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Opinions of Sunday, 25 October 2009

Columnist: Adam, Mohammed Amin

Investment Challenges In The Oil And Gas Industry:

Can Ghana Endure The Competition?

By Mohammed Amin Adam

Centre for Energy Economics and Policy (CEEP) Ghana


1.0. Short History of Upstream Development In Ghana

Ghana has always wished to find oil in commercial quantities since independence but it was not until the 1970s that commercial levels of offshore oil reserves were discovered. In 1983, the government set up the Ghana National Petroleum Corporation (GNPC) to promote exploration and production. In 1990 production begun even though it was insignificant to qualify the country as an oil producing nation. The GNPC entered into several agreements with Amoco of the United States, Petro Canada International and Diamond Shamrock among others to prospect for oil in offshore blocks between Ada, Tano Basins and the Keta Basins respectively. In fact the prospects in the Tano Basin led to a production of about 6,900 barrels a day by 1992.

In the early 1990s, GNPC reviewed all earlier oil and gas discoveries to determine whether a predominantly local operation might make exploitation more commercially viable. GNPC wanted to set up a floating system for production, storage, off-loading, processing, and gas-turbine electricity generation, hoping to produce 22 billion cubic feet per day, from which 135 megawatts of power could be generated and fed into the national and regional grid.

The new oil discovery at the Mahogany-1 exploration well was struck by Anadarko Petroleum Corporation on the deepwater Kosmos Energy’s West Cape Three Points Block, while Ireland’s Tullow Oil announced the findings of its nearby Hyedua-1 well in the adjacent Deepwater Tano license. This deepwater find with about 800 million barrels of recoverable oil show that there still exist huge potentials in Ghana’s oil story.

3.0. Upstream Investments – Difficult Times

Investment in exploration and development is about the biggest in the oil value chain. It requires substantial resources. According to the US Energy Information Administration (EIA), about US$689 billion investments are required in global exploration and development by 2010. Whether these investments could be raised is uncertain. In the event that some of these resources are realized, there are questions as to the proportion of it that will flow into Africa since the continent is still unattractive despite her huge hydro-carbon potential. Apart from the low levels of development in the industry, the associated political cost and low human capacity in the continent have contributed to the low investment attention the oil industry receives. Ghana's expectations therefore need to be moderated. In a study by the Baker Institute, they found that the Big Five (ExxonMobil, Royal Dutch Shell, BP, Chevron and ConocoPhillips), used 56 percent of their increasing cash flow on share repurchases and dividends, which even though was good for investors in the short term, put the long term reserves of these companies at risk and therefore undermined their future investments. Their oil production also declined from 10.25mb/d in 1996 to 9mb/d in 2006. Thus there is increasing uncertainty surrounding the world oil industry compounded by oil price uncertainty which raises serious implications for future investments in the oil sector and for that matter future oil supply security.

Upstream costs continues to rise as a result of rising cost of oil rigs, storage facilities, pipelines and skilled manpower (World Oil Outlook, 2008). According to the Outlook, upstream cost and average worldwide unit of capital for additional new supply of oil per barrel and gas more than doubled since 2000 with as much as 76% of the increase occurring in the last three years. This has been attributed to increasing prices of steel and other raw materials and higher finding and development costs.

In fact, future price uncertainty has been at the centre of investment decisions. Incorrect interpretation of market signals especially low price speculations have led to cancellation of many investment projects with commercial viability. These price spikes have been attributed mostly to geopolitical developments originating from the Middle East. Moreover, political and civil tensions in Venezuela and Nigeria have had significant impact on the price of oil. Also major economic crises like the Asian crisis of the late 1990s and the current global financial crisis have led to uncertainties in the oil industry and causing investments to fluctuate in what is referred to as ‘boom-bust cycles’.

