Investing in East African Oil and Gas: Going for the (Fragile) Golden Egg

As East African nations line up to become the next key oil and gas market, now is the time to enter the game, but beware the pitfalls. Major discoveries are tantalizingly promising, but questions of infrastructure to make them commercially viable, uncertain regulatory environments and the potential for conflict put up plenty of roadblocks. Oilpri...

Investing in East African Oil and Gas: Going for the (Fragile) Golden Egg

Kenya

Kenya is East Africa’s largest economy, and a major discovery in March 2012 has set it on the oil map and promises to turn the country into the region’s main energy hub. Unlike its neighbors, Kenya’s capacity for infrastructure development is more ambitious and its plans are feasible, if not perhaps overly optimistic in terms of estimated completion dates.

The oil juniors are having trouble keeping up with their contractual obligations, and we’re likely to see some buy-outs and joint ventures in the near future, as Kenya seeks major players who can contribute to its massive infrastructure plans.

Oil companies are still about a year away from determining whether they can extract what they’ve found and turn it into revenues. But Kenya is confident. This confidence is expressed in the largest African infrastructure project ever—the Lamu Port-South Sudan-Ethiopia Transit corridor (LAPSSET). The corridor includes a new export terminal and refinery at Lamu, a 2,000km pipeline that hopes to pump oil from South Sudan to Kenya, stopping off for refining in Ethiopia, and a massive highway and network connecting the region. The cost of the project is about two-thirds of Kenya’s GDP.

The ground was broken on Lamu Port construction in March, and authorities estimate that it will be up and running in three years. While this is a feasible estimate, estimates by Kenyan and South Sudanese authorities that the pipeline will be online as soon as next year is clearly not reasonable. More than anything it reflects South Sudan’s desperation for an alternative route for its oil that bypasses Sudan (but more on this later).

Is there a downside? Yes (there’s always a downside):

• Kenya’s infrastructure plans are impressive and likely to go ahead, but there are still uncertainties as to timing; while the Kenya government is in talks with China for the construction of the LAPSSET highway and rail network ($1 billion), there have been no commitments yet

• Kenya’s north is a bit on the volatile side and sees its share of ethnic conflict and kidnappings of foreigners

• Lamu, the site of the new port, is a popular tourist area that has in recent years become a target for al-Shabaab extremists from Somalia—irked by Kenya’s military offensives, which are intended precisely to secure its borders to make way for a safe oil extraction environment

Mozambique

Gas is the rage in Mozambique, riding high on a major discovery big enough to supply Germany, the UK, France and Italy for nearly a decade and a half. The majors are now jockeying ahead of the next round of block auctions. And this is only the beginning—the country has hardly been explored.

In the first quarter of 2013, Mozambique will likely offer up some 12 new oil and gas exploration blocks. Three of those blocks will be in the Rovuma basin, the site of 130 trillion cubic feet of gas discoveries by Andarko (US) and Eni (Italy). The government estimates there may be another 150 trillion cubic feet left to discover.

The larger objective for Mozambique is to build liquefied natural gas (LNG) plants and transform itself from a net fuel importer to an exporter and provide itself with a cheap source of electricity. It’s a major goal for a country in which 80% of the population has no energy access. Mozambique hopes to start exporting in 2018.

This is all part of Mozambique’s “Natural Gas Master Plan”, which it hopes will earn it over $5 billion in annual revenues beginning in 2026.

For next year’s auction, Mozambique is hoping to lure in big players who have an interest in, and the capacity for development. The country’s plans include an LNG refining and transport infrastructure that will require around $20 billion in investment.

While Eni and Andarko have made their discovery, Shell, ExxonMobil and Chevron are said to be vying for a piece of Mozambique’s lucrative gas market.

Here are some pitfalls to look out for:

• Infrastructure is a problem: for now, there is no way to bring extracted gas onshore, no facilities to liquefy it and no infrastructure for export—again, we’re talking about $20 billion in investment to build the necessary infrastructure

• This means the game is all about the majors. (There are indeed rumors that Andarko may sell out to Shell)

Tanzania

While less impressive than Mozambique’s gas finds, Tanzania’s estimated 33 trillion cubic feet boosted by recent offshore discoveries will place it on East Africa’s gas map nicely, and we don’t expect any major upsets to development and production. For now, it’s a good game for the juniors.

Tanzania has a natural gas processing plant on Songo Songo Island, with a 70 million cubic feet/day capacity. It is also planning an LNG terminal.

Some key points to consider:

• Tanzania does not have a national gas policy, but expect authorities to unveil one before the end of November

• There will also be a restructuring of the state-run oil company with an eye to increased regulation of gas discoveries. The plan is to split the body into two parts, including an upstream regulator and a publicly-owned commercial oil company

• Opposition politicians are pushing for a moratorium on new oil and gas exploration licenses until regulations are in place

• Tanzania is hoping to build a new 530km pipeline from Mtwara to Dar es Salaam, which could transport 784 million cubic feet of gas

Uganda

Uganda discovered 2.5 billion barrels of oil in 2006, and announced another 1 billion-barrel discovery last month in three new wells. The country had hoped to begin exporting in 2017, but last week brought bad news with the announcement that they were at least a year off from this initial estimate.

While Uganda’s oil potential is vast and untapped, the pitfalls are equally compelling and investors will find the greatest challenges in the regulatory environment. Now is not the time to invest.

• The authorities are having problems with plans to build a refinery in the country’s west, in Hoima. To wit, they can’t get the oil companies on board for the refinery, which is simply too massive a project for Uganda’s reserves, which can be refined elsewhere more cost-effectively

• It looks like Uganda is going to scrap the refinery plans and instead build a 1,950km southern pipeline to the Tanzanian port of Dar es Salaam or a 1,325km northern pipeline to Mombasa, where Kenya has a refinery.

• The biggest problem is Uganda’s new draft oil law, which is being held up in a government stalemate, divided on how much control the country should maintain over oil companies.

• Amid these regulatory delays, there is a moratorium on licensing of new exploration blocks, which will further delay production and infrastructure development

• Oil majors are extremely frustrated at the Uganda bureaucracy, which has kept production behind pace even though the country was the first in the region to discover oil

South Sudan

Landlocked South Sudan won some 80% of Sudan’s total oil reserves (about 6.7 billion barrels) when it gained independence in July 2011. But for now, production is offline as the new country, locked in a border dispute with Sudan, has no way to export its production. As such, Kenya’s LAPSSET project is urgent.

Earlier this year, Juba (South Sudan) and Khartoum (Sudan) threatened to renew bloody conflict over oil transit fees. Juba halted production in January this year over Khartoum’s tactic of charging prohibitive transit fees. This summer, the two agreed on transit fees, but production will not resume until border disputes over key oil-rich areas are resolved. Juba is stalling in talks because it is hedging its bets that the LAPSSET pipeline will be completed in time to give them more negotiating power.

This is the riskiest of East African investments:

• The LAPSSET pipeline will not come on line soon enough and stalling over a resolution to territorial disputes could bring to the two to the brink of war—again

• Neither Juba nor Khartoum can hold out much long without oil revenues, which account for much of their economy. This in turn risks unrest at home.