Meeting East Africa's oil expectations in Kenya
The next 12 months will be critical for the region's hydrocarbons play. But as Will Crisp discovers, the challenges ahead extend beyond firming up reserves
There is a certain sense of expectation in Lodwar, a dusty and rapidly expanding oil town in Kenya's Turkana region. Street children sleep in the shadows at the side of the road next to a shabby guest house called The Seed of Hope Hotel. Tribeswomen rest outside a shop called The New Dawn Town Grocer.
Over the last two years, Kenyan businessmen, optimistic workers and government security forces have moved into the area en masse - and it's not just Kenya that has turned its attention to this region in the country's northwest.
Since oil was discovered in the Turkana region March 2012, multinational oilfield services companies Halliburton and Baker Hughes have moved into the area and Erik Prince, the founder of the private military group Blackwater, has bought out a local aviation company to provide logistics in the region.
Amid the surge in interest, UK oil company Tullow Oil has hailed its Turkana discoveries as transformational - claiming they have put Kenya "at the heart of East Africa's emerging oil province".
East Africa's boom has been a long time coming. While Nigeria, for example, spearheaded a West African oil boom that began in the 1950s, East Africa largely missed out. Multinationals, including BP and Total, started exploration in a number of countries, including Kenya, Ethiopia and South Sudan, but were either forced to put work on hold because of local insecurity or failed to discover commercial volumes. East Africa was for a long time considered too expensive, too difficult and too risky for a major push.
This did not deter smaller explorers, however. In 2006, Tullow struck oil in Uganda. Its Kingfisher find, a 600-million barrel-plus field in the Lake Albert basin, dealt a blow to the idea that East Africa was devoid of large hydrocarbon deposits. Five years later, Tullow has racked up seven oil discoveries across the Turkana play. On 15 January, Tullow said results from the Ekales-1 well, in Block 13T, and Amosing-1, drilled on Block 10BB, had doubled the estimated size of its reserves in the South Lokichar basin to around 600m barrels of oil. It also increased its estimate for the potential total recoverable oil in the basin to more than 1bn barrels.
Tullow's success sparked celebrations in Nairobi and a scramble among oil companies, now eager to gain a stake in premium onshore East African acreage. The finds in Kenya's onshore play follows a remarkable string of offshore discoveries elsewhere in East Africa, notably Tanzania and Mozambique.
These discoveries have further charged expectations about the size of East Africa's untapped oil and gas reserves. Firms already operating in the region are hoping these finds will encourage the investment needed to develop the region's infrastructure and commercialise their finds. The region is now entering a key 12-month period during which investors expect to learn just how much potential it has and whether some worrisome obstacles to commercialisation can be cleared.
The size of the prize is still unknown in Kenya but that is set to change. So far, Tullow has drilled eight wells in Turkana's South Lokichar basin and struck oil with seven of them. South Lokichar is one of eight basins that Tullow has exposure to in the region. It is aiming to explore at least two more basins before the end of 2014, drilling 40 exploration and appraisal wells over the next 24 months.
Dougie Youngson, research director at FinnCap Research, says: "At the moment there is a lot of hype about Kenya - but in some ways it is justified. At the moment we don't know whether Turkana is going to hold 1bn barrels or 8bn barrels. It really could be a huge discovery."
Aside from Tullow's operations in Kenya, a number of companies are gearing up to carry out exploration work across onshore Tanzania, Somalia and Ethiopia. RBC Capital Markets energy analyst Al Stanton says the exploration programme for the next 12 months could drastically rearrange East Africa's onshore hydrocarbons map. "There's potential for new basins to be opened adding whole new provinces. We already have Lake Albert in Uganda and the South Lokichar basin in Kenya. Will there also be the Omo basin in Ethiopia - or Kerio in Kenya?" he says.
But with major discoveries, problems with infrastructure are thrown into sharp relief. Pipelines are needed, as are refineries. Plans have been mooted for an East African energy corridor, running from Ethiopia to the Kenyan port of Lamu, with the possibility of spur lines carrying flows from South Sudan's oilfields, and possibly Uganda's with the main trunkline. Whether this comes to pass remains to be seen.
There has been movement in Uganda, however. On 6 February this year, the Ugandan government signed a memorandum with Tullow Oil, China National Offshore Oil Corporation (Cnooc) and France's Total agreeing that there will be a refinery near the oilfields and also a pipeline to the Indian Ocean coast. Foreign investors, Uganda and neighbouring states are to build the refinery and the upstream partners will build the pipeline. According to officials in Kampala, oil production in Uganda - most likely from Kingfisher - should begin in 2017-18.
