Falling Crude Prices Pose Challenge For East Africa’s Oil Programme

November 25, 2014 | Field Case Studies

By Michael Wakabi | –

East Africa and Uganda in particular will be watching keenly as the Organisation of Petroleum Exporting Countries (OPEC) meets on November 27 over the plummeting global crude oil prices.

Theoretically, a cut in production by OPEC could edge crude prices upwards but this would be countered by slumping growth in some of the world’s largest economies and increased domestic production in the US.

For Uganda, which is racing to select a partner for development of an oil refinery by year-end, the fall in crude prices from $115 per barrel to $80 last week, could affect its ability to attract private sector participation in development of an oil refinery and a 1,325 km crude export pipeline.

While officials are saying the developments will not affect the government resolve to proceed with the two key projects, lower international prices have the potential not only to impact the economics of the projects but bring possible competition from imported refined oil products that are be cheaper.

“We are proceeding with the programme regardless of the price movements because whichever way the price goes, we have to get the oil out of the ground,” said Energy Minister Irene Muloni  adding, “what this means is that the operational costs that go into harnessing the resource have to come down, so efficiency will be paramount in whatever we do.”

Ms Muloni argued that given the cost of equipment is a constant and that everybody along the oil value chain will be looking for a return on the investment, government and the industry will be keeping a close eye on operating costs.

Kabagambe Kaliisa, Permanent Secretary at the Energy Ministry also said while long term prospects for energy as a commodity remain positive, cost management will be critical to the profitability of Uganda’s crude extraction programme.

“Energy as a commodity is not about to collapse, so the near term risk is minimal. But crude prices do fluctuate and regardless of which direction they take, managing the cost of bringing that oil to market is important. It will take a combination of volume and efficiency to keep the programme viable,” he said.

“It is also imperative that we begin to broaden our thinking to look at the mining sector as a composite rather than focusing on oil alone,” he added.

Uganda’s proven reserves have recently shot up to 6.5 billion barrels and close to 2 billion of that volume can be recovered if the most efficient methods are employed.

Despite that, the location of the reserves more than 1,000km from the nearest seaport and the natural properties of the crude, which make it solidify at surface temperatures, meaning it must be transported in heated pipelines require high international prices to assure profitability.

According to government documents that The EastAfrican has seen, at the proposed production rate of 60,000 barrels per day, the crude export pipeline would require a tariff of $17 and $28 per barrel to achieve post-tax rates of return of 10 and 20 per cent respectively.

The tariff will only come down to $13 per barrel if the capacity were adjusted to 120,000 barrels per day but at the correspondingly lower post tax rate of return of 10 per cent. Whichever the case, the transport tariff would have to be deducted from the prevailing international price to arrive at the FOB price for Ugandan crude.

Ms Muloni refused to discuss the benchmark Uganda is using in projections for anticipated oil revenues but coupled with the high cost of developing both the pipeline and the refinery, a further fall in prices for crude could have a significant impact on the earnings curve.

On November 12, the US Energy Department told consumers to get used to cheap fuel, signalling that the current trend is likely to hold for the foreseeable future.

According to the department, rising oil production in the US combined with a weakening of key economies will keep oil prices in the $83 per barrel range during 2015.

The US, a major consumer of the commodity, has seen domestic production increase 70 per cent since 2008 while weak economic growth in Asia and Europe is slowing down demand for oil. Although the US anticipates that lower prices will force a cut back in oil production, the impact will be minimal and unlikely to drive prices up.

US production is projected to drop from 9.5 to 9.4 million barrels a day in 2015 but a growing fleet of fuel efficient cars will keep aggregate demand for oil down.

The Tullow-Total-CNOOC triumvirate who between them own the rights to Uganda’s oil reserves were not available for comment but a knowledgeable industry source said the fall in oil prices was likely to be adversely affect for investments in the upstream sector of the industry because it reduces the internal rate of return of projects there.

“But while historical experience shows that prices fluctuate and it is conceivable that they will go up again, the underlying commercial argument for the Uganda programme remains sound based on the volumes available and the cost of extracting each barrel. So it is unlikely that the economic logic of investing will be affected by a short term dip in the price,” the source said.

He, however, cautioned that issues around the fiscal regime and revenue sharing were more likely to affect the inclination to invest.

He added that the delays in clearing key milestones on schedule, would translate into higher overheads and lower rates of return for both government and investors in the sector and delayed cash flows to support national development.

Written By Michael Wakabi, The EastAfrican