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Imagine investing $50m (sh125b) in a business venture and after seven years there is nothing to show. This is what happened to Neptune Petroleum Uganda Ltd when it invested $50m in drilling three wells -Iti-1, Avivi-1 and the latest Mvule-1 in West Nile in Uganda.
Only to discover a dry well or a well filled with water. The $50m was not readily available on Neptune's account. Like any other independent oil explorers, the firm used shareholders' money with no certainty of finding oil and/or gas.
But shareholders do not only expect their money back. They also want it back with high returns in form of dividends for them to continue investing.
And dividends cannot be distributed to shareholders if there are no sufficient profits from operations.
The $50m invested by Neptune is a sunk cost and no returns are expected.
It means that the firm will encounter problems in raising money to continue its operations in Uganda.
But again it also underscores the risky nature of the oil and gas business though equally rewarding.
"The costs exclude our robust corporate social responsibility with the communities we have been working with. We have also been paying taxes to Uganda Revenue Authority," Marilyn Hill, the Nep-tune Petroleum country manager, pointed out.
"(But) we are here to stay because we feel a loyalty to the people of the area, and we want to help get Uganda's oil industry up and running."
The actual costs are yet to be known. Neptune is obliged to restore the drilling areas in a manner they found it and the company will have to dig deep into its pockets.
"This demonstrates that the oil and gas industry is highly costly and risky venture. The company was licenced in 2005 and implemented all agreed work plan," Ernest Rubondo, the commissioner in the petroleum exploration and production department, explained.
“Unfortunately Neptune has not found oil. The company’s licence expires on March 26 and the area will revert to the Government for future licensing.”
As Neptune is nursing the losses, Parliament, the media and civil society are accusing the international oil companies of cheating Uganda using bad contracts.
Suppose the $50m were invested by the National Oil Company of Uganda (NOC) to conduct petroleum operations on behalf of the Government and there were no discoveries made.
The same group would blame the technocrats in government for incompetence, lack of priority in investing into other sensitive sectors and planning.
The search for oil is costly and involves risk taking with much higher political and physical risks.
“A piece of seismic, a well, a day of a rig, have tripled in cost,” an oil expert said. “Today’s exploration well is a more technically complex animal than one 10 years ago.”
Exploration is not just more technically difficult; it is also fraught with political risk that may lead to contractual uncertainty, which can jeopardise investment projects.
To protect the Government from incurring such heavy costs yet unsure of the returns, Uganda opted for the production sharing agreements, which transfer exploration, appraisal, development and production risks to international oil companies.
“The agreements were structured in a manner that if they (oil company does not discover oil, all operation expenses are not recovered and that is what will happen with Neptune,” Rubondo explained.
If the oil companies find oil and produce it, then their costs with interests are recovered. They will have to share the profit oil (this after royalty and cost recovery oil are deducted).
And discovering oil means that the oil company can transfer its interest to another party if the development and production costs are high. This explains why Heritage Oil invested only $150m and on transferring its interest to Tullow walked away with $1.5b.
The agreements are designed in a way that when oil production starts, royalty of 5% and 12.5% are first deducted ei¬ther in cash or in kind and transferred to the state.
After royalty has been deducted, the next item to be considered is “recoverable costs.” These are costs that the companies will have incurred during exploration, appraisal, development and production and they are entitled to recover.
This only arises when oil has been discovered and produced. But even then only up to 60% of the recoverable costs are deducted at a time in order to allow Uganda start enjoying the oil revenues.
After royalties and recoverable costs have been removed, what remains is known as profit oil. This is to be shared between the Government and oil companies through a pre-agreed profit sharing arrangement. The Government stakes increases up to 85% as production rate increases.
The Government shares are very high, especially on the larger field where the higher tiers of production sharing are quickly triggered by the daily production rates. From what the oil companies will take as profit oil, Uganda Revenue Authority (URA) will tax 30%.
Is this really a bad contract when most of the exploration, appraisal, development and production costs have been covered by international oil companies?
“The oil and gas sector is a high risk industry in terms of investment and project returns. It is capital intensive and the costs progressively increase from exploration, development and production up to refining or transportation,” Rubondo said.
“This is why we need political and macroeconomic stability to keep attracting investors to develop our industry.”
And crucial is the fiscal and stability clauses inserted in the oil agreements. “No international company would be able to finance long-term projects without being able to assure both its lenders and investors that the risks that they are taking have been mitigated,” Jimmy Kiberu, the Tullow Oil corporate affairs manager, noted.
Oil and gas projects pose acute project risks for international investors, which are heavily reliant on advance project financing from a number of different financial institutions (who in turn require the international investors to meet strict repayment schedules over the life of the project).
But Neptune’s bad omen provides Uganda with lessons. Despite holding the world’s discovery success rate (92%) in the oil potential areas of Lake Albert, there are some risky areas remaining.
“Neptune’s experience has taught us that the chances of discovery can vary from the normal situation and some areas are still risky,” Rubondo admitted.
“But the West Nile remains with potential to find oil and we shall promote the areas to new investors for licensing in the near future."
By Ibrahim Kasita: The New Vision Newspaper
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