Why the Discovery of Oil and Gas won’t Change East Africa’s Fortunes

An oil refinery plant. Kenya is set to export its first batch of crude oil from the Lokichar oilfields to its storage facilities at the coastal city of Mombasa in readiness for export. Photo credit Nation

June 29, 2018//-Will Tanzanians, Kenyans and Ugandans realise their fantasies of oil and gas-fueled prosperity?

This, the last part of a series on oil and gas explores the development implications of these resources for East African countries.

The world holds 1,709 billion barrels of crude oil whose lifespan at the present rate of production is estimated at 50.6 years.

East Africa’s 10.754 billion barrels of crude oil is 0.63 per cent of the world total and 7.5 per cent of Africa’s 128 billion barrels of crude oil.

Where the United States extracted 12.354 million barrels of crude oil a day in 2016, South Sudan produced 118,000 barrels.

Less all production costs, US producers earned approximately $200 million a day or $92.5 billion in that year; revenues that were greater than Kenya’s gross domestic product, which stood at $70.52 billion.

Were Kenyan producers to enjoy a similar cost structure to their US counterparts, selling oil identical in flavour to American West Texas Intermediate (WTI) at the 2016 price of $43.34 a barrel, Kenyan producers would earn revenues of $618 million annually. In reality, extraction and transportation cost Kenyan oil production operations $25 and $20 per barrel respectively.

Current oil prices of $73 per barrel would leave producers with $24 in revenues.

Assuming government revenues of $10 per barrel and that Kenya’s Turkana oil wells were extracted at the gazetted rate of 80,000 barrels per day (bpd), the National Treasury would earn daily revenues of $800,000 a day or $292 million in a year. That figure would only make up an insignificant 0.004 per cent of Kenya’s GDP in 2016.

Seen in another light, given the preceding variables, Kenyan oil revenues would only make up 13 per cent of Safaricom’s earnings in 2017. Safaricom is Kenya’s most valuable company.

At the onset of Kenya’s early oil pilot scheme (EOPS), the crude is being extracted at a rate of 2,000 bpd, significantly less than the gazetted full capacity of 80,000 bpd.

At that rate, it is expected that a yield of $10 per barrel for the government of Kenya cost come to $20,000 in daily revenues, $7,300,000 in annual revenues or a mere .00001 per cent of Kenya’s GDP in 2016.

The EOPS will see Kenya’s crude transported to the port city of Mombasa by road. The numbers seem to suggest that transporters are the greatest beneficiaries of Kenya’s oil.

At a gazetted extraction cost of $25 per barrel and transportation cost of $20 per barrel, Kenya’s crude costs 63 per cent of the DME Oman price of $71.17. The numbers suggest that Kenya’s EOPS oil revenues are encumbered by exorbitant transportation costs.

We estimate therefore that Kenya will require oil prices above $50 to remain profitable.

Resource curse

A country can be diagnosed with the paradoxical resource curse if its economy is heavily dependent on a natural resource yet sees little to no benefit from that resource.

The resource curse is characterised by an abundance of one resource, little to no economic diversification and little to no economic growth, leading to political strife and negative developmental outcomes.

Overdependence on natural resource exports, for example, results in strong currencies that stifle production and exports of other goods. If the natural resource is bountiful enough, the nation is left flush in resource- fuelled wealth.

As other sectors of the economy are crowded out by strong currencies, the government can resort to deploying its resource-dollars in creating artificial employment.

That process can itself be marred by disagreements, corruption and outright theft, sparking socio-political and economic malaise and conflict.

It must be said, however, that a resource curse is not an inevitability of resource wealth, rather, it should be understood as a result of the collective mismanagement of a nation’s resource bounty. For every poorly managed Venezuela, there is an exemplary Norway and Qatar.

Uganda

Kenya’s negative experience with evidently hasty extraction and Uganda’s relative slowness to produce oil suggests Kampala’s patience is wise.

As oil revenues will make up less than 1 per cent of GDP at gazetted peak production rate of 60,000 bpd, it is not likely that the nation is threatened by a resource curse.

A 2018 population of 44 million people gives it per capita oil revenues of $24.72, 3 per cent of income per capita, which would stand at $632.34 in 2018.

A consolidated effort to develop transport infrastructure with Kenya and South Sudan will reduce transportation costs and give each nation’s oil industry more room to produce profitably, should oil prices dip.

