Extraction economics: How to get the most out of oil, gas reserves

Wednesday June 20 2018

The crude oil storage tanks at Kenya Petroleum Refinery in Changamwe, Mombasa. Such facilities are best situated as close to the port as possible. PHOTO | LABAN WALLOGA | NMG


In this second of a three-part series we continue to explore the quantum of oil and gas in East Africa, extraction economics of those hydrocarbons and marketing and conclude with examining development issues surrounding the discovery, extraction and marketing of crude petroleum and natural gas deposits in East Africa.

Part I of this series sought to put into context the quantity of East Africa’s oil and gas bounty and reveal the ubiquity of the resources to the rest of the globe.

As the region will be a price-taker, selling its oil at the global price level, this study will use Dubai/Oman as the reference price for East Africa’s oil and seek to explain the global price level at which the region’s oil can be profitably extracted.

We will compute this price level on the assumptions that the region is one oil market and also that each nation is a separate actor in world markets.

In this scenario, East Africa will not only be self-sufficient in petroleum production, we will also explain why as one market, the region will be a net exporter of oil.

It will be advantageous for the region to consolidate its oil transportation infrastructure in order to keep transportation costs low and have profitable margins. The “go it alone” alternative will result in white elephants and an exorbitant break-even point.


As Tanzania is poised to be the sole producer of gas, we will consider the costs of different means of transportation and build an argument as to the global price level of gas that will render Tanzanian gas profitable.


Will East Africa be self-sufficient in petroleum production?

Africa has more than 20 oil producing countries, with a daily production ranging from a few hundred barrels to more than a million barrels.

Angola, Algeria and Nigeria are top producers extracting up to five million barrels daily in 2016. Based on these numbers, it is certain that East African countries will not be big players even within the continent.

Currently, only South Sudan is a net exporter of crude oil. All the other East African countries are importers.

Countries included in this survey --Kenya, Uganda, Tanzania, Rwanda, Burundi, South Sudan and Ethiopia -- require 265,000 barrels of refined petroleum energy products per day as per 2016 figures.

This requirement could be fulfilled by 310,000 barrels of crude petroleum, meaning that the region is technically self-sufficient in crude oil because South Sudan’s total production could meet the present demand for all seven countries classified as East Africa in this survey.

Thus Uganda and Kenya’s potential for an additional 140,000 barrels per day would ensure that the region has sufficient reserves to adequately cover energy demand growth for at least another decade.

Holding the production peaks constant, the South Sudan, Kenya and Uganda could supply close to 500,000 barrels of crude oil daily for at least 20 years.

At the country level, Kenya’s intense energy utilisation is estimated to require 110,000 barrels of crude petroleum per day going by 2016 figures.

While official estimates are to be treated with caution, the current plan to extract at least 80,000 barrels daily for the lifetime of existing reserves in northwestern Kenya imply that even at its best, the country will remain a net importer of petroleum energy resources.

While South Sudan and Uganda currently consume 5 per cent and 50 per cent of their daily extraction rates, Kenya already consumes 37 per cent more than what its best estimates of future extraction would allow.

In the medium to long term, five of the seven countries in East Africa will continue to rely on international trade for this form of energy.

These differences in current energy demand and the sizes of the economies show that the oil market picture in East Africa will be dynamic in the next 20 years.

Most of these countries are growing at rates that are above the African and global averages and it is expected that intensity of energy use in that time will rise. Over time, that surplus in oil production from the region will diminish unless alternative sources are found or the ongoing prospecting leads to more discoveries.

Extraction costs

The investment decision behind the methods of extracting crude oil hinges on the quality of oil and the ease with which drilling equipment can access it.

Kenya’s oil is waxy. Its quality has been said to be close to a flavour termed Dubai/Oman. Kenya’s cost of extracting crude oil was quoted by Tullow Oil at $25 per barrel.

Saudi oil by contrast can be extracted for $3 while Iranian oil costs even lower at $1.94 to extract. These oil producers can continue extracting crude oil with profitable margins at very low market prices.

The extraction costs of Uganda’s 6.5 billion proved reserves are unavailable as drilling has yet to begin. South Sudan’s extraction costs proved difficult to confirm at the time of writing.

Crude oil can be transported by road, rail or pipeline. Refineries constitute the final market for crude oil and are situated physically dispersed as lone enterprises or large clusters whereas refined petroleum products find market at very local levels.

Refineries are strategically located as close to the points of export as possible, thus tend to be commonly found at seaports. Kenya’s refinery at Changamwe in Mombasa is one example.

Though located thousands of kilometres away from the port of Mombasa, its closest port, a proposed refinery at Lake Albert in Uganda is to strategically serve the East and Central African markets.

Whatever the circumstances, transportation of crude is most economically viable by pipeline while transportation of refined products is most viable by truck.

The United States boasts an efficient, well developed and large transport sector making the average cost of transporting crude oil in the US $20 by road, $15 by rail and $5 by pipeline according to the economic think tank Strata.

These estimates form a useful guide in this discussion.

A historical pipeline construction cost analysis allowed us to model a pipeline of a 36cm radius whose per kilometre cost works out to be $980,000.


Its specifications match those of the existing retail petroleum pipeline operated by the Kenya Pipeline Company with a throughput of 200,000 litres an hour.

Straight line distance from the port of Mombasa dictates that South Sudanese oil would be costliest to transport by pipeline.

