Uganda still faces significant hurdles to its stated 2018 target for oil production despite the selection this week of a developer for its 60,000-barrels-a-day oil refinery.

The unresolved dispute with upstream companies over taxation and an ongoing standoff between the oil companies and Kenyan authorities over the routing of the export pipeline, are likely to drag on for some time, according to people familiar with the negotiations.

The government announced on February 17 that Russian firm RT Global Resources had been selected to build the refinery in western Uganda and a 250km-long pipeline to Kampala.

READ: Russian firm wins Uganda oil refinery contract

While analysts say the development is a step towards independence from imported oil, they caution that the expected benefits will not materialise until issues holding up the upstream sector are resolved.

“Looked at by itself, the selection of a developer for the refinery is a positive development, but for the refinery to pick up, the upstream project needs to be unlocked,” commented one analyst.

Unenthusiastic about a crude export pipeline, Uganda commissioned studies that showed that a domestic refinery would have a better internal rate of return and net present value compared with an export pipeline.

But at a national demand of only 30,000 barrels, a refinery configured around domestic consumption would consume only 10 to 15 per cent of the proposed peak production of 220,000 barrels per day. The oil companies have argued that without a crude export pipeline, the returns would be too thin to support the required investment of approximately $9 billion to bring the upstream oil to production.

“It is unlikely that investors would be willing to spend $9 billion to refine only 15 per cent of the available crude,” commented one analyst who asked not to be named.

With a typical industry equity ratio of 80-85 per cent debt, it is also unlikely that lenders would be able to reach investment decisions in the absence of progress on the financial issues holding up the upstream, he adds.

The Energy Ministry and upstream operators Total E&P, Tullow and China’s CNOOC entered into an MoU pipeline just over a year ago that provides for the concurrent development of a refinery and export pipeline, but there has been little progress towards allocation of production licences beyond the one given to CNOOC.

None of the 14 production licences applied for by Tullow and Total have received the nod.

Without these, the oil companies cannot complete field studies and front-end engineering design, which are essential to determining the social and environmental footprint and thus their investment plans.

And without these, the companies cannot raise the estimated $13 billion- $15 billion that will be required to develop upstream infrastructure and the export pipeline. And even if production rights were granted, there are still tax hurdles to negotiate.

Ministry of Finance PS and Secretary to the Treasury Keith Muhakanizi said the “outstanding issues will be resolved sooner rather than later.”

The oil companies are reported to be concerned over the requirement to pay VAT at the rate of 18 per cent and withholding tax at 15 per cent on supplies, when 90 per cent of them will be imported. That means that either the suppliers or the oil companies will lay that additional cost off by raising the value of their invoices.

This has the potential to increase the upstream project cost with some analysts suggesting that to lay off the 15 per cent withholding tax, the oil companies or their suppliers would have to raise the invoice value by 18 per cent.

Tax costs

According to Dr Fred Muhumuza, a senior manager at KPMG Uganda, one way to break the impasse would be to make the tax costs recoverable, since Uganda wants to collect taxes on the go rather than wait for the revenue phase.

“While it could unlock stalled progress, the challenge with that is that it does not take away the issue of finance costs for the oil companies and the final cost of the project, because it means they would have to borrow more and pay interest on the tax component of the loan,” he said.

The stalemate in the upstream sector pushes back the date when Uganda’s fields can go into production, but it is not the only threat on the horizon. According to estimates by industry experts, it would take a minimum of five years from the time oil companies are given the go-ahead to first production.

READ: Oil and gas in EA: Without enabling structures, region could alienate investors, delay projects

According to independent sources, the troubles in Uganda are only part of a larger problem. While the partners in the LAPSSET corridor to which Uganda is a signatory have engaged a consultant to design a route for a crude export pipeline, its routing in Kenya remains a matter of contention between the authorities there and the oil companies.

Given the large number of expatriate workers they will be employing, the oil companies are uncomfortable with the northern routing that would see the pipeline terminate in Lamu, an area they consider to have been Al Shabaab’s headquarters in Kenya until recently.

Kenya’s President Uhuru Kenyatta, on the other hand, is keen on the route because he needs the LAPSSET Corridor to open up northern Kenya and bring development to the area.

According to informed sources, cost is not an issue since the Central Corridor that would terminate in Mombasa is only marginally cheaper. Though shorter, its execution would have to find solutions to the congestion around Mombasa.

Combined with Uganda’s production sharing agreements, at a ratio of 80:20 in favour of the government during the post-cost recovery phase, the recent fall in oil prices also makes investment in Uganda’s oil industry a complex decision for investors.