In the past 50 years, East Africa has never been completely off the radar screen of the international oil and gas industry, but apart from some small gas discoveries in Tanzania in the 1970s and ‘80s, exploration efforts in the region were unsuccessful until the discovery of commercial quantities of oil in Uganda in 2006.

Since 2010, we have also seen major gas discoveries offshore of Tanzania and Mozambique and on March 26, this year, Tullow Oil announced an oil discovery in the Kenyan Rift Basin (though this is not confirmed as a commercial deposit despite the hype after the announcement).

Coupled with this exploration success there has also been a good deal of M&A activity in the region’s oil and gas sector, culminating in the ongoing sale of Cove Energy plc, whose assets in Mozambique and Kenya have attracted the attention of many companies.

So amid all the enthusiasm, what is the reality?

It is true that the events of the past six years have confirmed hydrocarbon potential in the region that was long suspected but which technology has only recently enabled the oil and gas industry to positively identify.

And it is also true that there are likely to be significant additional reserves of both oil and gas yet to be discovered. But there are a lot of hurdles that need to be overcome before East Africa can reap the benefits.

The most important hurdles relate to the linked questions of geography and infrastructure. This is best illustrated by the story of the Songo Songo gas field in Tanzania. This was discovered in 1974 by Agip (now part of the Italian oil and gas group ENI), but it was not until 2004 that the field commenced commercial production.

The reason for this delay was primarily because Tanzania has only developed as a gas market very recently and the gas reserves were too small to justify the cost of developing the infrastructure to export the gas to a more mature market such as India or South Africa.

Although the East African economy is growing rapidly, it is still very small, and the oil and gas found here is remote from the world’s major energy consumers: Europe, North America and Asia.

Commercial companies (and their shareholders) cannot be expected to invest billions in developing infrastructure without a secure and lucrative market to enable them to earn a reasonable return.
Governments in this part of the world do not have the financial muscle to develop oil and gas by themselves. This has created a “chicken or egg” dilemma for the region’s governments.

New-found hydrocarbon wealth could be a major stimulus to economic development, but until that development happens, oil and gas companies will remain focused on developing export markets, diverting the potential hydrocarbon production to foreign instead of domestic markets.

This is a critical issue for Uganda in particular. The Ugandan government has made it a key element of government policy to develop a domestic oil refinery and an associated petrochemical industry.

For the oil companies operating in Uganda, this must create major uncertainty. To make a reasonable return on the $10 billion they must invest to develop Ugandan oil, they need to produce in the region of 200,000 barrels per day.

This implies construction of an export pipeline to the Indian Ocean. Uganda currently consumes the equivalent of around 15,000 barrels a day of oil in the form of fuel, which has to be imported, mostly by road from the port of Mombasa.

Understandably, the Ugandan government wants to prioritise a refinery to substitute domestically produced fuel for imports, to protect its reserves of foreign currency, reduce its dependence on the sometimes uncertain security of the import route and to develop domestic industry, creating much needed jobs.

But this implies a much lower level of production as well as the construction of a refinery (to be paid for by whom?). Common ground will need to be found on this issue before full-scale development of Uganda’s oilfields can go ahead.

If Kenya’s recent oil discovery turns out to be commercial, the same issues will arise in that country also.

The case of gas discoveries could be even more difficult. Massive reserves of gas have now been found off the shores of Mozambique and Tanzania. More may soon be found off the coast of Kenya. The cost of developing these will be vast, even by comparison with the $10 billion estimate for Uganda’s oilfields.

ENI has suggested that its Mozambique discoveries could cost $50 billion to develop. Mozambique, and even South Africa, are potentially not the primary markets that ENI and the other companies have in mind. Instead, they are probably looking at Asia, in particular India.

This is why the cost of development will be so huge: because to move gas that distance it has to be converted to a liquid (Liquefied Natural Gas, LNG) and the processing facilities needed to do this is are very expensive to construct.

And there remains one huge question mark: Recent technological advances have not only enabled the discovery of East Africa’s hydrocarbons, they have also enabled the exploitation of other hydrocarbon resources previously thought to be uneconomic — for example Canada’s oil sands and shale gas reserves, which have slashed North American gas prices and prompted US politicians to start discussing a return to US energy self-sufficiency.

China, Europe and other regions also have significant reserves of shale gas. Perhaps by the time East Africa is producing LNG, no one will want to buy it.

So geography is a hurdle, because the oil and gas found are remote from major markets and local markets are still small. That means the infrastructure needs are huge, because the industry is new to the region and everything from LNG plants, to roads and office buildings has to be built from scratch.

That means that development will be very expensive and that in turn links back to geography: The local markets are too small to justify the billions needed, so companies have to look at export markets.

So, to cut to the chase, what does this actually mean for ordinary East Africans? In my view, it means that the enthusiasm over the recent discoveries has to be moderated with some realism.

The economic challenges to oil and gas development in the region are still enormous. Governments should not be complacent, and should certainly not start to spend a supposed windfall before it is in the bank.

The views expressed are those of the author and do not necessarily represent those of Deloitte Consulting Ltd.