Economic Benefits are REAL but FROM REAL- Uganda Oil Economics

 

Often time transparency and accountability dominate the oil discussion among the key stakeholders, with limited attention paid to the economic consequences. The two are necessary but not sufficient for sustainable management of the resource and are arguably strongly correlated negative economic consequences including the oil curse.

If you remember where you were and how you felt when Uganda discovered its oil in 2006, optimism was on the lips of many Ugandans. Today there is a sect of the population that would prefer to have the oil remain in the ground than being out. Uganda enjoyed commendable macro-economic stability from the early 1990s to mid-2000s or late 2000s but since then the economy faced some hard times including the 20 year low record economy growth of 3.2% and record high inflation of 30.7% in financial year 2011/12. It is also notable that annual exchange rate (bureau mid-rate) has depreciated from 1$ =1772 Ug. Shs in financial year 2006/07 to 1$ =2585 Ug. Shs the last financial year. The exchange rate is expected to depreciate further in the next couple of years. This calls for investing in enhancing the non-oil sector export competiveness.

In 2006, Uganda’s debt burden was reduced from $4.1bn to $1.6bn under the World Bank/IMF led Highly-Indebted Poor Countries (HIPC) Initiative. However, the debt stock has already shot back to the 2006 levels.  In this current financial year – Uganda intends to borrow 1 trillion shilling from the domestic market. In the same year, the interest bill accounts for almost the same amount in our current appropriated budget. This represents 7.5% of the national budget and is more than the share appropriated to either health sector. Despite recent assessments showing that Uganda’s debt is sustainable, it is evident that the cost of the debt is on the rise. Depending on which school of thought one subscribes to, some argue that this rising trend is due to the expectations of future oil revenues.

This period of economic challenges coincides with the period oil was discovered in 2006. Hypothetically it is arguable that there is a correlation between the discovery of oil and the economic trend over the period.

Prospectively Uganda will defacto face some economic challenges ahead of oil extraction. The first challenge is the high expectations that oil has cast on Ugandans. The recent tullow Oil report indicates that 150,000 Jobs both direct and indirectly. It is also worth noting that Uganda average churns out about 400,000 from its higher levels of education (universities, tertially). According to Uganda National household survey 2009/10, the unemployed were 480,300 – accounting for of 4.2% of the labor force. Evidently the oil jobs will not significantly bridge the unemployment gap. 

 Related is the skeweness of the economic activity towards oil, likely leading to slow progress.  Over the last 7 years, it is noted that the services and manufacturing sectors that have strong linkages with oil sector increasingly account for the economy cake relative to agriculture.  Commendably Uganda has enacted a local content policy, but this also risks skewing attention to the oil sector. It is of critical importance that the next development plan incorporates a holistic plan of the economy local content which incorporates the oil local content.

On a positive side, the Oil revenue management policy envisages the economic challenges associated with the oil revenue management and proposes measures to address them and has developed a public finance bill, once passed will operationalize the management of the bill. The bill was submitted to parliament in March 2012 and is yet to be passed. A set of 55 amendments have since been re submitted to the responsible parliament session committee for consideration. The delays in passing the bill has its own economic implications including the delay in setting up the respective institutions and structures the bill intends to create, consequently the oil production. Further delays of oil production beyond 2018 will compound the recovery costs.

Oil is a finite resource and its prices are highly volatile. Worryingly, the proposed law does envisage creation of the stabilization fund. The stabilization fund, aims to……. It is indeed important to follow up the recommendation of the ORMP and ensure that pricing stability /benchmarking mechanisms are to be put in place. A pricing committee could be established to consult the Government and Parliament on medium term oil price projections with a view to smoothing future spending based on expected oil receipts.

 There are some best practice cases for Uganda including my employers Norway who have been in the oil business for 40 years and boast of over of oil fund reserves of 760bn dollars for just 5 million people. The reserves by any standard are astronomical more so compared to Uganda forex reserves of 3-4 bn reserves. The key has been in the Norwegian model is that Legislation and institutional framework must be correct. Capacity should be built while enabling all actors to perform their roles especially the institutions responsible for the management of the resources

 

 

Shared benefits for all require openness about oil resources( published in vision 26th november 2013)

 

The 3.5 Billion barrels reserves of Oil find present Uganda with an opportunity of windfall revenue when oil production commences. Commercial production is expected to commence 2017 and the estimates of oil revenues are in the range of 2- 3.5 Billion dollars per annuam which is more than 50% of the current cumulative national debt. The current reserves are expected to last 20-24 years if production is at 200,000 bpd.  In essence, if oil revenues are managed well, they will not only go a long way in leveraging Uganda from its debt, but will also deliver critical development infrastructure.

