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The Rise of East African Hydrocarbons

Comprehensive Information on Complex Issues

May 2013 Eray Basar North Africa Desk Officer eray.basar@cimicweb.org

This report examines the most recent developments in the hydrocarbons sectors of five East African countries, namely Ethiopia, Kenya, Mozambique, Tanzania and Uganda. It serves an update to the Civil Military Fusion Centre (CFC) thematic report titled Emerging Energy Resources in East Africa released September 2012. This report presents risks and challenges facing these countries industrial progress. It also explores the resource curse a commonality affecting oil rich, developing countries. Related information is available at www.cimicweb.org. Hyperlinks to source material are highlighted in blue and underlined in the text.

Recent on- and offshore oil and gas discoveries in East Africa have made the region a top priority for exploration and development. Large multinational companies are planning and competing for the abundant energy resources on the Indian Ocean rim of the continent, Reuters informs. It is hoped that these discoveries will improve the economies and the infrastructure of the East African countries. For instance, impoverished Mozambique, where the average income is a little over USD 400 a year, could potentially surpass Algeria as the worlds six largest natural gas e xporter. In the long run, the discoveries are also expected to significantly increase government revenues. The collective tax for all countries is estimated at USD ten billion per year, an amount considerably high when compared to the annual budgets of USD 13 billion in Kenya, USD 8 billion in Tanzania and USD 4 billion in Mozambique, which may achieve annual revenues of USD 30 billion by the middle of the next decade. However, risks and challenges may arise alongside potential benefits.
Source: Control Risks

According to Control Risks consultancy, the infrastructure development and economic activity that accompanies natural resource discovery may create collateral benefits for previously neglected regions within the different countries. For instance, the planned construction of a new mega-port in the Kenyan coastal town of Lamu is expected to benefit the historically marginalised town with new infrastructure developments such as roads and high-speed railway connections to transport extracted hydrocarbons. Such grassroots-level development would be unlikely in poorer locations without the entry of large multinational companies into these areas. However, as discussed later in this report, East African countries currently lack the necessary infrastructure and legal frameworks for oil or gas production. As such, it is difficult to predict the actual benefits for each country. This report provides the status of initial exploration and discovery efforts, and their prospective impact should their potential be realised.

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The Rise of East African Hydrocarbons

Current Developments Ethiopia Tullow Oil Plc, a United Kingdom-based company which discovered the first Kenyan oil a year ago, commenced exploration and drilling at the South Omo block on the Kenyan border in February 2013, reports Bloomberg. Oil revenues would provide a critical engine for the landlocked countrys economic growth. Moreover, the country currently relies on imported gas and oil; the discovery of such a valuable a domestic resource would increase Ethiopias self-sufficiency. Although gas has been discovered in the east of the country, to date there has been no oil discovery. However, Tullow Oil considers South Omo to be an extension of the East African Tertiary Rift, on which it discovered oil in Kenya last year and in Uganda in 2006. Consequently, the company believes the South Omo block may contain oil, reports New York Times. Tullow Oil and the Ethiopian government denied media reports in early March regarding the discovery of oil in the South Omo zone and noted that the discovery process is in the initial stages. The terms of the agreements for oil exploration allow the Ethiopian state to retain only ten per cent of any discovery, making such endeavours initially fairly attractive for the companies. However, an economic model known as obsolescing bargain suggests that a government and a multinational company (MNC) may initially reach a deal that favours the MNC, but as the MNCs fixed assets to support their operations in the country increase, bargaining power would shift to the country. In other words, Ethiopias initially low share may attract companies to establish their oil facilities, and once companies invest in non-movable Source: Africa Oil Corp assets, Ethiopia would have the possibility to seek higher shares. Kenya Following the discovery of oil in the Ngamia-1 well by Tullow Oil in spring 2012, and natural gas at the Mbawa-1 offshore well by Apache Corporation in September 2012, exploration in the country gained momentum. During the first quarter of 2013, the Kenyan government offered nine licences for exploration. These and all future licences will be awarded through competitive bidding. In efforts to garner a larger profit share of the newly booming oil, gas and minerals sector, the Kenyan government has been eagerly revising its regulatory framework for exploration business over the past few months, reports The East African. The government raised the minimum expenditure requirements and fees to qualify for exploration rights. Companies operating in the country must now commit to spending USD 28.2 million onshore in the initial two years and USD 31.2 million offshore in the first three years. In addition, USD one million (up from USD 300,000) must be paid as a one-time commitment fee. If companies intend to sign a production-sharing contract (PSC) which regulates the amounts of oil shares between the company and the country in case of extraction. Other regulatory amendments were also implemented pertaining to taxes, royalties and revocations of exploration Source: Africa Oil Corp licenses if firms fail to meet the minimum work requirements.