What is mostly seen as the likely reason for the oil price volatility is the increasing demand for oil as against supply. Demand for oil is one of the significant reasons for more investments in the upstream segment of the oil industry. The International Energy Agency (IEA) predicts that oil demand will reach about 90 million barrels/day by 2010. This requires that production capacity is increased to produce a further 8 million barrels/day. By 2020, IEA’s prediction of global demand hovering around 104 million barrels/day will require another addition of between 14 – 20 million barrels/day in production capacity. The demand for oil by large economies led by China, India and other emerging economies, has grown rapidly over the years. This requires significant investment now and in the near future to sustain their economies. Most of these economies are reaching a stage where more of their populations can afford the use of automobiles. The US economy saw a decrease in oil consumption because of the high prices recorded in 2007 and 2008 but this is only temporary.

There were many issues that affected international investment in upstream oil industry in the past. One of such was the reduction in capital spending in this segment as the international oil industry continued to stabilize following the difficult times of the 1990s. Also some sovereign countries hindered international investors from entering their oil sectors due to issues of nationalism, exploitation, environmental and human rights concerns.

However, due to the competition that have built up in recent times and following shortages of capital especially resulting from the global financial crises, the petroleum sector is faced with serious investment challenges across the world. According to the IEA, between October 2008 and mid-April 2009, more than US$240 billion worth of oil and gas investments were either postponed or delayed due to the credit crunch. Also, between 2008 and 2009, the investment plans of Anadarko and Lukoil, two companies that have interests in Ghana’s oil, have been reduced from US$5.3 billion to US$4.2 billion and from US$11.1 billion to US$5.1 billion respectively.

As a result of the investment challenges facing petroleum resource rich countries, most countries are now reviewing their investment policies and programmes to cover important issues such as technology infusion, fiscal regime enhancement, local content legislation and policy, environmental concerns, energy diversification and flexible development and production timelines. This paper looks at technological infusion, fiscal systems and environmental considerations as they affect investments in the petroleum industry.

4.0. Economics of Technology

There are several questions that need to be addressed in upstream oil sector such as where the source rocks are, what is the reservoir quality, location of wells, cost of building wells, how long the wells will perform and the extent of oil saturation are some of the questions that must be answered if any decision on whether to invest in exploration is to be taken. In fact, these issues determine the risk portfolio of any prospector in making a decision to invest in the stream.

Upstream oil economics involves several steps ranging from prospecting, drilling, determining the discovered field size, the quality of the reserve and then its commercial viability. This makes the component the most risky in the whole oil sector business because of uncertainties surrounding such operations. Ghana's several attempts at finding oil became elusive over a long time not because the explorations were not successful but the commercial viability of the earlier discoveries was not encouraging. It was also largely due to technological deficiencies.

One significant relief to upstream oil which has led to many recent discoveries has been the enhanced technology now emerging in the oil industry. In spite of the high risk of the upstream segment, there continue to be global progress with modern technology reducing the risk. Hence, the accuracy of discoveries have improved and thereby making upstream investments more viable. Whether the new technology will reach the African fields sooner is another question.

One thing is certain. If Ghana is to attract the kind of technology which deep water exploration requires and which will prolong Ghana’s petroleum history then, there must be strong efforts at attracting the ‘majors’ such as Shell, BP, ExxonMobil, etc, who have high technology and more investment resources and who have been successful at reactivating old and abandoned fields. Thus, the unconfirmed news about Exxon’s acquisition of Kosmos interest in Ghana is refreshing and will put Ghana on the investment map of the international petroleum industry.

5.0. Petroleum Fiscal Systems

Oil contracts and negotiations determine the fiscal regime that governs the sector. These fiscal regimes then serve as investment triggers to potential investors. The negotiations usually between the government and the oil companies centre on three major areas among others; royalty, taxes and local content.

