Uganda’s oil reserves

FROM THE ECONOMIST INTELLIGENCE UNIT

A battle is being fought for the rights to Uganda’s burgeoning oil sector. The risks–and rewards–for potential investors are substantial.

Uganda has oil–lots of it. Another discovery in the Lake Albert Basin along the Congolese border in fourth-quarter 2009 brought total confirmed reserves to 700m barrels, with only 30% of the exploration programme complete; probable reserves are around 1.5bn barrels. While this is much less than Sub-Saharan Africa’s two oil giants, Angola andNigeria, it is enough completely to transform the country’s prospects.

Following a couple of years of discoveries which have firmed up Uganda’s prospects, the focus has begun to shift from exploration to extraction, and companies with more downstream experience are moving in. UK-listed Tullow Oil and Canada- based Heritage Oil own the three blocks with confirmed reserves, and in November Heritage accepted a US$1.5bn offer from ENI–backed by the Italian state–for its 50% share in blocks 1 and 3A. However, Tullow, which shares exploration rights with Heritage, claimed that it had the option of first refusal on the Heritage share, and matched ENI’s offer. In late January 2010 shareholders in Heritage accepted both offers, and the Ugandan government will now have the deciding vote in the sale.

Both bids have their own advantages. ENI has more experience bringing oil to market–its experience as an operator and pipeline builder in difficult markets like Kazakhstan would be useful as the Ugandan discovery is 1,300km from the nearest port in Kenya–and it would prevent Tullow from having a monopoly on the sector. Tullow, on the other hand, wants to enlist a new partner (China’s CNOOC and French oil giant Total are interested), keeping control of the overall project while also tapping finance and additional skills to transport and refine the oil.

Do not pass go

However, the Ugandan government is not keen on a monopoly and could scupper Tullow’s plans. The energy minister, Hilary Onek, voiced this concern publicly in mid-January and wrote to Tullow saying that the government would veto its pre-emption rights. Neither company believed that was the end of the matter, and both continued to lobby heavily. The Italian foreign minister has recently visited Kampala to press the case of ENI, which has targeted Uganda as a strategic priority. Meanwhile, Tullow has been on a charm offensive, flattering the government in the Ugandan media, promising 10,000 jobs and hinting at listing the company on the Ugandan stock exchange.

While the government, and particularly its powerful president Yoweri Museveni, has been ambiguous about whose bid it will back, it has made it very clear that it expects the successful bidder to refine the oil in Uganda to maximise the local payoff. There are two options for getting the oil to market: one is to build a 1,300-km pipeline to the Kenyan coast and export the oil in crude form; the second is to build a refinery in Uganda. The government argues that the waxy nature of the oil means that it would have to be heated to transport it, adding significantly to costs and supporting the case for refining it locally instead. It is conducting a feasibility study for a refinery with a capacity of 150,000 b/d. Indeed, such is the importance of a local refinery to the government, the posturing in the past month and delay in backing one side could simply be a ploy to increase its bargaining power and strike a better deal; Tullow’s chief executive, Aidan Heavey, has compared the situation to signing a prenuptial agreement at the start of a long relationship.

However industry analysts expect that it will refine 50,000 barrels/day in-country at most, enough to appease local political demands. Most of the oil, along with the upstream assets, will be transported out in crude form. Investors are also looking keenly at the Democratic Republic of Congo (DRC) and Southern Sudan–reserves there would boost the profitability of an oil pipeline if they could be directed through Uganda, effectively making it an oil hub for the region. Tullow is already in talks with the Congolese to get the concession for the other side of Lake Albert. The Ugandan government can take some consolation from the potential sale of Heritage’s stake–it stands to reap US$300-400m in taxes from such a deal.

Vision emerging

A framework of the oil industry in Uganda is thus beginning to take shape but large risks remain both to government policy and investors’ operations. The revenue windfall will, perhaps worryingly, free the government from the binds of aid. The Ugandan authorities are hardly a model of development at present: limited respect for democratic principles may suffer further when the administration no longer feels a need to respond to the prods of donors.

Meanwhile, the risks for investors are substantial. Tensions between the semi-autonomous region of Buganda and the government in the past year have created uncertainty about the presidential successor and made public policy less predictable. Mr Museveni’s long-time rival, Kizza Besigye, has already begun populist talk about getting a better deal for Uganda from oil reserves. Instability in the DRC and Southern Sudan is not going to be resolved in the foreseeable future, making investor confidence more fragile, and the prospect of oil has already tipped off ethnic tensions over land rights.

Yet, beyond the bluster of oil companies talking up their share price and a government promising the sharing of infinite riches, a vision of Uganda’s future economic landscape is finally emerging. No matter which company wins the right to buy Heritage’s stake in the coming days, the regional risks mean that this vision could still be radically altered.

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