Mozambique Four of the five largest oil and gas discoveries of 2012 were in the waters off Mozambique. Eni SpA, an Italian company, made three of those discoveries and say that the total amount of gas discovered is now about 69 trillion cubic feet (tcf). Eni SpA estimate that their discoveries so far are worth USD 15 billion. US Anadarko Petroleum, responsible for the Mozambique gas discovery, and Eni SpA, Anadarkos fiercest competitor, are currently negotiating a development plan with the government. Should the presence of oil be confirmed, Mozambique would rank fourth in the world, in terms of natural gas reserves, behind Iran, Russia and Qatar, according to Ventures. In addition, Anadarko and Eni SpA agreed to build the worlds second largest Liquefied Natural Gas (LNG) plant in Mozambique. LNG fuel exports would commence in2018, reports Bloomberg. Currently, Galp Energia of Portugal, Kogas (Korea Gas Corporation) of South Korea, and Mozambiques national oil company ENH each hold a 10 per cent share of the discoveries, while the majority shareholder Eni maintains control of
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Source: 2b1st Consulting

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a 50 per cent share after its recent sale of 20 per cent to the Chinese CNPC for USD 4.21 billion. Tanzania Tanzania also holds very large amounts of natural gas, informs Financial Times. Exploration and other natural gas related work is carried out by the Norwegian Statoil and UK-based BG Group. The two companies recently announced plans to build an LNG facility worth USD 14 billion in the country. The announcement, made by Tim Dodson, Statoils head of exploration, followed Statoils third major gas discovery in Tanzanian waters. Dodson said We said last year we would need 8-10 tcf...to underpin an LNG project and to date we have found 10-13 tcf. The two companies plan to build two LNG plants initially, with the option to expand. However, according to energy consultancy Wood Mackenzie, the region (Mozambique and Tanzania combined) has a potential gas capacity of 100 million tonnes per annum, which would allow up to 20 LNG plants worth USD 7 billion each. The volume of gas in the region is much greater than the worlds leading natural gas exporter, Qatar, which has a capacity of Source: BG Group 77 million tonnes per annum. Uganda Uganda is a rising oil producer in East Africa according to E&P Magazine. The country currently has an estimated capacity of 3.5 billion barrels (Bbbl) of oil and may surpass 10 Bbbl as exploration continues, according to Ernest Rubondo, commissioner of the Petroleum Exploration and Production Department in Kampala. Oil prospects and the sector momentum increased in early 2013 when Total announced the discovery of hydrocarbons in Nwoya District of northern Uganda. Totals exploration licence was due to expire on 03 February 2013, but with the January discovery, the company will retain its exploration license and will seek a production license for the Nwoya discovery site (Block 1A). Total, which works in a trilateral partnership with Tullow Oil and Chinese state-run company CNOOC, aims to begin oil production in Uganda by 2017. Total E&P general manager in Uganda Loic Laurendel said Total is intending to deliver approximately 20,000 barrels per day (bpd) in the initial phases, which will gradually increase to the range of 200,000 to 230,000 bpd by 2020. The Ugandan Parliament has so far passed two parts of a three-part oil bill to Source: Tullow Oil regulate oil sector development. The first part of the law, the upstream Petroleum Bill, regulates exploration, development, and storage; the second part of the law, the midstream Petroleum Bill, regulates refining, gas processing, conversion, transportation and storage. The government is expected to pass the third bill within the first half of the year, before a licencing round takes place. Uganda also hopes to hold a licencing round for oil companies by mid-2013; however, the government must first lift a licensing ban imposed on 2007 after the initial discoveries. Although Uganda initially wanted a refinery on its own soil with an output capacity of 200,000 bpd to process oil extracted from the region, it reached an agreement with Total and CNOOC on 15 April 2013 to build a smaller refinery of 30,000 bpd to expedite commercial output, reports Reuters. The two companies favoured a smaller refinery and a pipeline to Kenya, which will allow the export of Ugandan crude via the Indian Ocean. The companies argued that the local demand in the region was insufficient for the size of refinery sought by Uganda. The government wants a forty per cent share in the new refinery. At the same time, Kenya and Uganda are seeking investment partners for a USD 300 million pipeline project to connect Eldoret, Kenya, to the Ugandan capital Kampala, reports Reuters. The pipeline will transport petroleum products to and from Kampala. Uganda has been importing its oil, primarily through the Kenyan seaport of Mombasa via tankers, a method deemed unreliable and costly. Risks and Challenges As the regions natural resource potential evolves, challenges to its development also become apparent. Although the region is considered more stable than the Middle East and other parts of Africa, oil and gas companies may face challenges in their dealings with these countries as they lack the hydrocarbons production experience, relevant infrastructure, adequate legal framework and bureaucratic efficiency. Moreover, corruption and insecurity offer additional challenges for the oil and gas companies operating in the region.
