Frontier Markets Race To First Oil


BMI View: Despite smaller proven resources and a shorter exploration track record, Kenya may be poised to produce oil as soon as 2016 while Uganda is not due to see first oil until late 2017 at the earliest. While this reinforces our view that Kenya was in line to outperform Uganda, there are challenges ahead for both frontier markets as East Africa further proves up its hydrocarbon potential.

Kenya: Bets Big On Black Gold

Frontier East Africa moved a step closer to a commercial development of its energy resources. In the latest move, Africa heavy explorer Tullow Oil raised the stakes revealing in its H213 results tha t discussion had begun with the government regarding the development options . According to Tullow chief operating officer, Paul McDade , Kenya could begin oil production as soon as 2016. The latest earnings statement from Tullow i ndicated exploration had significantly de-risked Kenya's portion of the onshore East Africa Rift basin , with discovered resources in excess of 300mn barrels (bbl) and above the threshold for commerciality .

The news from Tullow coincides with rising optimism among Kenyan officials regarding their own resource potential and the likelihood that commercial production could begin in the next several years. In a scenario that was already seen as optimistic given the nascent state of exploration and appraisal (E&A) in Kenya, officials were targeting first oil within a 6 - 7 year (2018/2019) timeframe ( see, 'Frontier Players Sets 2019 Target For First Oil,' May 17 ).

Tullow's move to quickly develop its Kenyan acreage may stem from a number of factors, including recent pressure on the company to move more quickly to monetise its assets. This pressure has grown in the wake of several unsuccessful exploration attempts across its portfolio, uncharacteristic of the independent which had become known for its drilling success , although an accepted part of the industry in which the odds of a discovery are often low.

Kenya Could Skip Uganda In Race To First Oil

Planning for first oil by 2016, could also stem from better than expected drilling results and may well r eflect a better operating environment in Kenya than in neighbouring Uganda. In Uganda, Tullow alongside partners Total and China National Offshore Oil Corporation (CNC) have inched toward production since the first discovery made at the M puta -1 well in 2006.

We have long held that Kenya had a number of advantages in comparison to other frontier markets in East Africa's oil and gas boom:

  • Although civil strife following the 2007/8 election was concerning , the more recent peaceful political process reinforces Kenya's claim as a stable place to do business. The country continues to serve as the hub of economic activity in East Africa , leaving it in a stronger position to grow ;

  • Kenya's economic hub status is supported East Africa's best physical infrastructure - with roads, rails, ports leaving the country well positioned to reach other markets;

  • This physical infrastructure is supported among the strong institutions which compare well to neighbouring Uganda where political and tensions over how best to develop resources have slowed first oil.

We have long held the view, that Kenya could outperform its neighbours should exploration prove successful. However there are some above ground risks we are closely watching as the country's resource potential comes into greater clarity:

  • Kenya is reportedly w orking with the World Bank to update existing petroleum laws that are outdated and ill-suited to requirements of a modern oil and gas sector. Given Kenya is eager to develop its hydrocarbons potential, the risk that extremely unattractive or onerous legislation would be introduced appears low , but at present, the regula tory environment is uncertain as new laws being drafted ;

  • A risk that may take longer to fully asses is the potential that oil could become another source of ethnic tensions in a national where such cleavages have at times led to violence. Given existing polarisation between ethnic groups, and previous battles over land and resources, Kenya's nascent oil wealth could become another source of social conflict that leads to greater instability.

Overall Outlook Is Positive

Yet overall, Tullow's move to aggressively develop its' discoveries in Kenya is a positive de velopment. Kenyan officials have suggested that the development of oil could help the country achieve middle-income status ahead of their previous target of 2030. There are still outstanding questions regarding infrastructure, market, in particularly whether production will be in excess of domestic demand allowing for exports. Therefore while there is cause for optimism, greater clarity on a number of important issues supports a cautious view.

