ANALYSIS-East African oil safe from price drop - policies are the problem
Wed Nov 5, 2014 10:48am GMT
* East Africa has become hot spot for oil and gas finds
* Uganda and Kenya could export crude by early 2019
* Projects easily profitable with oil at $85 a barrel
* Temptation to hike government take risks deterring firms
By Edmund Blair
NAIROBI, Nov 5 (Reuters) - 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.
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.
INVESTORS RATTLED
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."
GOVERNMENT RESPONSE
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.
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."
(Additional reporting by Elias Biryabarema in Kampala, editing by William
Hardy)