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East African countries lack the operational experience of their North and West African counterparts. Given their lack of experience, these countries approach oil companies with suspicion, reports Control Risks Consultancy. Even in cases where a stable structure is established with model agreements, governments and non-governmental organisations (NGO) remain wary of companies. Contracts are often carefully scrutinised by civil society and NGOs, which are anxious to track revenue flows. In addition, companies may face the problems of poor infrastructure, archaic or non existent regulations and competing political interests of various groups. Moreover, vested political interests are lik ely to affect corrupt behaviours. As the use of local content1 requirement is not included in most of the current contracts, large corporations are likely to bring workers and equipment from abroad to facilitate more efficient construction, reports Reuters. This situation would leave domestic firms side-lined, excluding them from the immediate benefits of the development of oil and gas sectors. Companies may have difficulties in their dealings with states due to corruption and undeveloped business environments. All five of the countries covered in this report hold a low rank in Transparency Internationals Corruption Perceptions Index (CPI) 2012. Tanzania was 102 nd, Ethiopia 113rd, Mozambique 123rd, Uganda 130th and Kenya 139th out of 174 countries in the list. In addition to corruption, these countries also score poorly on the World Banks Doing Business 2013 report; Uganda ranks 120th, Kenya121st, Ethiopia 127th, Tanzania 134th and Mozambique 146th out of 185 countries. The location of the oil discoveries in Uganda may lead to some political and security related challenges for the country. Oil was discovered beneath Lake Albert, which is shared by Uganda and the Democratic Republic of Congo (DRC), according to the think-tank Think Security Africa. According to oil and gas production experts, the resources beneath the Ugandan side of the lake can be extracted on the other side, thus creating concerns about probable disputes between the two countries. DRC and Uganda have historically tense relations, although the insurgency in DRC, which involves two groups originating from Uganda, brought the two countries closer for security cooperation in the recent years. Tanzania and Kenya both have outdated legislation (passed in 1980 and 1986 respectively) governing the petroleum sector, according to Control Risks Consultancy. Drafted in an era when these countries were inexperienced in dealings with multinational corporations, these laws cannot provide a satisfactory framework for revenue management. Moreover, despite the fact that officials in both countries acknowledge the need to renew the legislation, both governments lack the institutional capacity and political will. On the other hand, in terms of petroleum legislation, Mozambique appears to be a step ahead, as its petroleum legislation passed in 2001. Bureaucratic capacity of countries in this region remains a major concern; bureaucratic processes are cumbersome in countries such as Tanzania and Mozambique. Slow bureaucratic processes in these countries may raise questions of integrity, risking the relations between governments and companies, says Control Risks Consultancy. Distinguishing between bureaucratic delays due to incompetence or understaffing and those due to deliberate attempts by officials to solicit bribes may be difficult. In Tanzania, although the government appears to be operating according to the principals of a free market economy, many key officials still carry the statist ideology of the old socialist regime; the government is very cautious in its dealings with companies. Security concerns may arise in certain parts of countries such as Kenya; tribes within the pastoral communities in the Turkana region (the location of the new gas discoveries) clash regularly with each other over access to resources such as land, water and cattle, according to Integrated Regional Information Networks (IRIN). The government remains unable to curb banditry and exert authority in the region. Compared to Kenya, Tanzania appears behind in terms of investment environment, as its infrastructure is not yet at an adequate level to meet the demands of the extractive industries. In addition, the electricity service is unreliable and facilities at the port of Dar es Salaam are not operating on par with others in the continent. Mozambique also lacks the infrastructure; current estimates indicate that a functional infrastructure for the gas flow will only be available in 2018. Although the current infrastructure is wholly inadequate for extractive services, foreign investors took the lead on development after the gas discoveries in the past year.
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Domestic content requirements compel firms to purchase a certain percentage of their inputs from domestic firms as a precondition for local market access or preferential policy treatment.

