The longer Ugandan oil stays in the ground, the better for all

January 18, 2016 in Business, Columnists, Editorial, Energy, Opinion, Policy by Editor

KAMPALA, JANUARY 18- During an interview a couple of years ago, a Ugandan official told me in an off- the record remark that the longer Ugandan oil stayed in the ground, the better off the country was. His reasoning was that while many were eager to cash in on the newly found black gold, it was foolhardy to rush into production in the absence of a well thought legal and commercialization framework. There was also the danger that many decisions related to what to do with the oil and its proceeds would be premised on the intoxication generated by the abnormally high prices prevailing at the time.

I was about to lift my phone to remind him of how procrastination had led to missed opportunity for Uganda when I read media reports of a brewing conflict between Juba and Khartoum over transit South Sudanese crude through Khartoum’s pipeline and port.

As global prices for crude raced towards their unprecedented peak earlier this decade, a row broke out between Khartoum and Juba over transit fees for South Sudan’s. In the beginning, Khartoum was demanding as much as $50 per barrel, way above the world average of $3.

Juba balked at the proposal and at one time opted to suspend oil exports for one year. As the standoff hurt both economies, the Chinese used the opportunity to broker a deal under which Khartoum would collect $25 for each barrel that traveled through its pipeline. That was in addition to the $15 tariff the pipeline operator collected on each barrel. In effect Khartoum’s ransom was a way of getting as big a share as it could exact from a resource it no longer owned.

That worked well for as long as prices were in the $125 band. But with oil now tending below $30, Juba cannot sell its oil profitably and shutting down production is a more practical consideration. The good news is that Khartoum is willing to reconsider the fee but that still leaves the question of the $15 pipeline tariff pending.

This turn in the fortunes of a hitherto well-heeled oil economy are instructive for Uganda on two fronts. One is that making investment decisions during a high oil price regime is fraught with multiple downside risks. High oil prices create inflated expectations across the board that influence not just spending decisions by host nations but even the cost of infrastructure.

Ridiculous as it might sound, it would cost Uganda less to build a pipeline and refinery today than if the same contracts were procured just a year ago. A downturn creates redundancy as demand for infrastructure services abates.

The second lesson for Uganda is that it is not wise to throw caution to the jet stream of high oil prices. Six years ago, President Museveni acquired overpriced Sukhoi fighter jets against future oil revenues. At $125 a barrel, it would cost Uganda just under 6 million barrels to payback that debt excluding interest. At $30, the cost in crude rises exponentially to almost 25 million barrels. That is the cost of just one item borrowed against a stock of 1.2 billion barrels of crude.

With hindsight, as many worried about a weak oil governance structure, we should be thankful that the oil never left the holes and we have not yet placed pen to paper on expensive pipeline and refinery deals.