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Risks raise barriers to East Africa’s LNG export ambition

09 Mar 2012 15:55:53 | glm

A string of vast natural gas discoveries in Mozambique and Tanzania over the past year has cemented the region's prospects of becoming the next major LNG export hub, potentially challenging Qatar and Australia in the long term.

Three large-scale LNG export projects are being underpinned by natural gas reserves from the Rovuma Basin straddling the border of Mozambique and Tanzania.

Up to 60 trillion cubic feet (tcf) in the Mozambican sector is being developed by consortia led by US-based explorer Anadarko Petroleum and Italy's Eni, which have both outlined plans to take final investment decisions by the end of 2013 on their respective liquefaction schemes.

Meanwhile, north of the border, BG Group is currently screening locations for an onshore LNG plant in Tanzania, with the company planning investment of between $10 and $20bn in the country over the second half of the decade.

The region's prospects have been underlined by the emerging bidding war for UK-listed explorer Cove Energy, which has an 8.5% interest in the Anadarko-led consortium, which is developing the Rovuma Offshore Area 1 licence.

Last month, the Anglo Dutch major launched an all-cash £1.95 ($3.07) per share offer for Cove, valuing the company at $1.6bn. This was immediately trumped by Thailand's state energy company PTT, which countered with a $1.8bn offer, while India's state energy companies GAIL and ONGC are also reportedly preparing a joint bid for Cove (see GLM 24 February).

With the region only a seven-day journey away from the growing LNG market of India, which BG tips to become the third biggest global LNG importer by 2025, and around 14 days away from East Asia, there is plenty of motivation for international oil companies and buyers alike to secure an upstream foothold in East Africa.

Increasing numbers of international explorers such as Brazil's Petrobras, Norway's Statoil and US major ExxonMobil, have stepped up their exploration campaigns and recently joined the list of companies with promising exploration results in the region.

Speaking at the IHS CERAWeek conference in Houston this week, Statoil's CEO Helge Lund said the company was moving rapidly forward with its recent discovery in Tanzania's Block 2, noting that it would ideally like to target Asia with an LNG project.

Similarly, Eni's CEO Paolo Scaroni has said that he has received significant industry interest from its plans to divest a 20% stake in its block in Mozambique.

However, the costs of developing LNG and the number of participants now engaged in Tanzania and Mozambique could yet inhibit and slow the series of liquefaction projects.

"There are too many proposed projects in this region that need to be consolidated," said Leigh Bolton, principal and managing director of Holmwood Consulting.

The size and cost of liquefaction plants has been trending upwards for a number of years, and although East Africa's LNG development costs are understood to be much lower than Australia - where costs for the recently sanctioned Ichthys development came in above the $4,000 tonnes per annum mark - the outlook for developing major projects in a frontier province are not without potential stumbling blocks.

Regulatory over-haul in Tanzania

Factors such as regulatory risk and contract frustration are two factors that could slow LNG development in Tanzania and Mozambique, according to Robert Besseling, a senior Africa forecaster at Exclusive Analysis, a political risk intelligence company.

Tanzania has planned a regulatory overhaul of its energy sector for a number years, but progress has stalled. However, with the prospect of multi-billion dollar investments over the next five years the government now expects to finalise its Natural Gas Master Plan by June 2012.

The plan will go some way to outlining the legal and institutional framework ahead of large-scale gas production but it isn't until the end of 2012 that a report will identify how to deliver that plan.

Aside from identifying the steps on the road to a new tax and royalty regime through licensing laws, it would also assess the possibility of a sovereign wealth fund as part of a revenue management bill that would be presented to parliament next year.

Given there is very little current natural gas legislation in the country, the government has recognised "considerable work is needed in a macroeconomic and budget management context" to ensure its successful transition to a new "gas economy".

Although environmental standards, ­employment and local procurement provisions are also expected to feature in the wide-ranging report, Besseling believes the legal framework could still be in place by as early in 2013. Without a credible framework in place planned investments in the country would be stalled.

