East Africa: Will Uganda Overcome Its Own Fears to Revive Stalled Hoima-Tanga Oil Pipeline?

Kampala — Uganda has been trying to get oil of out the ground for the last 12 years, having discovered reserves in 2007.

Two weeks ago Tullow Oil ended its proposed farm-down to China National Offshore Oil Corporation (CNOOC) and Total of 21.7 per cent of its 33.3 per cent shareholding in the Joint Venture Agreement (JVA) with these two firms.

Then Total announced an indefinite suspension of the pipeline project plus planned investment in the oil production facilities. Both CNOOC and Total have begun a massive lay off of staff by about 70 per cent. Tullow did this a long time ago.

As I write this article, Uganda's prospects for oil are remote. The deadline for first oil has been shifting since 2011. Today we are eight years behind the first target for exporting oil.

The prospect of oil can now be projected beyond 2027 at best. Incidentally, the reason for these days is the extreme care government of Uganda has taken to avoid being accused of corruption and mismanagement of oil revenues.

The result has been well-negotiated Production Sharing Agreements (PSAs) combined with a level of stubbornness that borders on absurdity leading to no production.

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In many ways, government delays to place its fingers on oil defies logic. Ideally governments, especially in poor countries that are under constant demand for revenue to finance many spending demands would forego many niceties to move towards oil production.

This is because oil would bring revenue windfalls to finance both investment in infrastructure (which Uganda is doing on a massive scale right now) and pay for patronage. For whatever reasons, government of Uganda does not seem to be in a hurry, which ideally should be a good thing. However, when examined closely, it is the most absurd thing one can do.

What is the dispute between oil companies and government today? It began with Tullow selling its 21.7 per cent stake in the JVA at $900 million (Sh2.07tr) to CNOOC and Total. It bought the oil block ("the asset") it is selling from Heritage at $345 million (Sh793bn). It spent an extra $272 million (Sh625.6bn) to develop it. The National Petroleum Authority (who approves each and every cost oil companies incur) and the office of the Auditor General (who audits government books) agree to it as a "past cost". This brings Tullow's total past cost on this asset to $617 million (Sh1.42tr).

When Tullow sought to sell this to CNOOC and Total at $900 million, it anticipated paying Capital Gains Tax (CGT) of $85 million (Sh195.5bn). This was done by subtracting past costs of $617m from the sale price of $900 million, leaving capital gain of $283 million. In Uganda, CGT is 30 per cent of extra value one realises above the purchase price of an asset when selling it. Assuming you buy a house at Sh500 million and sell it at Sh800 million, the capital gain is Sh300 million. So you pay 30 of Sh300 million as CGT. But if after buying the house, you spend Sh200 million renovating it and then sell it at Sh800 million, your total cost would have been Sh700 million giving you a capital gain of Sh100 million. So CGT would be 30 per cent of Sh100 million.

Uganda Revenue Authority refused to recognize the $272 million past cost Tullow had spent developing the oil field. It insisted it would charge CGT on the difference between $900 million (selling price) and $345 million (buying price) i.e. on $555 million. This brought the CGT to $167 million. Tullow insisted it would pay only $85 million, Uganda Revenue Authority (URA) insisted on her position as well. The impasse lasted more than a year. Then CNOOC and Total, to end the standoff and allow the investment in oil to go ahead offered to pay the difference between Tullow's offer ($85 million) and URA's demand ($167 million), which came to $82 million.

Then a new dispute occurred. Sometime after Heritage's sale to Tullow and Tullow's farm down to CNOOC and Total, Uganda passed a crazy law saying that if one buys oil assets, past costs would not be transferred for tax deductibility purposes when calculating profit (corporation) tax. CNOOC and Total found this law bad. I am going to explain why I agree with them and it is counterproductive. They asked either parliament repeals the law or the executive gives them an exemption. President Yoweri Museveni refused. It is on this dispute that the negotiations hit a dead end.

Essentially this law is saying two absurd things. First if Tullow doesn't sell, it will enjoy the tax deductibility. If it sells, the buyer will not enjoy the same. This means the law was made to discourage the buying and selling to Uganda's oil assets -- which is another way of saying that Uganda passed a law to discourage investment in her oil industry. This is even the more absurd because industry practice is that it is small firms that take the risk to come to our poor countries to prospect for oil. When they find it, they sell to big firms who then invest in the development and production of oil fields.

In passing a law discouraging the selling of oil blocks, Uganda has essentially blocked itself from a wide array of investors interested in prospecting for her oil. No wonder, mid this year when Uganda auctioned new oil exploration licenses, no small company with a good reputation for skills and knowledge in exploration showed up. I am informed that only three, most probably briefcase companies from Nigeria expressed interest in our mighty oil.

Secondly this law is absurd because it essentially means that one's investment cost would be treated as revenue and therefore taxed. I do not know of any investor, except a fake one, who can accept this. All public officials outside of URA that I have talked to think Uganda's position borders on madness. They are not willing to express their views on the matter for fear of being accused of having been bribed by the oil companies. The fear of corruption has led to an incredible absurdity -- bad policy wins the day.

The reader should not think that the dispute over the $185 million in taxes is actually about a tax likely to be paid tomorrow. This is a hypothetical tax -- that at some future date (it could even be ten years from now) when CNOOC and Total make a profit, this $617 million will not be considered a cost when calculating their profit tax. Essentially Uganda has blocked an investment of anything between $15 and $20 billion, which would also make our economy double in five years over a hypothetical tax of $185 million realizable ten years hence. If this is not the height of madness, what is it? This articles was first published in The Independent of Uganda.

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