Uganda will soon start producing oil. However, oil is a non-renewable resource, and it is estimated that the life cycle of oil production is between 25 and 30 years. The question that arises is: what happens next?
The country's legal framework must provide two major important issues: balancing local content policies and decommissioning the infrastructure that will be used in the oil and gas production processes. Decommissioning in the oil and gas industry denotes the procedure of securely retiring and dismantling oil and gas facilities upon the conclusion of their operational lifespan.
This procedure guarantees environmental preservation, safety, and adherence to regulatory requirements. The methodology for decommissioning differs throughout nations, shaped by distinct legal frameworks and legislation. In Uganda, a decommissioning fund is proposed in the Petroleum (Exploration, Development and Production) Act, 2013, Sections 112 and 113.
The Act establishes a decommissioning fund for each development area or other facilities operated in relation to a license or permit granted by the Act. Important to note in the Act is the timing of payment into the fund.
The Act provides for payment into the fund when (i) the fund has reached 50 per cent of the aggregate recoverable reserves as determined in an approved development plan and any successive reappraisal of such initial recoverable reserves, (ii) five years before the expiry of the license or (iii) on notice of surrender.
These triggers are weak and present the country with a high risk. The absence of guidance and detailed regulations on decommissioning aggravates the situation.
Waiting to start payment into the decommissioning fund when the fund has reached 50 per cent of the aggregate recoverable reserves as determined in an approved development plan, and any successive reappraisal of such initial recoverable reserves, poses a risk of failure to accumulate the required funds for decommissioning costs and loss of the time value for money.
The second trigger is when five years are remaining to the end of the oil production cycle. Here, it is construed that 50 per cent of recoverable oil has not reached and this presents a big risk because in only five years, it may not be feasible to accumulate the funds needed to fund decommissioning costs.
The third trigger is on surrender of the production license granted by the Act. This implies that once the surrender is granted by the minister in accordance with the Act, the operator will have no liability thereafter. However, the operator will still be responsible for the liabilities before the surrender. On application for surrender, decommissioning obligations will be triggered.
The operator has a short period to fulfill the decommissioning obligations. As asserted above, the period is so short that it may not be sufficient to raise the needed funds. It should also be noted that by the time the operator applies for surrender, the company may be facing financial challenges, which complicates payment into the decommission fund.
To ensure that there is a financial security guarantee, and that there is no turning to taxpayers' money to cover decommissioning costs, nations have put in place strict laws and detailed guidance on decommissioning. These guidelines are regularly updated to comply with changing environmental, economic and regulatory requirements.
This requires investment in human resource to ensure there is accurate monitoring and assessment of decommissioning costs. Building capacity in this area is key. It may seem far, but 25 years is a short period, and we need experts now in addition to reviewing the regulatory framework. Below are some of the instruments that nations have negotiated to guarantee financial security of decommissioning costs.
SURETY BONDS
These are financial instruments that transfer risk from the government to a third-party, reducing taxpayer exposure. Surety bonds provide quick access to funds should the operator default on decommissioning obligations. However, they require a commitment of funds on the part of the IOCs.
DECOMMISSIONING TRUST FUNDS
This approach involves setting aside funds that are separate from the operators' assets. The funds are accumulated over a lifecycle period of the project and the trust funds are managed by professionals. Uganda can benchmark from Norway and the United Kingdom.
LETTERS OF CREDIT
Like escrow accounts, letters of credit also provide quick access to decommissioning funds should the operator default. These letters are issued by the banks, guaranteeing that if the operator faces financial difficulties the bank will provide the required finances for decommissioning costs.
The challenge is that letters of credit can tie lines of credit of the operator, limiting their ability to secure additional project financing. Again, this is another option that Uganda can explore.
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INSURANCE PRODUCTS
Some countries such as Mexico have developed insurance products to finance decommissioning costs in the event of default by the IOCs. Insurance can effectively spread financial risks across the industry and ensure that funds are available for decommissioning costs.
The disadvantage is that insuring decommissioning costs may demand prohibitive premiums, especially in regions with elevated operational risks and coverage terms may vary, leaving gaps in decommissioning costs.
ENVIRONMENTAL BONDS
Environmental bonds provide quick access to funds compared to accumulating funds at 50 per cent of recoverable oil as it is the case in Uganda.
They provide another layer of assurance in case of default by the operator. However, the premiums are also high in the case of small operators.
It is high time Uganda revised decommissioning laws and issued detailed guidance on decommissioning of oil and gas installations if the country's treasury is to be saved from carrying the burden.
The writer is a member of CFA Institute and an LLM student at Institute of Petroleum Studies, Kampala.