Royalties are paid to the government on behalf of the state. One fundamental feature of the oil industry is that oil belongs to the state. The State then invites investors to bring in their money to explore and find the oil, produce and distribute. For instance in Ghana, all petroleum operations are governed by the Petroleum Law of 1984, which sets out the policy and framework for participants in the industry. According to the Law, all petroleum found in its natural state within Ghana is deemed to be national property and is to be developed on behalf of the state. So whiles the state requires the rent for the use of its resources, the investors are interested in the returns on their investment without which the oil of the State will continue to be beneath the oceans. It therefore makes sense that in the Production Sharing Agreements signed between the State and the investor, the latter's take is more.

The debate in Ghana as to whether the 5% royalty demanded by the Government of Ghana under the current agreements with Tullow and Kosmos is not too small and therefore shortchanging the people is very interesting even though uninformed by industry knowledge. What must be clear is that the agreements were signed with the companies before the oil was discovered. During such negotiations allocation is made according to risk portfolios and since the investor takes about 80-90% of the risks, it is not investment friendly for the government to take more. In fact most countries rather discourage royalties on their hydro-carbon resources. For instance, Angola, Equatorial Guinea, Cameroon all offer zero royalties in their fiscal regimes. Nigeria’s deep water exploration attracts zero royalties. It is expected that Ghana will reduce its royalty levels even further if her future investment prospects in the oil sector are to be improved.

What most countries now emphasize in their petroleum agreements are higher income taxes sometimes hovering around 35% as it prevails in Ghana for instance, profit sharing clauses and increased shareholding after investors have recouped substantial part of their investments. Depending on the circumstances, some countries do not even encourage the inclusion of signature bonuses any longer in their agreements. These measures are intended to attract more investments to the sector. Taxes are a major factor both exploration investors and the state consider before entering into any agreements. Taxes such as export duties, profit gain taxes, sales taxes, pollution taxes, permits and others often swell up the government take in spite of low levels of royalty payment. The government take even becomes bigger than the investor’s and sometimes going above 50% of upstream costs as estimates by the GNPC in the case of Ghana shows. In the event of the government having shares in the operation of the investor then government receives part of the profits in addition to royalties. This is exactly the case in Ghana because of GNPC’s participation.

Local content factor by far captures the development dimension of the oil sector investment. The benefits of the oil sector must be shared between investors and the local actors. Some of the ways to do this is to use local equipments, manufacture rig platforms locally, develop local skills and employ those skills. Several oil rich countries have supported their local content policies with legislations. The difficulty though has been the availability of appropriate equipments and personnel locally. Where there is none such as in Ghana, it is expected that local businesses will be partnered to import such equipments for use by oil companies. Ghana needs to take a giant step at this although care must be taken not to prescribe provisions that make investment in the sector difficult. After all, local content provisions are realized only when there are investments in the oil sector.

6.0. Environmental Concerns

The environmental cost of exploration and development has now become the most worrying in the investment analysis of upstream oil. The euphoria that greeted the large discoveries in Ghana therefore calls for serious concern. This is why the recent misunderstanding between Tullow and the Environmental Protection Agency over the issuance of environmental permits cannot be glossed over. While Ghanaians are jubilating over the oil find, there exists enough evidence that other countries have been restricting entry to their fields because of the environmental effect of oil production. Perhaps the environmental consequences of upstream development have been at the centre of the debate on oil exploration and production. Ghana must be applauded so far for the emphasis being put on environmental governance in the on-going consultations for an oil and gas policy development for the nation.

Environmental laws must be stringent in the sense that they do not only protect human health but also the ecosystem which is essential for human survival. The conditions of future generations therefore need to be considered if further explorations are to be allowed in the country. Ghana must not compromise on this irrespective of the type of investor and amount of investments targeted. Environmental laws must also not discriminate between investors. If investors recognize a leveled-playing field in the sector, they are emboldened to comply with environmental regulations and sanctions. However, the problem is not with the laws; it is with enforcement.

