Economic Vulnerability in Uganda's Oil and Gas Sector amidst the Covid-19 Pandemic
By Joseph Mukasa Ngubwagye, Senior Research Fellow | @ACODE_Uganda
The COVID-19 pandemic has presented unique challenges across all aspects of society. Healthcare systems have been strained, schools closed, and economies constrained. The energy sector has not been spared.
Travel and transport restrictions, in a bid to contain the spread of the virus across the world, have led to a record global drop in the oil demand since 1995. While the World Bank had predicted a rise of 1.2 percent for the year 20201, the global oil demand has dropped and is expected to fall at an average of 9.3 percent2. During the first quarter of the year 2020, oil demand fell so sharply, leading to a record negative trade on the world market.
Many oil producing countries have suffered big losses, and their economies have been threatened. They have had to employ several interventions to save their economies from collapsing while keeping their competitive advantage on the world market. In a desperate effort to alleviate the current global oil market imbalance, for example, oil-producing countries, under their umbrella organization, Organization of the Petroleum Exporting Countries (OPEC), cut down their output by 9.7 mb/d from May to end of July 2020. They will, until the end of the year cut production by 7.7 mb/d, and thereafter by 5.8 mb/d until 30 April 20223. These developed oil-producing countries are much more integrated into global markets and their economies are facing huge shocks. It is even worse for countries which have no well-established wealth funds, mainly those in Africa.
Uganda’s oil resources are still beneath the surface. The resource rents have not been integrated into the wider economy, and therefore the impact of the pandemic is quite different.
While the plummeted oil prices have greatly affected the already oil-producing countries, Uganda’s oil sector is still at the development stage. The country is thus more concerned about the future than current oil prices. It is even possible to leave the resources under the ground and concentrate on alternatives to sustain the economy. Nonetheless, the journey to production continues, and a number of processes have been affected, delaying further the possibility of getting the first oil out of the ground as soon as had been anticipated.
The pandemic led to a halt in the development operations. Several local companies had positioned themselves to partake of the projected fifty billion shillings worth of investment during the development phase. The host communities were equally looking forward to being compensated, in monetary terms, for their land and property which they ceded to the oil companies during the land acquisition process for infrastructural development.
Hotel businesses in the oil districts were booming due to the heightened activity. Meetings, monitoring activities, as well as field operations, kept it profitable and promising before the pandemic struck. Businesspeople and entities, therefore, had borrowed highly to invest in this service industry which was showing potential for high returns. With the pandemic disruptions and reduced activity, these investors have been left to service the debts from lending institutions, unsure of when business would resume normally.
The local technical firms which were undertaking field operations were equally flourishing. They had procured many equipment and hired staff, all of which came at a huge cost. Many of these companies had borrowed money from commercial banks to meet the financial need of their respective undertakings, loans for which they have to service. The contracts of these companies were suspended, partly due to the process of transfer of interests between the international oil companies grounding to a halt but exacerbated by the suspension of field operations due to the COVID-19 pandemic. With the transfer of Tullow’s interests in the Lake Albert Development Project complete, these firms would have already resumed work, and probably been able to service their debts with ease. This was not to be because of the pandemic.
The host communities, on the other hand, had had their land valued and were waiting on their compensation money. The expectations for an improved life were looming high. Nonetheless, the physical disruptions, in the form of social distancing, could not allow the compensation process to continue. While people had given their rights on land to the oil companies in exchange for monetary compensation, this did not happen. They will even have to wait much longer until the pandemic is no longer a threat, a timeframe for which nobody is sure. They have, therefore, endured many months of economic hardships at a time when they cannot make their land economically productive. It has already been evaluated and a cut-off date instituted. The economic situation of these communities has consequently worsened.
The Final Investment Decision (FID) is now edging closer, following the completion of the Purchase and Sale Agreements (PSA) between Tullow and Total E&P Uganda. Tullow, in effect, transferred all its interest in the Joint Venture Partner projects in Uganda to Total E&P Uganda, paving a way for the FID. The FID is one most critical factor to have flood gates of investment in the oil and gas sector open. An estimated 50 billion shillings is expected to be sunk in the development phase before oil starts flowing. This comes at a time when potential Ugandan firms and individuals who would benefit from the sector are financially unstable.
The COVID-19 pandemic has led to a drastic and sudden loss of demand and revenue for companies in the oil and gas sector, severely affecting, and/or causing liquidity shortages. The impact of the virus might have potential spill-overs into financial markets, with further reduced confidence and a reduction of credit4. These various impacts are severe, particularly because of higher levels of vulnerability and lower resilience related to the small size of these firms.
Lack of financial support has been reported as a common barrier to the involvement of indigenous companies in the oil and gas sector5. Worse is the high cost of borrowing in Uganda6. Intense competition from international players with cheaper access to finance from international financial markets is likely to edge out the local companies in the oil and gas supply chain. There is, therefore, need for a deliberate government effort to financially support the local companies in the oil and gas supply chain so that their competitiveness in the industry is enhanced. Enterprise development initiatives aimed at the stimulation, incubation, and promotion of local firms is necessary for the long-term involvement of local firms in oil and gas business.
The Local Content bill 2019 was passed on May 21st, 2020. It creates room for Ugandan companies to get involved in government projects. While this is a move in the right direction, the economic vulnerability caused by the pandemic is likely to deter local companies from competing favourably in the oil and gas sector, which is capital intensive. A deliberate effort by government is needed to boost these companies so that their financial capacity is lifted to a level where they can compete individually, or partner with foreign companies comparatively, to win contracts in the industry. Financial instruments such as Loan guarantees, direct lending, and grants and subsidies should be thought about going forward to boost the capacity of local firms. Countries such as South Africa, Equatorial Guinea, and Angola are already applying some of these measures to save their local firms from collapsing7.
It is important to ensure that the bigger proportion of the huge investment in the development phase of the oil and gas sector is retained in the country to spur economic growth. This can only be achieved by empowering local firms so that they match the technical and financial capabilities of international companies. Otherwise, the country stands a risk of massive economic drain, with much of the investment going to the foreign countries where the financially capable firms are based.
1 IEA (2020), Oil Market Report - January 2020, IEA, Paris https://www.iea.org/reports/oil-market-report-january-2020.
2IEA (2020), Oil Market Report - April 2020, IEA, Paris https://www.iea.org/reports/oil-market-report-april-2020.
4Organisation for Economic Co-operation and Development (2020), Coronavirus (COVID-19): SME Policy Responses.
5Charles Ackah and Asaah S. Mohammed (2018); Local content law and practice; A case of the oil and gas industry in Ghana, United Nations World Institute for Development Economics Research.
6Alice Arinaitwe* and Rogers Mwesigwa (2015); Improving Credit Accessibility among SME’s in Uganda, Global Journal of Commerce and Management Perspective, Vol. 4(6): 22-30.
7Baker McKenzie (2020), The impact of COVID-19 on the Oil and Gas Industry; https://www.bakermckenzie.com/-/media/files/insight/publications/2020/04/the-impact-of-covid19-on-the-oil--gas-industry.pdf?la=en