Let Crude oil remain underground-unexploited

Soldiers guarding a crude oil
storage Tank in South Sudan
  In November 2020, we ran a story on the risk facing the fossil fuels industry, we asked; whither the industry and the economies that depend on it to fund national development?  https://eaers.blogspot.com/2020/11/whither-fossil-fuels-and-dependent.html

Now, a recent report on the Ugandan oil industry provides the answer- and it is gloomy. The Ugandan oil industry comprises the upstream wells, the Midstream oil evacuation pipeline, EACOP, and the downstream oil refinery. The crude oil prices, on the other hand, are declining with no prospect of turning north significantly in the future. Developing this industry could thus be spending good money in pursuit of bad.
The world is shifting away from fossil fuels due to climate concerns.

 The report, “understanding the impact for a low carbon transition on Uganda’s planned oil industry” by Climate Policy Initiative, CPI, suggests that the industry is stillborn.  Although the report focuses on the budding oil Industry in Uganda, the findings sound true of other Greenfield oil industries in the world and particularly Africa. The findings would hold true for Kenya as well.

It blames the change in fortunes on two things: Prolonged negotiations, and rapidly shrinking crude oil prices. The decline in crude prices is the result of a decline in demand due to the rapid transition to green energy, what the report calls “a low carbon transition that brings a structural long-term shift away from fossil fuel consumption.” 

 We reported in our previous story that the leading polluters, China, The European Union, and the USA have already begun the shift. The three combined produce 4530 GWh of electricity a year from various sources. Green and renewables sources such as wind, geothermal, and hydro generate 22 percent or 977.4 GW. The rest, an estimated 78 percent or 3553 GWh is generated by coal, oil, and nuclear energy. 

The leading economies are gunning to bridge this gap with renewables in the next 30 to 40 years.  Wind energy is emerging as a clear frontrunner especially in the European Union and China where it is already a dominant electricity generator and more is in the pipeline. Developing and emerging economies are not lagging behind either, as they are also players in the shift. This shift is a major threat to fossil fuels rendering investment in new sources unviable.

 The CPI report says that the lengthy preparation before production, coupled with constant declines in demand and prices devalue fossil fuels. For instance, for the seven-years between 2013 and 2020, Uganda’s crude oil has lost 70 percent of its value, shrinking from US$61 billion in 2013 to $18 billion in net present value. Given the accelerating climate transition risk, it could lose a further $10 billion in net present value terms.

The oil industry in Uganda and Kenya is likely to begin production just a few years to 2030 when major consumers of Fossils will be decommissioning dirty fuel generators, leading to a decline in demand. Prices will follow suit.

Crude oil prices have been declining since 2006 when Uganda discovered oil. At that time, a barrel sold for $114. There were dips and peaks along the way due to usual market volatility but still, the trend has been downward, devaluing crude by more than $60 a barrel. Currently, crude is selling at between $48.80 Northern Brent and $50.81 for the OPEC basket.

Although the decline this year was driven by the COVID-19 pandemic, and could rise on news of economic recovery next year, that positive sentiment will be temporary, not benign for Greenfield oil investment, says the report.

 CPI’s economic and financial analyses do not favour a Greenfield oil investment. Due to persistent price declines, the profitability of the project is in doubt. All decision-making tools point to a loss in value.  The internal rate of return, i.e. the growth in value of the investment in the project is below the acceptable thresholds.  The IRR ranges between 4 and 7 percent in the different scenarios. The globally acceptable rate of return for any project is 12 percent. Total Oil SPA has a 15 percent threshold.

 These numbers are in themselves a major deterrent to the final decision to invest, FDI.  The entire oil industry comprises of three assets viz, the upstream Oil fields at Kingfisher and Tilenga, the Midstream oil evacuation pipeline, EACOP, and the downstream Kabaale Refinery. Combined they will require a total upfront investment of US$13.6 billion broken down as follows; upstream development of the two wells US$6 billion; EACOP US$3.6 billion, and the Kabaale Refinery $4 billion. In addition, there is an estimated $3.5 billion operations cost over the entire life of the project, raising total costs to US$17.1 billion for a project whose current discounted value is $18 billion!

Although the international investors, Total oil and CNOOC, are upbeat about taking an FID, the decision-making tools do not support that position. 

Should Uganda choose to proceed with the project, cautions the report, it will have to sacrifice more from its meagre revenue. At the end of the project life, Uganda’s value will be $6.8 billion, way below the US$61 billion had the project began in 2015.

 To move the project forward, it will have to offer more incentives to the investors and financiers such as tax breaks that will eat another $600 million. Even then, the return on investment will not approach the threshold level of 12 percent, says the report.

Although CPI does not tell Uganda to abandon the project, the findings point to this scenario. Given that crude oil price declines are an external risk, over which the oil-producing countries have no control, then perhaps deciding not to invest-letting this resource lie unexploited is- for the time being- the best decision.


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