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Kenya, Tanzania and Ethiopia face the risk of demands for greater autonomy or even separation by some regions. The Mombasa Republican Council (MRC), a group from the Coast province of Kenya, demands the review of the agreement of 1963 binding the coastal region to the central government. The group was declared illegal in 2010, but a court overturned the ruling in 2012 upon opposition and violent protests. Similarly, disputes in Tanzania over the sovereignty of the island of Zanzibar have been reignited by Uamsho, an Islamist separatist group, calling for the secession of the island, according to Control Risks Consultancy. The group has been linked to violent protests in May 2012. Zanzibaris are seeking greater autonomy and control over the revenues of natural gas sources located in their waters, while the Union government (which has members from both mainland and Zanzibar) is seeking to evenly distribute revenue shares. The situation continues to create political uncertainty for companies and the license-awarding for the blocks around Zanzibar has subsequently been put on hold. In Ethiopia, security challenges are posed by the Ogaden National Liberation Front (ONLF) and the Oromo Liberation Front (OLF), according to Think Security Africa. Active in the oil-rich region of the country, both groups allegedly referred to violence in the past and both seek separation from Ethiopia. ONLF, an ethnic Somali separatist movement, carried out three major attacks against the oil sector in the country: The first incident, perpetrated in 2007, was against an exploration project of Sinopec and resulted in the deaths of 74 people of Ethiopian and Chinese origin. The second incident occurred in August 2010 when ONLF targeted the activities of Malaysian exploration firm Petronas, which later departed the country. Finally in 2011, ONLF attacked the members of the Ethiopian military and employees of the Chinese firm Petrotrans. Most recently, ONLF accused the Canadian-owned Africa Oil Corporation (AOC) of conspiring with the government to exploit the regions oil resources and urged them to refrain from oil explorations , reports Sudan Tribune. The situation raises concerns that increasing oil exploration activity in the country may provide further targets for such groups in the future, and that better knowledge of Ethiopias energy capacity may strengthen the resolve of such insurgent groups. The Resource Curse Although the discoveries of valuable natural resources in East Africa generated great excitement in the region, they risk leading to an economic paradox called the resource curse, according to CNN. Countries which depend on a valuable natural resource such as oil, gas or diamonds may have higher poverty levels, slower human development and internal instability among many other problems compared to countries with diversified economies. Nigeria, an economy dominated by oil, is among the examples of countries affected by the resource curse. Nigerias major oil wealth has not led to an economic growth, rather instead poverty increased following the oil boom. Well-known political economist Moiss Nam details the notion of oil curse and lists its common traits in developing countries as follows: The exchange rates of countries with oil as the dominant resource are often high, stimulating imports and limiting the exports of almost all other commodities except the dominant one. Such exchange rates do not allow other sectors such as agriculture, manufacturing or tourism to grow, making it very hard for the country to diversify its economy. The volatility in the market price of the dominant export commodity (oil or gas) may have devastating effects on countries economies. Ample fluctuations in the oil prices (boom -and-bust cycles) may lead to problems such as overinvestment, reckless risk taking, and too much debt during booms and banking crises and draconian budget cuts that hurt the poor who depend on government programs during busts. Moreover, export prices have a direct relationship with government revenues. According to Naim, since oil industries are highly concentrated and capital intensive, oil-based economic growth does not create jobs in the same ratio as the oils large share of the economy. While oil accounts for the major part of government revenue, it only employs a small fraction of the workforce, leading to high income equality in countries. Oil curse may also lead to bad politics and corruption; high oil revenues give governments the ability to allocate immense financial resources pretty much at will thus, allowing the leaders to be unresponsive and una ccountable to taxpayers. Another risk that comes with large natural resource discoveries is referred to as Dutch disease. In relation to the resource curse problem set, Dutch disease refers to a situation where a sudden increase in the inward foreign currencies increases domestic currency value thereby driving up domestic manufacturing product costs, resulting in products too expensive for other countries to buy. Dutch disease eventually weakens the traditional export sector. Examples of the Dutch disease can be seen in oil domestic markets such as place Angola, Gabon and Nigeria. Moreover, the drop in fuel