Uganda’s plan to build a 60,000 bpd oil refinery in the west of the country has been endorsed by both Kenya and Tanzania.

As per 2016 statistics, East Africa’s daily production potential exceeds the daily total crude oil consumption of Ethiopia, Kenya, Rwanda, Tanzania, Uganda, Burundi and South Sudan by 180,000 barrels.

This seems to suggest that were the countries networked by a refined petroleum distribution pipeline, crude oil produced in Kenya, South Sudan and Uganda and processed in Uganda would find a ready market in East Africa. Furthermore, the region’s oil producers would be left with excess amounts to export.

South Sudan

South Sudan’s crude oil has been exploited for much of the new millennium with little benefit to its nationals.

We estimate that in 2016, South Sudan earned less than a dollar on each barrel of oil it produced, this during a period when oil prices hovered around $40 and $45 a barrel.

Total government spending in that year was $64 million, of which an 0 per cent was funded by oil revenues. Running a 26 per cent deficit means the government only collected revenues of $47.6 million, 90 per cent or $42.8 million of which can be attributed to crude oil.

Given a rate of production of 118,000 bpd, South Sudan did not earn more than $1 from every barrel it produced. Concessions to Sudan, oil producers and possible corruption ate deeply into the margins.

Crude oil makes up a substantial amount of South Sudan’s exports and 60 per cent of its economic activity.

Petrodollars strengthen the currency, making it difficult to export other products. This, and the rampant inflation driven by budget deficits and corruption, are signals of an oil curse.

Sovereign Wealth Fund

Sovereign wealth funds are a national purse of excess treasure set aside for diversified investment in attractive assets on international markets.

Sovereign wealth funds are typically created by countries with budgetary surpluses. Plagued with debt, Kenya, Uganda, Tanzania and South Sudan preclude themselves from this exclusive club.

Oil conclusion
South Sudan, Uganda and Kenya’s oil endowments will never make them price-setters on the global market. Turning off East African oil taps will not result in an increase in oil prices. Overproduction will not result in a decrease in global oil prices either.

Though evidence suggests that Kenya and Uganda’s oil deposits merit sizeable investments, they are not enough to trap them in a resource curse.

The potential revenues are also not large enough to build those enviable war chests of sovereign wealth funds. Kinetic battles, corruption and economic malaise suggest that South Sudan is itself enduring the effects of an oil curse.

Lastly, there is a sound argument for the three nations to consolidate transport and refining infrastructure; Uganda and South Sudan would gain affordable access to international markets and the cost of exploiting Kenya’s relatively small oil endowment would be justified.

Without collaboration, the windfall from Kenya’s and Uganda’s oil will remain with transporters and creditors and South Sudan’s with Sudan.

Gas marketing and development issues: Size of the natural gas pie

Natural resource discoveries have the potential to drive a nation’s economic growth. Globally, the total natural reserves of gas stand at 186.6 trillion cubic metres, of which Africa’s bounty share is 14.3 trillion cubic metres.

Regionally, Tanzania holds 1.62 trillion cubic metres of unexploited gas reserves found in Likong’o Village in the town of Lindi on the Indian Ocean coast. The rest of East Africa’s bounty of gas is insignificant compared with Tanzania’s reserves.

Tanzania hopes to start production of natural gas in 2021. The country can either consume the natural gas locally through electricity generation, petrochemical industries and fertiliser production or export the gas to large markets in Asia and the United States of America.

As it is bulky in its gaseous state, an exporter must compress natural gas into a liquefied from termed liquefied natural gas (LNG) for ease of transportation.

According to the Bank of Tanzania, domestic consumption of the natural gas will add 2.0 per cent to the current 7.0 per cent growth rate.

It is estimated that the total project costs of a pipeline and an LNG plant in Lindi in Tanzania is $30 billion, which is more than 50 per cent of the country’s 2017 GDP.

Once this capital investment is made, Tanzania is expected to earn close to $5 billion per year in revenues. This figure will make up 10 per cent of Tanzania’s present GDP. Were production and sales to begin today, Tanzania’s GDP would rise in the medium term.

Estimates reveal that a price range of $7 and $11.60 per million British Thermal Units (mm/BTU) — the basic unit at which LNG is sold — will guarantee that size of revenue for 13 years. This amounts to a 10 per cent-15 pr cent share GDP.