Uganda

The news that Kenya could produce oil before Uganda despite proven reserves of 2.5bn bbl of proven reserves highlights the challenges facing the market. Since exploration success paved the way for operators to consider the commercial development of Uganda's oil, disa greement and delays have underscored the at times competing aims of oil companies and governments. For example,

  • Uganda, eager to manage the windfall that would come with oil production, has sought to develop oil more slowly than operators envisioned. While the government pushed for peak production of around 120,000b/d, developers were eager to maximise profits targeting a plateau of between 200,000 - 230,000b/d.

Oil Is There But Debate On Production
Uganda Production Scenarios (b/d)
  • There was also a protracted debate between officials from the Ugandan government and the partners developing the field over infrastructure . Uganda, keen to maximise the share of oil that would be refined and processed locally, pushed for a 200,000b/d refi nery that would have maximised local benefits and helped Uganda benefit from a significant shortfall of refining capacity in East Africa. Partners on the field however pushed for a much smaller 30,000b/d refinery and construction of an export pipeline via Kenya.

Uganda Saw Opportunity In Region's Shortfall
East Africa* Refining Capacity & Demand ('000b/d)

In April, after nearly two years of delay, Uganda relented to the construction of both a pipeline to Kenya's port of Lamu and a smaller 30,000b/d refinery which it eventually hopes to expand to 60,000b/d at a later date ( see, 'Pipeline Advances In Boost For Region's Crude Dreams,' June 26, and 'Refinery Compromise: A Small Victory For Upstream Development', April 16). Yet the setbacks have already taken their toll on the projects' timeline with first oil delayed from 2014 to possibly late 2017 under the most recent announcements.

Initial hopes were that production could have begun as early as 2009. However with development to be spread over the 160km long basin, the combination of the scale, environmental sensitivity of the area, and the distance from markets is making expensive infrastructure requirements necessary, setbacks due to wrangling between government and operators have only added to what was already due to be a complex and costly project.

US$14bn Away From First Oil
Oil Blocks In The Albertine Basin

More Risks in Uganda As First Oil In Focus...

As with Kenya, oil production in Uganda is in line to transform the economy, which is already benefiting from the inflows of investment associated with the oil sector. Yet with the country currently overhauling its regulatory framework, there already some troubling signs. One of three regulatory pieces to be passed, was a bill covering new upstream regulation which proved controversial as some in Parliament argued the new laws vested too much discretion in the energy minister at the expense of lawmakers oversight functio ns ( see, 'Regulatory Overhaul Continues As Above Ground Risks Remain,' December 12 ) Further consolidation in the hands of a small number of officials has only intensified existing concerns regarding corruption in Uganda.

Moreover, given Uganda i s a smaller and less diverse economy than Kenya, the development of oil is viewed as more important to the country's long term fortunes. This fact, combined with the country's track record to date in dealing with international oil companies (IOC's) and drafting new laws, indicates a higher risk of greater resource nationalist policies. Kenya's higher rating than Uganda in short and long term political risk rating only reinforces our perception that there are likely more challenges to come as Uganda makes its way to first oil.

Kenya Looks Better On Risks
Kenya & Uganda Short Term & Long Term Political Risk Rating*

...But Frontier Development Holds Risks

While we favour Kenya over Uganda from an above ground perspective, we highlight that development of natural resources in underdeveloped frontiers inherently carries risks even when conducted with the best intentions. During development of the oil sector in Chad during the 1990's the government received significant support from the World Bank in developing a regulatory framework designed to ensure certainty and offer attractive returns to developers while maximising the benefits to the domestic population by ensuring both oversight and a robust commitment , channelling oil revenues to tackle widespread poverty.

Yet since oil production beginning 2003, the government has renegotiated agreements to take a larger share of revenues and directed a growing share of oil dollars toward the military and away from poverty programs. The World Bank ultimately ended its cooperation in Chad as it became evident the situation had deteriorated but the experience is informative as it accurately underscores that even with best intentions, the oil windfall can be mismanaged.

This article is tagged to:
Sector: Oil & Gas
Geography: Africa, Kenya, Uganda

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