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prices or the depletion of natural resources in producer countries may cause a larger problem for them as the traditional sectors such as manufacturing or agriculture, which may lose their competitiveness due to countries oil rel iance, are unable to support the economy. Lessons to Learn: The Case of Angola On the western coast of the continent, Angola is among the richest countries in terms of oil wealth. 2002 marked the end of a long-lasting civil war and he beginning of an economic boom. The country became the second largest oil producer (after Nigeria) and the third largest economy (after South Africa and Nigeria) in sub-Saharan Africa, according to CNN. The country observed as high as 17 per cent annual GDP growth rate between 2002 and 2008 and a 5-8 per cent growth rate after 2009 due to the financial crisis and the oil price development. However, Angolas economic growth is vulnerable as it is the most concentrated economy in subSaharan Africa with 99 per cent of export revenue generated from oil. Moreover, such high profitability in the oil sector makes economic diversification difficult, exemplifying the conditions listed in the above section for the resource curse. Arne Wiig and Ivar Kolstad, senior researchers at the Chr. Michelsen Institute (CMI), argue that high growth rates in countries emerging from civil wars are common. However, Wiig and Kolstad also say: Experience shows that growth reduces poverty less in countries with high initial inequality. And oil-driven growth in a country with low political accountability is susceptible to wealth conSource: CNN centration rather than redistribution. Employment in the oil sector is typically also too limited to produce widespread economic opportunities. Indeed, Angola is ranked 42nd among 157 countries with 40.5 per cent of the population living below the poverty line as of 01 January 2012. Moreover, it is 148th among 185 countries in the 2013 Human Development Index (HDI) and 157th among 174 countries in the 2012 Corruption Perceptions Index (CPI). In line with the aforementioned rankings and statistics, Angolas high economic growth rate is not reflected in the socioeconomic life and development of Angolans, according to CNN. Income inequality is reportedly widespread; many people live under USD 2 a day and lack basic needs such as wate r and electricity. In addition, despite the governments denial of any corruption in the oil sector, activists argue that the oil wealth bypasses the ordinary people. Isaac Elias, Angola programme manager of the Open Society Initiative for Southern Africa, highlights the lack of transparency in the oil sector governance and the dealings of Sonangol, the state oil company, in the country and argues that oil revenues are funnelled to the countrys elite. In his article appearing on the Journal of Science & Society , John L. Hammond states for Angola [t]he hallmarks of the resource curse have followed: a corrupt, rent-seeking government which made secret deals with foreign oil companies and completely disregarded the well-being of the population. Among the typical examples of the resource curse scenario, Angola represents a recent and relevant case for the emerging East African oil and gas sector. Therefore, it is crucial for the East African countries to increase their political accountability and transparency, diversify their economy and build their infrastructure in order to avoid the resource curse threat that may accompany their newly discovered resources. Conclusion Continental Africa in general and countries of East Africa in particular, have enjoyed rapid economic growth and development in recent Source: The Economist years. As the aforementioned developments in the hydrocarbons sectors gain momentum, the region could undergo significant socioeconomic development. However, East African nations are restricted due to country specific infrastructural and sociopolitical issues. Each country faces specific challenges that must be addressed in order to advance hydrocarbon develMay 2013 Page 6

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opment. Furthermore, economic development through the rise of oil and/or gas sectors does not necessarily ensure longterm prosperity unless effective governance is in place, says Foreign Policy. Failure of government authorities to effectively manage national economies and ensuring diversification may result in the resource curse, effectively negating the resource benefits for its citizenry.

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