Oil Revenue Management will be guided by the Oil Revenue Management Policy (2012) and the Public Finance Bill (PFB) currently before parliament. The proposed law provides for a single petroleum fund in Bank of Uganda (BoU) where all oil revenue collections will be deposited. All oil revenue collections and administration will be done by Uganda Revenue Authority while the Ministry of Finance, Planning and Economic Development will be in charge of the petroleum fund with a delegated authority of management of the petroleum funds to BoU.

The Petroleum fund has twin objectives of financing the budget and Investing/saving for future Generations. The withdrawal of funds to cater for the national budget will be through Parliamentary approval on a year-by-year basis. In the short run, the oil funds will be limited to funding the non-oil Budget deficit agreed as part of the Budget process.   The withdrawals of petroleum funds to the budget left to discretion of Parliament presents a clear risk that political pressure that could result in revenues being spent rather than invested.

The funds that then remain on the petroleum fund will be invested in accordance with the petroleum revenue investment policy issued by the Minister in consultation with the Secretary to the Treasury and on the advice of the Investment Advisory Committee. The members of the Investment Advisory Committee shall be appointed by the Minister after approved by Parliament‖.  The future savings provision withstanding, the bill does not explicitly provide for the stabilization fund which would provide a steady level of government revenue in the face of oil price fluctuations.

There are various forms of accountability and transparency provided in current bill which include the Minister tabling table the annual report to parliament. The Office of the auditor general will audit both the funds on the petroleum fund and the funds transferred to the budget and present annual reports to Parliament.

 

The proposed legal framework provides Uganda a strong foundation for management of oil revenues; however the main challenge lies in the implementation of its laws. The implementation gap between policies and regulatory frameworks on the one hand, and actual performance on the other must not be allowed for the petroleum sector in Uganda.

The legal framework provides the necessary foundation but to realize full benefits, open transparency is key- information for all. As much as the proposed law requires the Government of Uganda (GOU) to publish incoming revenue receipts, it does not specify how reported receipts will be disaggregated, nor does it require companies to publicly disclose the payments that they make to the GOU. A critical and more urgent action for Uganda is to adhere to the International standards of transparency. An example of these International standards is the Extractive Industries Transparency Initiative (EITI) which requires its member Countries to publish all payments made by oil, gas, and mining companies to government, and all revenues received by the government from those companies.  EITI implementers also commit to closely involving civil society in the design and monitoring of the EITI process. Also the Dodd-Frank Act in the US and the Accounting and Transparency Directives in the EU require all private oil companies that fall under the jurisdiction of these requirements to publish annually details of all revenue payments to the host governments, including taxes, royalties, licensing fees and bonuses.

If the Uganda truly intends to join the EITI, as it has repeatedly stated by President and the respective ministers, it perhaps makes logical sense, harmonizing its reporting requirements with the EITI Standard   in order to limit administrative burden going forward. In fact some international companies, including Tullow Oil, Total E&P, Dominion Petroleum and CNOOC will be required to report their payments to the GOU by virtue of their stock exchange listings or home jurisdiction law. As such, it would be wise to include a requirement in the Public Finance Bill to require companies to declare their payments to the GOU in line with international transparency requirements.  In fact, Ghana which signed to the EITI in 2003 has a separate EITI bill.

 

EITI compliance helps to prevent oil, gas or mining revenues being mismanaged or lost to corruption. Experience shows it also leads to improvements in the tax collection process and boosts public finances as it has in Ghana and Nigeria. Nigeria’s first EITI audit report found a discrepancy of $230 million between what the companies reported to have paid, and what the Nigerian Central Bank reported to have received.

