East Africa is emerging as the next frontier region for oil and gas. But with political instability, barely-existent legal frameworks and little to no infrastructure, attracting investment is going to be anything but plain sailing. Eleanor Wragg reports.
While the presence of hydrocarbons both off and onshore has long been suspected in East Africa, its tricky geology has meant it has taken until now for the technology to be developed to allow the oil and gas industry to positively identify its potential. Today, according to the US Geological Survey’s (USGS) World Oil and Gas Assessment, the East African coast holds 27.6 billion barrels of oil, 441.1 trillion cubic feet of natural gas, and 13.77 billion barrels of natural gas liquids.
With rising energy prices acting as a catalyst, new techniques have allowed global energy companies to bring online new oil and gas reserves in East African countries. But scraps between Kenya and Somalia over their boundary line in the Indian Ocean, tussles between South Sudan and Sudan over oil transit fees, and Somali pirates too close to comfort to offshore drilling sites all contribute to the feeling that the region is far from a safe bet.
“The real disappointment at the moment is South Sudan and its attitude to Sudan,” says Geoff Wynne, partner at SNR Denton, which is actively representing companies eyeing the region. “South Sudan has the oil, it’s got to sell it somewhere and the natural place would be to sell it back to Sudan. To try and boycott selling it to Sudan seems to be a very classic example of shooting yourself in the foot because they’ve now got oil but nobody to buy it.”
“Another problem that we have seen has been border issues and these could become potentially tricky with offshore fields that often tend to straddle maritime borders of two countries,” says Dolapo Oni, oil and gas analyst at Ecobank. “The two Sudans and, more recently, Somalia and Kenya, are existing examples of this issue. In our opinion however, except where political considerations are prioritised, these disputes are likely to get some economic resolution involving both countries getting a share of the revenue from the field.”
Oni adds that the Somalia vs Kenya case is particularly interesting as Somalia’s ongoing exploration activities have been severely limited by the political instability and insecurity brought about by pirates operating off its coasts.
“Its decision to dispute maritime borders with Kenya are thus likely to be more economic than political, ie to get a share of the revenue heading towards Kenya for exploration and production in coming years,” he says. “These issues are not likely to deter investments however, as the massive potential of the East African region and its proximity to energy-hungry Asia continues to attract investors.”
Companies are now prospecting for oil in Ethiopia, Democratic Republic of Congo, Eritrea and parts of Somalia, while Madagascar is widely tipped to hold enormous gas reserves. According to research by Morgan Stanley, 23 wells will be drilled off Kenya, Tanzania and Mozambique this year, almost double last year’s figure and requiring massive investment.
The International Energy Agency (IEA), in its most recent World Energy Outlook, expects that almost US$2.1tn will need to be invested in African oil and natural gas supply infrastructure over the 2010 to 2035 period — an average of more than US$83bn per year; more than the IEA expects will be invested in the Middle East, Latin America or even in Asia over the same period.
“The first wave of exploration efforts in East Africa was financed mostly by equity and very little debt. Traditional commercial banks, both local and regional, will not fund oil exploration, except for the larger independents and international oil companies (IOCs) like Total, Shell and ExxonMobil, who are able to provide other producing fields as security for their loans. However, with the almost 90% success recorded in finding oil and gas over the last few years in East Africa, subsequent investments in infrastructure to support production and exploration activities are likely to have a larger debt financing component,” says Oni.
Infrastructure is sorely needed in East Africa. Other than a rickety colonial-era railway, there is little in the way of infrastructure, from pipelines to ports, to export oil. Although things are changing, and local banks are beginning to engage in participation of underwriting and financing of oil and gas projects through consortium loans, most of the financing still comes from international financial institutions, such as the Africa Finance Corporation (AFC), who is currently doing transactions in Zambia’s downstream sector and is eyeing transactions in both Kenya and Mozambique.
Taiwo Adeniji, the AFC’s director of financial institutions and advisory services, says: “The local banks in each of these countries are also contributing to the financing. Sometimes it’s difficult for the local banks to be able to provide the foreign currency so international banks like the AFC fill that gap in that respect.”
In most cases the AFC does its financing in collaboration with the domestic banks, so while it doesn’t aim to displace the domestic banks, it does provide sources that might be more difficult to find domestically in those countries.
