Cost oil check down the line: Understanding how oil recoverable costs could erode Uganda’s petroleum revenue gains

Uganda found commercial oil in 2006. But only now is the country readying itself for the Final Investment Decision. The FID, expected this March or thereabouts, is the point in the capital project planning process when the decision to make major financial commitments by oil companies is taken. Uganda plans to commercialize its petroleum resources, estimated at 6.5 billion barrels, through use of crude for gas and power generation, refining, and crude oil export via pipeline. These plans require key pieces of infrastructure. These include an international airport, which is under construction at Kabaale in Hoima; tarmac roads, some of which are under construction; plus other infrastructure yet to be built — a crude oil export pipeline, feeder pipelines, and a refined products pipeline, a storage terminal. The government is building some of these like the airport, while oil companies will take the lead on projects such as the crude export pipeline.

Uganda adopted the Production Sharing Agreements (PSA) model, where the country signed contracts with international oil companies (IOCs) for exploration, development and production of petroleum resources. For Ugandans to benefit from these resources sustainably, it will require a well-designed and properly administered fiscal regime (petroleum revenue generation and spending frameworks). This should determine how the petroleum revenues are shared between the government on behalf of citizens and the investors (IOCs) who are the providers of capital, technology, and expertise in the petroleum sector. According to PSAs, all exploration, development and production expenditures and operating expenses shall be recovered by IOCs i.e recoverable costs. Royalties and cost oil are deducted from gross production in arriving at profit oil, which is shared between the government and the contractors, according to the terms of the PSA.

Uganda’s petroleum regulations and PSAs provide for an advisory committee made up of representatives from the Petroleum Authority of Uganda (PAU), Uganda Revenue Authority, Ministry of Finance and the licensees (IOCs) that review and approves the oil company annual work programmes and budgets which form the basis for allowable recoverable costs. The work programmes are monitored by PAU to ensure alignment with approved budgets and plans.

As already indicated, oil companies submit oil development plans with the budget before commencement of work. While this seems all right, it presents significant risks to the government because the approved budget in the development plan is considered a recoverable cost. By the end of 2018, PAU had approved up to $$483 million, equivalent to UGX1.7 trillion as recoverable costs by the five oil companies operating in Uganda. The companies are Tullow, Total, China National Offshore Oil Company (CNOOC), Armour Energy and Oranto. The oil recoverable costs increased to $483 million in 2018 from $283 million in 2017. This cost is certainly much more since there are pending cost audit reports that are yet to be released by Office of the Auditor General.

The fact that PAU approves oil companies’ development plans without any form of oversight and a thorough audit of the planned recoverable expenses is a recipe for loss of revenue to Uganda. Unless oil development plans have in-built flexibility regarding detection of fraud at any stage of implementation, the companies can arm-twist the government and limit its ability to fight inflation of expenses, which might erode expected revenues. For example, the Office of the Auditor General rejected up to UGX290 billion ($82,294,117) in cost claims in 2016 as ineligible expenses. This would easily cost government lots of money in court awards if the oil companies chose to challenge the rejection in the courts. Also, lack of parliament’s oversight on recoverable costs compounds the risk. The Office of the Auditor General audits the recoverable costs and submits its report to parliament after development plans have been approved and costs have been incurred by oil companies – this is rather post mortem.

Uganda has the potential to turn around the economy and accelerate economic progress if petroleum revenues are put to proper use. However, the government needs to design prudent fiscal strategies for the production of resources and the subsequent use of the revenue, which will address the likely risks of possible cost oil-inflation that would erode revenue gains to the disadvantage of Ugandans.

Policy recommendations

  • The government should strengthen the audit and cost verification function. This will include adding oversight on the cost verification by PAU.
  • Revise the Petroleum (Exploration, Development and Production Act), 2013, to include parliamentary oversight on the recoverable costs. The ad hoc committee that approves oil development plans should report to parliament before approving the plans.
  • Ensure adequate cost control and monitoring.
  • Enforce technical oversight during negotiation and signing of PSAs.
  • Update the accounting procedures to negotiate revisions to the existing PSAs to rid them of weaknesses that could put government revenue at risk.