If Tanzania’s natural gas wealth were divided equally among all 56 million Tanzanians, each citizen would claim 0.0287 million cubic metres worth of the resource. That quantity amounts to $559.3 per capita at a price of $7 per mm/BTU or 884.5 at a price of $11.60/mmBTU.

When compared with the endowment of Iran, the nation with the largest global reserves of natural, this contribution is clearly modest.

Iran has a population of 80.2 million and proved total reserves of 33.49 trillion cubic meters. The nation’s per capita reserve stands at 14,735,924 million cubic metres. This translates into a per capita annual endowment of $166,487 at a price of $11.70 mm/BTU.

How is the natural gas pie divided?

Globally, the demand for natural gas is high, especially in countries that experience cold winters and are seeking cleaner sources of energy for both domestic and industrial purposes.

In Tanzania, the year-on-year demand for natural gas has doubled from 4.10 million cubic metres to 8.49 million cubic metres in 2017.

An internet source (Tanzania Invest) estimated that about 70 houses in Dar es Salaam have been connected to the natural gas-produced electricity and more will follow in the course of this year. Quite a number of industries have also been fitted with power from this facility and are running efficiently.

The purchases of domestically produced natural gas as opposed to importing other fossil fuels have seen Tanzania save around $4 billion between 2015 and 2017, according to researcher Aristides Katto from the Tanzania Petroleum Development Corporation (TPDC). There are other benefits such as employment, government revenues and the development of local businesses.

The development of natural gas fields will create temporary construction jobs and more permanent openings in various related trades. In 2014, more than 600 Tanzanians were employed in the natural gas sector.

Energy projects of this scale also present countries with the socio-politically delicate task of moving and or compensating communities occupy resource-endowed land.

In many parts of Africa, customary laws — not official title deeds — govern land ownership. As communities on such land may be undocumented and therefore unofficial, they can be vulnerable to unfair eviction without compensation.

A World Bank report states that a mere 10 per cent of rural land in sub-Saharan Africa is registered.

In Tanzania, according to a statement from TPDC, the government has set aside Tsh12 billion ($5.2 billion) to compensate 450 families in the acquired area.

This adds up to Tsh26 million ($11,418.5) per person, which is not insignificant when compared with the per capita income of Tanzania that stands at Tsh1.9 million ($834.4).

The oil and gas industry is divided among upstream, midstream and downstream players whose specialisations span the gamut from extraction, transportation, processing and marketing of refined products. This means that many contribute to producing gas products and many will lay claim to its revenues.

The policies that dictate how natural resource royalties are split, seek to balance the interests of the public and potential investors.

These policies form the basis of the working relationship between a country’s leadership, locals and investors. Evidence suggests that Tanzania’s relatively bountiful endowment of gas and its socio-political stability are attractive to investment.

Seeking higher returns from the natural resource, the Tanzanian government recently reviewed its mining law. Successful application suggests that the natural gas sector will face the same measures. That proposition may lead to the exit of Exxon Mobil from Tanzania.

Delays in project ‘‘go-aheads,’’ and a lack of supporting infrastructure were also cited as reasons for Exxon’s move to Mozambique.

Tanzania’s gas reserves are divided into two blocks. Pan African Energy is the 100 per cent owner, investor and developer of the first block — the Songo Songo block. The second block’s ownership is split between Exxon Mobil and Norway Equanor.

Environmental concerns as expressed by leading Western powers through their administrations and development partners have seen institutions such as the World Bank signal their exit from funding exploration and exploitation of fossil fuels.

As the depletion of crude oil pushes up its price, natural gas will grow as an increasingly viable alternative, stimulating the flow of private sector investment.

Tanzania’s natural gas endowment will not generate revenues far beyond 10 per cent of the nation’s GDP. Though this contribution to GDP is not negligible, analysis suggests that it is highly unlikely that Tanzania will be affected by the natural resource curse.

Though Tanzania’s proven gas reserves and Kenyan, Ugandan and South Sudanese proven oil reserves are plentiful, it is unlikely that their economies will be stratospherically catapulted by their oil and gas bounties.

Sovereign wealth funds, price-setting and glitzy oil and gas-fuelled real estate may be beyond the reach of these countries.

The Institute of Economic Affairs is a Nairobi-based think tank.

Leave a Reply

*