fundamentally change their value," Britain's Tullow Oil, a major regional player, said in a statement to Reuters.
Uganda and Kenya have together found about 2 billion barrels of recoverable crude to date, part of a string of finds that could soon make the region a major global supplier of oil and gas, although it has yet to ship a single cargo.
"These kind of projects, although they are kind of remote and politically tricky, would not be the first projects that would go in a falling oil price environment,” said Tim Hurst-Brown, research analyst at Mirabaud Securities.
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Yet the hosts risk deterring newcomers by policy initiatives such as moves to impose a potentially hefty capital gains tax in Kenya or tougher terms on production sharing deals in Tanzania, where the prize is gas.
It highlights the dilemma for governments which face public pressure to deliver swift results from big finds but must keep terms sweet enough to draw in new explorers, now feeling the added budget squeeze of falling oil prices.
"There is a little bit of give and take," Al Stanton, energy equity analyst at RBC Capital Markets, said of the industry. "I kind of feel recently the governments have been more focused on the take side. They do need to do some nurturing as well."
Uganda and Kenya are on track to become oil exporters, by late 2018 or early 2019. Combined output could reach 500,000 barrels per day (bpd), equivalent to 0.5 percent of world supply.
Tullow, with stakes in Uganda and Kenya, sees a final investment decision on the projects in early 2016. Its partners are France's Total and China's CNOOC in Uganda and Africa Oil in Kenya.
Exports depend on building a 1,200-km pipeline worth $4.5 billion to connect Ugandan and Kenyan fields to the coast.
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Industry experts said there were enough reserves, as well as good prospects for finding more, to ensure a long production plateau to justify the capital expenditure.
The Ugandan and Kenyan projects would not face commercial challenges even if prices fall closer to $80 a barrel. A Reuters poll of analysts in October saw prices hovering above $90 for the next two years.
Africa Oil said that a decision in Kenya to invest might only be brought into question if long-term outlook saw prices falling below $70 a barrel.
What has rattled investors in Kenya, however, is a move to impose a capital gains tax on energy firms that, legal experts said, would be set at a rate of 37.5 percent for foreigners and 30 percent for residents from Jan. 1.
"We honestly believe that this could have a negative, adverse affect on investment in Kenya," said Keith Hill, Africa Oil's chief executive. "Given we are at a very early stage in this industry, you don’t want to start putting on a lot of burdens before it gets up and off the ground."
He said Africa Oil, which may seek to offer part of its stake in Kenya to a new partner by early 2016, said it expected any such tax would be at a rate of 10 to 15 percent.
The tax strikes at the heart of how the industry usually operates in frontier markets. Smaller firms tend to explore first and then sell stakes to bigger firms to share the risk and bring experience and funding for development.
The bigger the tax on any capital gain, the less incentive there is to start the search in uncharted regions.
Kenya is not alone in imposing this tax. Uganda, Tanzania and Mozambique, another east coast nation with big gas finds, impose the tax. It ranges from 30 to 32 percent.
"There is a very high temptation at this stage, particularly when government's see the amount of acquisition and disposal activity, to try to impose some tax," said Bill Page, an expert on the region's industry at Deloitte. "It is a serious mistake for the governments to try to tax that aggressively."
A steep tax could backfire if bigger firms, which can deliver production more swiftly and cheaply, were kept away as smaller firms held their stakes while weighing the cost of government policies and lower oil prices.
"That process of bringing in a partner, or 'farming out', has become trickier when the oil price is lower, unless you are looking to give up more value of the asset," said Sanjeev Bahl of Numis Capital. "Companies in sector will be looking at their budgets in light of the slightly lower oil price environment."
But Kenya's government may be responding. Experts said it was already scrapping a withholding tax that would have made some stake sales more costly for the seller. One official suggested even the capital gains tax could be revised.
"There has not been any implementation yet, and there is a debate about it about whether it should be done or not," Kenya's permanent secretary to the oil ministry, Joseph Njoroge, told Reuters.
Such taxes and other moves to stiffen terms or conditions for investors could risk deterring bidders for energy blocks.
In May, a Tanzanian bid round drew just five bids for four out of eight blocks offered, a low response blamed in part on technical challenges of some very deepwater prospects but also tougher terms on new production sharing contracts, including hiking royalty fees for some offshore areas.
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Uganda, which found commercial oil in 2006 long before Kenya did, has yet to produce a drop. Delays have partly been blamed on wrangles between oil firms and the government over its demand for a 120,000 bpd refinery that the companies said would not be commercial. That has now been reduced to 30,000 bpd initially.
It has talked for several years about offering new blocks. After many delays, and an official has said it would now take place by the end of the year.
Given the slow pace of Uganda's plans, one expert said: "It is going to be interesting to see if anyone comes to that particular party."
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