The country would spend $1.74 billion dollars on construction and incur an additional $1,750,000 per day to transport at its peak production of 350,000 barrels to the port of Mombasa. At a marginal net revenue of $10 per barrel, our model suggests that South Sudan would repay its initial investment in 1.362 years.

One must note, however, that South Sudan’s budget is funded by oil revenue so the country cannot afford to set aside all its oil revenue to pay for a pipeline.

Kenya’s reserves’ proximity to the sea port would mean that at $5 per barrel, the country would incur a daily cost of $400,000 in transportation costs based at a peak production rate of 80,000 barrels per day – the lowest among the three countries. At a marginal net revenue of $10 it would take the country 2.6 years to repay the cost of constructing a pipeline.

Additionally, Kenya’s waxy crude oil must be heated in transit meaning a pipeline may have to incorporate a design that allows for the oil to remain warm as it is pumped through to the Coast. This implies that trucks transporting Kenyan crude may themselves need to have specialised heating equipment, increasing the cost of transportation by road.

Uganda’s lower rate of production at 60,000 barrels of oil daily and being 1,374 kilometres away from the port of Mombasa, gives it 5.3 years to repay the cost of constructing a pipeline.

Uganda’s reserves-to-production ratio of 296.8 years however means the 5.4 years to repay the cost of pipeline construction makes up only 1.78 per cent of the total 296.8 years lifespan of its proved oil reserves.

Kenya would take 10.4 per cent of the lifespan of its reserves to repay while South Sudan would take 5 per cent of the life span of its reserves to repay for a single pipeline.


It is important to note that global convention dictates that crude oil transportation pipelines be networked in order to increase efficiencies and reduce costs. Based on these facts, it is clear that even the proposed LAPSSET pipeline by Kenya could only be viable if South Sudan, Uganda and Kenya were to co-ordinate their pipeline construction efforts.

The LAPSSET authority itself projects that its pipeline transportation costs would be $2.45 or half of the North American average, a cost that analysis suggests is impossible without the participation of all the three countries on the project.

Extraction of natural gas

Gas is also categorised as associated gas (found together with oil) as is the case in South Sudan or non-associated gas (found without oil) as is the case in Tanzania.

Exploration and production of gas is very similar to that of oil. Natural gas can flow freely to the wells and doesn’t need any kind of pumping system due to its natural pressure from the reservoirs. To increase the pressure, geologists sometimes create fractures within the rocks.

The second method involves a pumping system. Depending on factors such as the terrain of where the identified reserve is, the capital required vis-a-vis the expected revenue, skilled labour, national regulations among other factors affect the decision to extract the natural gas.

Qatar is the largest producer of Liquefied Natural Gas (LNG), producing 25 per cent of the global production (Institute of Economic Affairs, 2014) and Japan is the largest importer of LNG, taking up 37 per cent of the total global LNG trade.

Transportation of natural gas

Gas can be transported either by pipeline, road or rail. Transportation by pipeline is the most cost effective of the options.

In Africa, associated gas is mostly flared up or re-injected as is the case for Nigeria and South Sudan. This is because the demand for natural gas isn’t as high as in other continents. Natural gas must therefore be prepared for export; a costly process involving the liquefying of the natural gas.

Globally it costs about $1 billion to $1.5 billion per 1,000km to construct a pipeline of about 40 to 60 inches in diameter according to a survey by the World Bank. For instance, the 36-inch radius Alliance gas pipeline running from Canada to the US cost about $3 billion to build in 2000.

It is estimated that the total project costs of a pipeline and an LNG plant in Lindi in Tanzania would be $30 billion, which is more than 50 per cent of the country’s GDP in 2017. Once this capital investment is made, Tanzania is expected to reap close to $5 billion per year in revenues.

With the lifespan of the reserves standing at about 13 years, then the project will break even in six years or halfway into the project schedule.

Natural gas can also be transported via road. However, this option is five or six times more expensive even before accounting for environmental costs.

For LNG, the specialised trucks have to be insulated in order for them to prevent re-gasification of the natural gas. This adds to the cost of the trucks.

Transporting by trucks takes certain factors into consideration such as the size of the truck and the distance it has to travel, to help in estimating the total number of trucks that the project needs, if it is to go this way.

In the US, the cost of transporting oil by pipeline and truck are the same at $20. This emboldens Tanzania’s determination to construct the pipeline and compression infrastructure.

In as much as this would be the ideal situation that would lead to economic growth and development in Tanzania, there are various unfavourable expectations that may contribute to this project not taking off any time soon.

Other than it being capital intensive, one of the factors that are discouraging mining of natural resources in Tanzania by foreign investors is the Tanzanian mining policy which remains a major bone of contention.


A networked design that efficiently combined the pipelines of South Sudan, Uganda and Kenya would reduce the overall cost of pipeline transportation for crude oil. If each were to build their own pipeline, they would have white elephants.

Natural gas is a cheap source of energy globally. However, it is extremely capital intensive to extract. Even though this is the case, the fact that it is generally economic feasible, ensures its continuous extraction worldwide.

Investors do not want a scenario where they put in so much in the infrastructure, only for the reserves to be depleted in a few years. In the case of East Africa, a regional gas market would be the ideal as one of the ways of reducing the initial costs of production.

Institute of Economic Affairs is a Nairobi-based Think Tank.