Meanwhile, as liquidity issues hit European banks, the oil sector is also seeing the retreat of some of its traditional financiers.
“Because of the situation in Europe, the European banks are scaling back their operations generally,” says Adeniji. “There has been a tailback of confirmation lines that have been made available to African banks to be able to finance their foreign trade. Given that oil and gas transactions are generally high-volume transactions in terms of the amounts involved, those transactions will have been affected as well.”
However, there are plenty of opportunities for financing that even the most capital-starved bank would look upon favourably.
“It’s not just oil that is exciting but all the developments that will follow,” says Guillaume Arditti, managing director of commodity structured debt for Middle East and Africa for BNP Paribas. He points to the related logistics, road, transportation and other infrastructure investments that are being planned and implemented: “When you go to Uganda and Kenya, you see that the natural resource discoveries have brought a new momentum to project development, such as the Lamu port and the related Kampala – Nairobi corridor,” he adds.
Construction of Kenya’s new Lamu port began in March. It is part of a proposed US$22bn development plan to connect the country to Southern Sudan and Ethiopia and decongest the port of Mombasa. The project is set to include an oil pipeline, roads, railways and airports in major towns along the way, bringing with it many opportunities for trade finance.
It is likely that with East Africa’s proximity, it will attract more debt funding from China and Japan. In 2011, China provided Tanzania with a US$1.06bn loan to construct gas pipelines, while Japan extended a US$300mn soft loan to Kenya to develop gas-to-power projects.
“It is not unusual to look at the strategy of China for example, which is to secure long-term contracts for the supply of important commodities of which oil is one, and again East Africa will be no different,” says Wynne at SNR Denton.
Legal frameworks are another test, with many of the region’s governments’ out-of-date and unsuitable laws leaving them ill-equipped to strike fair deals with big oil companies.
“Investors in Kenya’s upstream energy sector are likely to face regulatory hurdles due to poor institutional capacity, resulting in delays in the awarding of contracts and energy operations,” says Robert Besseling of Exclusive Analysis in a research note.
“When the first sets of discoveries in East Africa were announced, most of the countries [in East Africa] had little or no hydrocarbon reserves; the existing body of regulations then were targeted at making the environment conducive for exploration companies,” says Ecobank’s Oni, adding that there has been no real pressure on governments to develop comprehensive regulations.
He indicates that the existing legislations are outdated and need to be reviewed. “In reviewing these legislations, these governments are likely to consider increasing their share of revenues from some of the new discoveries and position their national oil companies to control more share of the oil and gas fields than previously.”
The question remains, therefore, whether the East African region, in spite of its many challenges, has the potential to become a major global focus for the oil and gas sector in 2012.
Arditti at BNP Paribas believes that Kenya is set to become a central trade hub, and will likely play a key role in the future of the oil and gas sector in the region. “It’s not just one single transaction to be financed; it’s more of a general dynamic that we’re seeing. It’s the entire coast. When you look at South Africa, Durban was congested, so Mozambique became a kind of distribution hub for the sub-region. Input came to Mozambique and was routed to Zambia, Botswana, Zimbabwe and Malawi, and now the same is happening with Kenya.”
Many believe that despite the region’s perceived instability, there will always be investment.
“I think the one common theme about oil and gas companies is they tend to be hardened. You just don’t know when the change is going to be in any one country; that’s the excitement about Africa. Oil and gas and indeed mining companies get on and make sure the place is secure for them. They have their own evaluation of political risk,” says Paul Bugingo, partner at SNR Denton.
Wynne agrees that compared to some other parts of the world such as Iran and Iraq, the risk in East Africa is “not bad”. “If you can get the structure right then there will be excitement,” he says.
Nevertheless, there are worries that the region’s political situation will discourage long-term investment. This is further compounded by the fact that, historically, the oil and gas sector is often the very source of conflict.
“Obviously when you have a volatile political situation it dampens the appetite of investors,” says the AFC’s Adeniji. “Given that the capital is not as plentiful as it used to be, when investors have to make a decision as to where they will deploy their capital, if it is between a relatively quiet region and a volatile region the volatile region will lose out.”
As such, there’s a risk that Africa may miss out on investment opportunities if current and potential conflicts are not swiftly resolved.