 

To attain shared benefits for all from oil, it requires shared information for all. Informed citizenry, civil society organisations and the media are and will be crucial healthy transparency and accountability organs

 

 

No Emperical Literature supports the Ugandan Economic Consolidation arguement

No Emperical Literature supports the Economic Consolidation arguement by Morrison Rwakakamba

On reading Rwakakamba Morrison( a newly appointed special presidential assistant on research) article in the Newvision Thursday 5th september 2013 and in african executive magazine- http://www.africanexecutive.com/modules/magazine/articles.php?article=7437&magazine=455 " on Uganda certainly needs no constitutional crisis" I am only tempted to pen down a response just to enrich the debate. This paper attempts to address issues raised by Angelo in his paper- http://angeloizama.com/2013/08/30/speech-why-uganda-needs-a-constitutional-crisis-legal-and-institutional-limitations-of-ugandas-journey-as-one-of-africas-latest-oil-producers/. While the debate focused on constitutional crisis,Rwakakamba delved to a great extent the economic transformation of the economy from 1986 to date. As an economist,i will  restrict my reaction to the economic arguments by Morrison. Here are my 3 arguements;

1. Morrison is quick to allude to economic consolidation highlighting that Uganda’s economy has grown by 0ver 80 times in 26 years. In essence the economy has grown at 80/26 times annually in nominal terms. This again wouldn’t be the economic consolidation. The measures of economic consolidation range from the basic Income per capita to Human development index. The figures on GDP per capita show that Uganda has grown from about 280 dollars in 1986 to about 560 dollars i.e. is Uganda GDP per capita has only been able to double in 25years or so. If the same trend is one to go by- Uganda would attain lower middle income in next 25 years (at 1000 USD for GDP per capita).The poverty figure comparison with the East Africa economies is only blind at the fact that the rate at which Ugandan government has reduced poverty is slower than the rate at which population is growing. To illustrate the point- in 1986/1990 with about 12/14 million people, our poverty levels were 56% - making it about 7-8 million people poor. Today at 25%-30% of 35 million Ugandans are poor, that 9-10 million poor people. In a nutshell in no empirical literature is it enshrined that Uganda has attained economic consolidation like Morrison stipulates.

2. Uganda debt levels as assessed by IMF and World Bank are sustainable- This is in sync with Morrison's arguements. But we shouldn’t be blind of the fact that there are also key risks. One of them is the rise in domestic borrowing or risein levels of non concessional loans.In this current FY, Uganda intends to borrow 1 Trillion from the Financial Markets domestically. this should have a huge impact on the movement of interest rates and foreign exchange rates.To illustrate this further, the interest bill in the current financial is a significant share of the budget. At almost 1 trillion, this represents 8% of the budget and twice the budget of agriculture that employs 70% of Ugandan labour force. Who are loans trickling down too? Again the interest bill of 1 trillion as a share of the cumulative debt of 15 trillion means that Uganda is paying almost 7% interest annually. By all means this is not concessional rate. Also lets not forget that also notably In mid-1990’s, Uganda was classified as one of the most highly-indebted poor countries with unsustainable debt burden because it could not pay its debt. Following the accumulation of a debt stock of $3.6bn, Uganda became the first eligible country under the World Bank/IMF led Highly-Indebted Poor Countries (HIPC) initiative to reduce the debt burden, to receive a debt relief amounting to $2bn.Unfortunately, the debt stock shot up again in 2006 to $4.1bn prompting another debt cancellation under the enhanced HIPC initiative. Under the initiative, Uganda’s debt burden was reduced from $4.1bn to $1.6bn.

3. The debate on oil benefits to all is a timely one, but unless Uganda addresses its large implementation gap of policies and laws as well the skewedness towards power consolidation, oil will be as good as any revenue flows in an ineffective system.  Again the oil envisaged resources are significant  projected at 3.5 Bn dollars per annum for about  24 years BUT  not sufficient to uplift Ugandans upper middle income( see uganda's fiscal regime note - in my preceeding blog note for my calculations).

In a nutshell the arguements for economic consolidation are flawed, a simple illustration is a detailed review of the MDG progress beyond just the absolute targets but rather the relative progress.