RBC's Al Stanton welcomed the announcement, saying that while delays are still likely, he believes the agreement is a positive development. "The correct route was always going to be a pipeline for crude exports as well as a refinery producing a small amount of product for the local market," says Stanton. "The correct decision has now been made and the memorandum should speed up the pipeline project. The only problem is that it has already taken far longer than expected."
The issues surrounding Uganda's pipeline and refinery illustrate the wider problems facing East Africa's energy sector. Many of the recent oil discoveries have been made in remote regions, with inadequate roads and water supplies.
As well as basic logistical difficulties, large infrastructure projects often face delays because regulatory frameworks have to be legislated and there is a degree of government inexperience in the hydrocarbons sector.
Aminex, an independent oil and gas company that has operated in Tanzania since 2002, has seen extended delays to the approval of its gas sales agreement for its Kiliwani North gasfield. Chief executive Jay Bhattacherjee told Petroleum Economist the process has been frustrating, but it is part of the challenge of working in a frontier environment.
"We've been working hand-in-hand with the ministry and on the whole it's been good, but it's taken a long time as they get to grips with something that is for them still very new," he says. "I believe Tanzania is one of the better governments to deal with in the region, but it's still been difficult. Officials have been very nervous about the process because it lasts for 30 years and they don't want to be stuck with a bad deal."
Ophir, which also operates in Tanzania, says working effectively with the government is one of the key challenges in its operations. Spokesman Richard Rose says his company's strategy is to focus on working with governments, helping them through new processes."We're trying to help manage the risk and maximise the benefits for all parties concerned, especially the countries involved where we operate. If these projects are delayed or become stalled unnecessarily then nobody wins," he says.
Kenya has experienced similar problems. The ratification of its energy bill has been delayed, as have licensing rounds. While the lack of established frameworks and processes will present difficulties for some time to come, many analysts believe increased competition across the region for upstream investment may force a greater degree of inter-governmental cooperation.
Stanton says the February pipeline agreement may be a sign that Uganda is taking seriously the perceived threat of competition from Kenya. "Kenya's rise changes the dynamic in the region," he says. "Kenya appears to be much more proactive and keen to press on with development than Uganda has been in the past. But equally, Uganda doesn't want to see Kenya jump ahead and become the regional oil hub."
Stanton adds: "More discoveries and increased activity should bring more oil expertise to the region, as well as oil hardware, something that should make life easier for the oil companies."
The absence of clear regulations for the energy industry has led to costly legal disputes between oil companies and a number of East African governments - and analysts warn more could be on the cards.
Tullow and Heritage are still locked in a legal battle that dates back to the 2010 sale of a Ugandan oilfield. Both companies claim that the other should have paid capital gains tax on the deal - a levy that came to $313m. Heritage is currently appealing a 2013 court decision that ruled in favour of Tullow. Tullow is also involved in another legal tussle, this time with the Ugandan government, where it has contested the capital gains tax levied on it after it sold two-thirds of its stakes in a number of Ugandan blocks to Total and Cnooc.
Stanton believes that Tullow's legal problems in Uganda should serve as a warning to other companies looking to buy or sell assets in East Africa. "There could also be issues with assets changing ownership in Kenya, say if Tullow or Africa Oil farmed out their discoveries," he says. "This will not necessarily be a problem - Ophir negotiated the sale of its assets to Pavilion Energy seemingly without a hitch in Tanzania. But when big money is involved governments can be tempted to intervene."
One of the biggest challenges Tullow faces in Kenya's Turkana region is avoiding further civil unrest, according to the company's spokesperson George Cazenove. On 26 October last year, more than 400 protesters blockaded the compound at the Twiga-1 exploration site. The protesters, mostly local residents, included pastoralists, who fear exploration will damage the pasture needed for their cattle, and youths, demanding work and supply contracts for local communities.
The group sang traditional Turkana war songs as they approached the site. When officials refused to talk to them, a number of them scaled the compound's fences, forced doors and looted buildings. The protest forced Tullow to shut down all operations in the region for two weeks. "The incident in October was very serious and it shows the scale of the problem that we are dealing with," says Cazenove.