However, Tanzania's most advanced LNG project - a BG Group and Ophir joint-venture - is believed to have already sealed the terms and conditions of gas production. Before UK-listed explorer Ophir began its exploration campaign in 2010, a source close to the project suggested it had locked into a production sharing contract (PSC) that would make it exempt from the government's ­forthcoming regulatory overhaul.

Should the government's review advise a fundamentally different approach to the one agreed with Ophir and BG Group, however, it would not be uncommon for a government to use a get-out clause within the PSC, ­according Bolton.

Contractual uncertainties

Revisions to PSCs and taxes would not be a new phenomenon in the region. While the over-riding objective of government is to attract foreign investment, once in the country previous evidence suggests initial fiscal terms, can and do change.

For example, the Ugandan government slapped a $472m capital gains tax on UK independent Tullow Oil's farm-out from its Kingfisher field to France's Total and China's CNOOC. And the Mozambique government last week made similar noises to levy a capital gains tax on the sale of Cove Energy, ­underlining the risk of political interference.

The rate for this new tax has not yet been decided and Cove Energy is continuing to seek clarity on the issue, a source close to the matter told ICIS Heren this week.

Meanwhile, the Mineral Resources ­Minister, Esperança Bias is quoted as saying that the government would "legislate for capital gains tax so that it could be applied to such deals going forward".

With the proposed offers from Shell and PTT needing government approval the state can afford to take a tough stance on the tax.

The PSCs underpinning Offshore Areas 1 and 4 in Mozambique, operated by Anadarko and Eni respectively, are understood to have been initially structured for oil production rather than gas and have also come under scrutiny, with sources saying they are ­currently under renegotiation.

However, this is not expected to hold back the sale of Cove's assets nor the advancement of the project as the Mozambican government would be keen for the projects to move forwards towards monetisation, ­according to Bolton. Exclusive Analysis identified this as part of a wider resource nationalism trend in Mozambique that has already affected the mining sector.

It is a trend that is also present in ­Tanzania, which in April 2010 revised legislation to pave the way for increases in taxes and royalties to international miners active in the country from the early 2000s.

Piracy threat raises premiums

A more pressing concern for the East African developments has been the increased risk of collateral damage to exploration vessels posed by the threat of Somali pirates, who operate as far south as Mozambique. It is not a theoretical risk, with an attack by seven Somali pirates on a Petrobras-operated exploration vessel in the Tanzania Offshore Area 6 last October showing the international nature of the problem.

According to the International Maritime Bureau, the number of Somali piracy attacks rose from 219 in 2010 to 236 in 2011, although the increased presence and greater co-ordination in the international naval effort saw greater success in disrupting Somali pirate attacks before they could become a threat to commercial shipping. Nevertheless, the insurance premiums for offshore exploration and production vessels operating in the region have risen accordingly.

Anadarko's plans for a two train, 10 million tonne per annum LNG plant to be built with the flexibility to scale up to six trains would allow it to benefit from economies of scale. However, the absence of a local skilled workforce with the required engineering and manufacturing capabilities obliges the ­developments to import assistance.

With Anadarko selecting a modular approach there is a possibility parts for the plants can be constructed abroad without the need to import labour or train the local workforce.

Even if local content rules oblige onsite construction, importing labour from West African nations such as Nigeria and Equatorial Guinea with experience in liquefaction might not be hard, according to Bolton.

East Africa's project should be more economic than Australia's given importing labour would still be cheaper than the highly unionised workforce present in Australia.

The region's reliance on external assistance across the spectrum from labour to technology, however, leaves it particularly exposed to movements in currency markets.

"Plant costs are always quoted in US ­dollars but expenditure would be in a variety of currencies," Bolton said.

The weakening of the US dollar led ­Exxon-Mobil to announce a $700m cost increase at its PNG project to $15.7bn (see GLM 02 December 2011).

While currency risk can be hedged by commercial banks, it is the regulatory and contract risks borne by shareholders that are shaping up to be the most likely cause of upset in the long road to commissioning liquefaction plants.

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