7.0. Can Ghana Endure the Competition?

Even though Ghana has no strong history of oil production, the country has several advantages which make her a good investment destination. The country has a stable political system and governance. She is also very peaceful even though surrounded by neighbours that have a history of violent conflicts of national scale. She is recognized for the independence of her judiciary which instills confidence in the investor community. The location of the country is also strategic where oil produced can easily be transported to the market. The investment code has been revised to relax most of the difficulties confronting investors.

Nevertheless, there have been concerns about Ghana’s position on the Corruption Perception Index which puts Ghana at a disadvantage. With most of the major oil companies signed up to the Extractive Industries Transparency Initiative (EITI), the companies look up to countries that are transparent and endorse good governance practices covering petroleum agreements, disclosures, and revenue management. Ghana has already signed up to the EITI for the mining sector and it will serve a good investment purpose if she extends it to cover the oil sector.

However, for the oil sector in particular, the country needs to look at its royalty policy and fiscal regime especially on contentious issues such as signature bonuses and state participation. Signature bonuses and royalties have not helped in countries that have used them in the area of investment attraction. State participation has also proven to be counter-productive such as in Nigeria where substantial resources of public funds are invested to keep pace with the complexities of the industry at the expense of social infrastructural development.

Ghana should also approach some of the ‘major’ International Oil Companies and market some of the prospects to them. These majors do not only come in with financial resources but also new technology. It must however be noted that most of the ‘majors’ are not socially responsible and where they have operated, there have been major environmental concerns and conflicts which point to oil as a ‘curse’. Therefore, environmental laws should be reviewed to hold these companies accountable if they accept to invest in the sector.

Ghana’s position on global competitiveness deteriorated according to the World Bank’s latest report. This is somehow a disincentive to investments. Since the oil sector is new, the country would do well to remove administrative bottlenecks and political interference which slow down business operations and its interaction with global economies. It is appropriate that a new Petroleum Regulatory Authority is established so that the administrative and regulatory requirements of the industry are made simple. The role of GNPC as a regulator and a participant only creates doubts about the competitive spirits that should govern the oil sector.

It must be noted that an over-reliance on the oil sector may bring in revenues that will further reduce the competitiveness of the country since such inflows will likely lead to currency appreciation. This is why while looking for investments to make the petroleum sector competitive, sound macroeconomic management is necessary to insulate the negative effect of the growth of the petroleum sector from the non-petroleum sector of the economy.

Ghana’s quest to expand its continental shelf is another giant step which should not be compromised. Since there are estimates of about 8 billion barrels of oil reserves to gain if the shelf is extended, the country’s oil industry will be boosted for a long while if she is successful at that. The more discoveries made, the higher the investment prospects. This is why Tullow’s announcement of its Jubilee Field discovery in Ghana did not only raise the value of its shares on the Stock Market but also attracted financial support from the International Finance Corporation.

The country’s crude oil is of high quality with an API of about 37 degrees. Such quality crudes cost less to produce which itself derives investments. The amount of attention following the application to extend the continental shelf is therefore not surprising. The United Nations it is believed will receive Ghana’s request as one by a thriving economy to grow and develop her people. The UN is therefore expected to expedite its response to this request. However, this as usual will not escape the international politics and back-stepping which usually characterize UN operations. Ghana is once again challenged to use her maturity in international diplomacy to secure these potential resources for her accelerated development.

8.0. Conclusion

Ghana’s oil find has excited the population greatly. However, ‘not all that glitters are gold’ as the saying goes. A lot is required to translate the oil resources to development. One key ingredient to realizing this is to attract ‘good’ investment to the oil sector as well as manage the sector responsibly. The country should however not put ‘all its eggs in one basket’. That is she should not over-rely on the oil sector at the expense of equally important sectors such as agriculture and manufacturing. If all her investment focus is put on the oil sector at the expense of these other important sectors of the economy, then the oil may as well tend to be a ‘curse’ for the country rather than a ‘blessing’.