In the wake of the demonstration, Tullow increased the number of local workers it employs at its Turkana operations, opened three community liaison offices and signed a memorandum of understanding with the state. The memorandum saw Tullow agree to double spending on development programmes to £2.9m ($3.9m) in return for increased government security. Since then, there have been no major disruptions to operations but Tullow says it believes that the situation is still very delicate.
Speaking at a conference in Washington in February, Tullow's chairman Simon Thompson warned of "tremendous land tensions", saying big challenges lay ahead to maintain peace in the region. "What is going to happen with Tullow's presence in that region is that some will become rich. And there is going to be a period of time before that wealth really starts rippling into the population as a whole. So, that is a major and very significant challenge for the government of Kenya," he added.
For a long time, the Turkana region has been a buffer zone between Ethiopia and Kenya. Neither country had the capacity to police the border, so the authorities allowed the locals to arm and defend themselves.
The region is awash with weaponry. Economic migration and inequality are increasing - and some observers are concerned Turkana, one of Kenya's poorest regions, is at risk of descending into a Nigeria-style insurgency, with disenfranchised communities waging war on energy companies. "Tullow is a fast learner, but the extra development spending won't be enough to ensure regional stability by itself," says David Ekwee, Kenya's speaker of the Senate and a former member of parliament for the region."If ongoing issues surrounding revenue sharing aren't resolved properly, the consequences will be dire. If the tribes feel hard done by, or cheated out of their land, there will be a bloodbath."
Charles Wanguhu is the coordinator of Kenya civil society organisation, Platform on Oil and Gas, and says if the tensions do erupt into an all-out conflict, the government would find the uprising difficult to suppress. "These are very militant communities. They know the terrain, they are used to dealing with other armed combatants. Even young boys and women know how to use automatic weapons," he says.
Kenya is not alone in facing the difficulty of balancing communities' needs and expectations with those of oil and gas explorers. In Uganda, there are concerns that the displacement of 30,000 people to make way for the planned refinery in Hoima, next to Lake Albert, could be a catalyst for conflict. The evictions take place amid an increasingly uncertain backdrop as President Yoweri Museveni prepares to stand for re-election in two years' time. "Political uncertainty is going up," said Chatham House Africa Programme researcher Ben Shepherd, who believes Museveni is increasingly struggling to retain control and this could mean trouble for energy companies operating in Uganda. "I wouldn't want to say whether that will translate into general unrest - but there is a growing population of young people who don't see Museveni as a war hero and instead see him as an old man who is favouring his own clan."
Tanzania has also seen resistance to the government's energy plans. On 22 May last year, residents of the Mtwara region rioted in the wake of the energy and minerals minister presenting his budget proposals. Protesters said they would block the construction of a proposed 532 km pipeline from Mtwara to Dar es Salaam if their communities did not recieve a bigger share of the benefits from gas development.
The Mtwara proposal involves piping gas from the Maurel et Prom-operated Mnazi Bay and Msimbati gasfields via a 36-inch trunkline to large-scale electricity producers in Dar es Salaam. The pipeline is being financed by a $1.2bn loan from China's Exim Bank. Three people were killed in the violence and more than 100 arrested. Local media also reported that police fired teargas and several buildings were set on fire.
Aminex is one of the companies that plans to use the pipeline to transport its gas. Bhattacherjee says his company is engaging with local communities and isn't worried by unrest in the region, although it does expect further protests against the development."This pipeline is going down. Nothing is going to stop it. It is just too important to the projects," he says. "We're expecting flare-ups to continue - but in reality these flare-ups are mundane and easily resolved."
Regardless, the next 12 months are likely to be critical to East Africa's energy sector. Planned exploration will help give a better picture of the region's reserves base, and it is likely that the nature of the difficulties companies face on the ground will also become clearer.
If explorers manage to carry out their planned programmes without community unrest and regional governments continue to improve their energy industry regulations, that will send out a strong signal and may help bring in more much-needed investment. But if there is no improvement - be that in community relationships or greater regulatory clarity, further energy development could be at risk.
Energy Aspects geopolitical analyst Richard Mallinson says many energy companies in the region are equipped to reduce the risks by working closely with regional officials and by stepping up programmes to help poor communities develop.
Mallinson adds, though, that the main challenge for energy companies in East Africa is the vast range of risks. "The concern is: maybe one issue won't be dealt with correctly and that one issue will be enough to spark a major crisis."