How much worth is our Oil cash ( Published in the Newvision 29th october 2013)

How much worth is our Oil cash

Uganda’s petroleum fiscal regime is a production sharing agreement type with signature bonuses, rentals, royalty, income tax and ring-fence among others.  The fiscal terms applicable to upstream operations are governed by Part IXA of the Income Tax Act, (Cap 340) (ITA), the 2012 Upstream Act) and the terms of any petroleum agreement and. The Ugandan government has, to date, used a production sharing form of petroleum agreement. The principal fiscal terms are as follows:

ü  The government is entitled to a royalty computed as a percentage of gross daily production, such royalty to be in kind or cash at the government’s election. The percentage can be on an escalating scale as production increases. Royalty rates are biddable and will be set out in the licence or petroleum agreement- current information suggests Based on Gross Total daily Production. Where production (P) does not exceed 2,500 5%, 2,500<P<5,000 7.5%, 5,000<P<7,500 10%, and P>7,500 12.5%. Royalty is paid on a monthly basis.

 

ü  Under a production sharing arrangement, the contractor is entitled to cost recovery from a specified percentage of gross oil or gas production after deduction of any applicable royalty. Cost recovery may be ring-fenced with costs only recoverable from production from the contract area to which they relate. After deduction of Royalty, 60% cost recovery limit is allowed. For Purposes of the estimation below, 40% of the Gross revenue (prior to deducting royalties) is assumed.  Unrecovered costs can typically be carried forward;

 

ü  After deduction of royalty and cost recovery, remaining production is split between the government and contractor on a sliding scale as set out in a petroleum agreement, with the government’s percentage increasing as daily production increases. Available information suggests a 67.5% for government and the remaining share for companies;

 

ü  The contractor is required to pay income tax at the standard corporation rate tax of 30 per cent on the proceeds of the sale of their share of profit oil under the petroleum agreement. Contract areas are ring fenced for tax purposes with each contract area taxed as if it is a separate tax payer- this protects loss transfer by companies from one project to another to minimize tax payment;

 

ü  Under the 2012 Upstream Act signature bonuses are payable on the award of exploration and production licences and are not cost recoverable. Signature bonuses have, according to media reports, been paid in respect of petroleum agreements entered into under the repealed Petroleum (Exploration and Production) Act (PEPA) regime. It was reported, for example, that the PSAs that were signed on 3 February 2012 by Tullow with CNOOC and Total included a signature bonus of US$500,000 and development bonuses of US$2m;

ü  A licensee must pay an annual charge calculated on the grant of a licence and thereafter annually on the anniversary of the grant until the termination of the licence;

ü  A participation dividend paid by a resident contractor to a non-resident company is liable to a withholding tax at a rate of 15 per cent. A lower rate of withholding tax may apply if the dividend is paid to a resident of a country with whom Uganda has a favourable Double Taxation Agreement. This is indeed a welcome move to mitigate transfer pricing.

ü  Any capital transfer /appreciation/ gains is considered as an income and subjected to 30%.

ü  Thin capitalisation rules- Debt/equity ratio 2:1. Interest is allowed to the extent of the rule.

ü  Excise duty and VAT- Applicable on all procurements subject to the duties.

Despite the aforementioned, Uganda’s fiscal regime provides generous allowable deductions including initial allowances of 75%, decommissioning costs, loss carry forward, tax exemption of machinery and equipment and depreciation allowances.

 

It has been estimated that Uganda has 3.5 billion barrels of oil reserves. Assuming a recovery rate of 50%[1] implies that one billion, seven hundred and fifty thousand barrels of oil will be recovered. At envisaged peak production of 200,000 bpd expected in 2020, then the current deposits would be exhaustible in 24 years earning Uganda 3.6 billion dollars annually[2] based on the calculations in table below.

