Understanding Cost Recovery in Uganda’s Petroleum Sector
The cost management framework for Uganda’s oil and gas sector is based on the Production Sharing Agreement (PSA) which is one of the four (4) major types of petroleum regimes between International Oil Companies and Host Governments. The choice of regime depends on various factors including the availability of risk capital for investment, given that petroleum exploration is high risk and capital intensive, more so in virgin basins where no discoveries have been made. This was the case for the Albertine Graben prior to 2006 when Uganda’s first commercial discovery was confirmed.
Types of Petroleum Agreements/ Fiscal regimes
One of the four is a Concession Agreement, where the company acquires the right to explore and develop petroleum resources at its sole risk and agrees to pay royalties and income taxes to the host government. The company has control on production rates and marketing, therefore the government grants title to resources to company and collects taxes and other fees. Iran, Nigeria and Chad have used concessions.
Service Contracts are mostly used in countries with huge proven reserves, such as Saudi Arabia. The oil company finances and operates petroleum operations and receives fees for their services, either in cash or in kind. The entire risk is borne by the country and the title to the petroleum resources oil belongs to the country.
Joint Venture Agreements where both the host country and the oil companies share the risk and provide the required capital for exploration, development and later production. Kuwait and now Venezuela use these Agreements.
Production Sharing Agreements
Production Sharing Agreements were first used in Indonesia in the 1960s and are common in developing countries that do not have the risk capital to invest in petroleum operations. In these agreements, the government contracts an oil & gas company to finance and undertake petroleum exploration, development and production operations. The company receives a proportion of oil/gas production for the recovery of their costs and for a share of the profits. Uganda runs a hybrid PSA regime where in addition to cost oil and profit oil, the licensees pay royalties and other fees as prescribe by law.
The key features of Uganda’s and most PSAs include:
- The oil company is a contractor to the host government.
- Cost recovery begins when production starts.
- Host government and contractor share in production.
- Provision for sharing of profit oil.
- The contractors’ share of profit oil is taxed.
- The contractor is required to provide technology and financing; exploration and development expenditures are met by the contractor.
- The title to any goods and equipment brought into the country passes to the government.
- Ring fencing of costs, i.e. costs incurred in one contract area cannot be recovered from production from another contract area.
- Ownership of the resource remains with Government.
It is important to appreciate that no two PSAs are alike and various combinations of features can be adopted depending on the legal framework, negotiations between the government and the oil company, and the geological risk profile. Uganda currently has seven active PSAs with five oil companies.
The advantage of the PSA regime for a developing country like Uganda is that the financing risk is borne by oil companies and the title to petroleum remains with Government. Government also approves production rates and profiles, how the resources are commercialised (refining and/or export), monitors the expenditure by the company to ensure efficiency in operations, and approves recoverable costs.
Determining and Monitoring Recoverable Costs
In Uganda’s PSA regime, a company will only recover the exploration and development costs after a commercial discovery is made and production is undertaken. If no discovery is made (as was the case in EA 5 and EA 4b whose licenses expired before discoveries were made), no recoverable costs are due to the company. For areas where discoveries are made, companies recover their costs over a period of time and the amount to be recovered is capped for each year at a certain percentage (say 60%) of revenues. Therefore, a company cannot recover all its costs in one year and this enables government to receive revenue from the onset of production.
Additionally, in Uganda, before the amount to be recovered each year is calculated, the gross revenues are subject to a royalty payment to Government which ranges from 5.5% to 18%. Government will therefore receive a royalty payment each year before the recovery of any investments costs by the companies and will also earn its share of profit oil and taxes during the time the company will be recovering its investment costs.
The type of costs which are recoverable include all Capital investment in Exploration, Development, Production and Operating expenditure approved by the Petroleum Authority of Uganda (PAU) and audited by the Office of the Auditor General.
Uganda’s Petroleum Regulations and the PSAs provide for an Advisory Committee comprising of representatives from the PAU and the licenses that reviews and approves the oil company annual work programmes and budgets. Any changes must be submitted for approval. The work programmes are monitored by the Authority (previously by the Directorate of Petroleum in MEMD) to ensure alignment with approved budgets and plans. This also includes approving contracting strategies and organisational structures to ensure compliance with the laws and that Ugandans and Ugandan businesses are given priority.
In addition to Monitoring, the Authority holds regular operations meetings with the licensees and ensures submission of detailed reports and the geoscientific data acquired in order to carry out its independent assessment of the work undertaken.
Approval for expenditure does not amount to approval of costs for recovery since the expenditures have to be audited. The licensees submit their annual statements of expenditure to the PAU and these are examined by the Auditor General who gives final approval of which expenditures are recoverable. This means that any cost overruns that were not approved by the PAU cannot be recoverable. Indeed, from the cost recovery Audits for petroleum operations for 2001 to 2011 undertaken by the Auditor General, close to USD 40 million was determined unrecoverable due to non-compliance with the provisions of the PSAs.
The PAU will and continues to ensure that the oil and gas operations are undertaken in an efficient manner and in compliance with the country’s laws and regulations, and will work closely with the oil companies and the Office of the Auditor General to achieve cost efficient operations so that Uganda’s oil and gas resources create lasting value to society.
Mr. Ali Ssekatawa
Director for Legal and Corporate Affairs
Petroleum Authority of Uganda