The FALL IN OIL PRICES A WAKE UP CALL FOR UGANDA

 

To economists, oil prices follow a random walk (volatile and unpredictable), the very reason many economists are reluctant in forecasting oil prices. As a matter of fact, prices of oil have had five upward and downward swings since 2008.   As such, I shall not endeavour to foolishly forecast the path of oil prices, but I must intimate that since the 5 year forward oil price in futures markets is higher than the current (spot) price, it is a strong indication that prices will increase. In 2009, 5-year forward price was lower than the spot price, which was indicative of potential fall in prices.  From mid last year, oil prices have fallen by over 60 US dollars, and oil is now trading at 48 US dollars.  The underlying causes emanate from demand and supply. The global demand environment remains gloomy, in particular, China growth has slowed, so are the emerging markets, Japan is in a recession and the Euro zone is in deflation-which is a manifestation of demand deficiency. Last year, however, a surge in oil production has been observed in particular from the non-OPEC members and from non-conventional expensive crude production of North Dakota's shale formations (USA) and Alberta's oil sands (Canada).

 

The fall in prices if sustained at current prices for at least a year has implications for Uganda, both in the short-term as an importing country and in the medium- long-term as potential producer. In the short-term, the direct impact is through a fall in pump prices. As a petro consumer, I note prices are trading at UGX 3450, down from UGX 3850 late last year. There area strong indications that price could fall to as far as UGX 3200- leading to a saving of UGX 650 shillings.  An average lower middle-income consumer uses about five litres daily – which implies a net saving of more than one USD dollar daily.  The fiscal benefits on the national budget should also be immense given the size of fleet of vehicles that are owned by government. The challenge however, the potential benefit withstanding, is that Uganda unlike its regional counter Kenya, Tanzania, and Rwanda lacks a price regulator despite oligopolistic nature of fuel supply.

 

Since petroleum products represent the second largest component of the imports, there will arguably be, net savings, which would arguably ease the pressure on the exchange rate or least strengthen the Uganda shilling. On the contrary, the exchange rate has been rising and so have the electricity tariffs been increased. The simple argument is there are more than countervailing factors that indeed explain the exchange rate movement. First, the US dollar has gained against all the major trading currencies. The fall in remittances, potential fall exports to South Sudan and EU, and expectation of high import bill associated the big infrastructure projects only heightens the speculation. In addition, the fall in oil prices could imply that the oil companies could be downsizing or least the level of foreign direct investments are expected to fall in shorterm. All these, coupled with the envisaged monetary expansion that is often associated with elections, have heightened the pressure on exchange rate; unfortunately, investors are choosing to take a short position in the dollar at moment. The exchange rate happens to be one of the variables that guides the electricity tariff setting.  The other benefits will be in form of intensive energy usage – which arguably should spur production and growth of economy.

 

In the medium term however, Uganda is expected to in full-scale production- with potentially about 1.8 bn reserves recoverable of the 6.5 billion. Various estimations have used 100USD per barrel, to estimate the potential net revenues equivalent to 75 billion dollars (3bn dollars per annum over the 25 years estimated lifetime) that will accrue to Uganda. With 1.8 bn recoverable barrels, this implies a gross income of 180bn dollars at 100 USD per barrel and full scale costs of 105 billion dollars (Gross income minus net income). However, at the current price of 50 dollars- only 90bn dollars would be collected as gross income making it not commercially viable to produce. This simplistic illustration is in tandem with Global Witness economic model estimations based on Exploration Area 1A. The model illustrates profitability within range of 60 dollars and above. The five-year forward price is between 60-80 US dollars

Global lessons from the current fall in prices indicate that countries like Venezuela, Russia, Nigeria and South Sudan    that depend heavily on oil revenues have already felt the adverse heat of fall in oil prices.  On the other side, countries like Norway with strong fiscal rules and diversified economies have been able to wither the shock. Norway, which boasts of a 1 trillion dollar pension fund, has fiscal rule that specifies that the transfers from the Fund to the central government budget shall, over time, reflect the expected real return on the Fund, which is estimated at 4 per cent. As part of this, the state’s net revenues from the petroleum industry are transferred to the Government Pension Fund Global, which is invested abroad. Every year, an amount is transferred back into the fiscal budget to cover the non-oil deficit in the fiscal budget.  The use of funds from the Government Pension Fund Global in 2015 is anticipated to equal 3.0 per cent of the Fund capital at the beginning of the year. This is approximately in line with the average interest and dividend revenues as a percentage of the Fund capital received over the past five years. The average annual real return on the Fund has been just under 4 per cent since 1997.

 

ENOCK NYOREKWA TWINOBURYO( Published with Newvision on the 29th January 2015)