Annual Profits In USD- peak procuction 200,000 barrels per day
	A	B=12.5% of A	C=40% of A	D=A-B-C	E=67.5% of D	F=32.5% of D	G=30% of F	H=B+E+G	J=H*365
Quantity	(A)Total revenues of 200,000 barrels per day @100USD	(B) Royalties 12.5% of Total Rev	(C) Recovery costs 40% ofgross revenue	Profit Oil	Government share of tax 67,5%	company share 32,5%	company share taxed 30% corporate  tax	Government profit per day	Annual Profit
10000	1 000 000	125 000	400 000	475 000	320 625	154 375	46 313	491 938	179 557 188
20000	2 000 000	250 000	800 000	950 000	641 250	308 750	92 625	983 875	359 114 375
30000	3 000 000	375 000	1 200 000	1 425 000	961 875	463 125	138 938	1 475 813	538 671 563
40000	4 000 000	500 000	1 600 000	1 900 000	1 282 500	617 500	185 250	1 967 750	718 228 750
50000	5 000 000	625 000	2 000 000	2 375 000	1 603 125	771 875	231 563	2 459 688	897 785 938
60000	6 000 000	750 000	2 400 000	2 850 000	1 923 750	926 250	277 875	2 951 625	1 077 343 125
70000	7 000 000	875 000	2 800 000	3 325 000	2 244 375	1 080 625	324 188	3 443 563	1 256 900 313
80000	8 000 000	1 000 000	3 200 000	3 800 000	2 565 000	1 235 000	370 500	3 935 500	1 436 457 500
90000	9 000 000	1 125 000	3 600 000	4 275 000	2 885 625	1 389 375	416 813	4 427 438	1 616 014 688
100000	10 000 000	1 250 000	4 000 000	4 750 000	3 206 250	1 543 750	463 125	4 919 375	1 795 571 875
150000	15 000 000	1 875 000	6 000 000	7 125 000	4 809 375	2 315 625	694 688	7 379 063	2 693 357 813
200000	20 000 000	2 500 000	8 000 000	9 500 000	6 412 500	3 087 500	926 250	9 838 750	3 591 143 750
According to available information, Government will charge Royalties of 5% if production capacity is less than 2500 bpd, 7.5% if production is between 2500 bpd and 5000 bpd, 10% if production is between 7500 bpd and 10,000 bpd, and 12.5% for all quantities above 10,000 bpd. After deducting royalties, the oil companies are supposed to deduct their recoverable costs(40% of gross revenue) to obtain profit oil.  The profit oil is then shared between the government (67.5%) and the oil companies (32.5%) respectively.
Calculation by Enock Twinoburyo

 

 

Oil revenues over the 24 years at peak production of 200,000 bpd, would earn Uganda about 84bn dollars revenue. With a population of 35 million, the latter means $2,400 per capita, or more than 4.5 times GDP per capita at market prices. Thus, the value of the discovered oil is large but far from being large enough to itself lead to a revolutionary change in the living conditions of the average Ugandan. The oil will not make the average Ugandan a rich oil sheik but if the oil re- source is wisely spent, it certainly may make a difference.

 

An assumption can however be made and calculations made for different types of fiscal rules ( suggested saving thresholds for givernment) i.e. Bird in hand or Permanent income hypothesis rule.  To the done at later stage

It is also important- to take stock of how much Uganda has earned so far. Oil in Uganda (www.oilinuganda) estimates that Uganda has got close to 1 billion USD (UGX 2.6 Trillon- which is about 20% of the current Budget of UGX 13.6 trillion). Tullow Transferred two thirds of its rights worth USD 2.9billion ( a third each) to Total and CNOOC. Government levied a capital gains tax of 472.7m in capital gains and Tullow only paid a third of it (USD 141 Million). Tullow is expcted to pay full amount after a London arbitration hearing found that heritage should have paid full amount of capital gains.  According to Bank of Uganda- Uganda has so far received USD 620 Million and should expect another USD 286 Million the balance on capital gains of Tullow’s farm down to CNOOC and Total.  According to Tullow published reports about USD 32 million has been paid in other fees and taxes last year, assuming the same payments by Total and CNOOC would mean Uganda has so far received USD 720 milloon and expects USD 286 Million. It is a fair assumption that Uganda is USD 1 Bn Rich todate or more bearing in mind Uganda presumably has earned some cash from the eight years of oil exploration before 2012.

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[1] With improved and enhance recovery methods, Norway managed to increase recovery rate from 25% to 45% offshore. Recovery rate can even increase to 60% with the use of modern and efficient technologies.

[2] Without clear fiscal rules on how the government will share revenue between the budget and investment, Fiscal sustainability analysis has not been calculated due to missing information. An assumption can however be made and calculations made for different types of fiscal rules i.e. Bird in hand or Permanent income hypothesis rule. To the done at later stage