Somalilandsun- in this public sensitization article the writer Hasan H Farah Dudu argues the merits and the demerits of the quest for the liquid gold in Somaliland.
Search for Oil: Somaliland between Resource Prosperity and Resource Curse
By: Hassan Haji Farah Dudu
The purpose of this paper is to sensitize the general public, government officials and the media in Somaliland about the impacts and issues inherent in the hydrocarbon industry, to educate them and to recommend remedial actions in light of the recent development in the oil and gas sector of the country. A secondary objective is to open up public debate and discussion of the key issues which will impact citizens and stakeholders.
The paper consists of ten sections: the first illustrates the location of the Republic of Somaliland and recounts her recent history; the second describes the geology compared to hydrocarbon producing countries in the region or those that made recent significant discoveries. The third to the seventh present the features of “standard” international petroleum contracts compared with recent contracts the country signed with multinational oil companies (MNOCs). The eighth outlines the advantages and disadvantages of these contracts. The ninth and tenth identify and discuss issues that need careful attention and close management to enable the country to employ her natural resources for a sustainable economic development, growth and social equity.
2. The Recent History of Somaliland
The Republic of Somaliland, situated on the tip of the Horn of Africa, restored its independence from the union with Somalia on May 18, 1991. Somaliland gained its independence on June 26, 1960 from Britain and united with [Italian] Somalia and formed the Somali Republic. It is bordered by Djibouti to the west, Ethiopia to the south and the Puntland region of Somalia to the east. Somaliland has 740 kilometers (460 miles) of coastline, with the greater part lying along the Gulf of Aden. The country is slightly larger than England, with an area of 137,600 km2 (53,128 square miles). Sixty percent of the population is nomadic rural and forty percent urban.
Somaliland has formed a hybrid system of governance under a constitution combining traditional and Western models. The government is run by the executive branch of an elected president, a vice president and a cabinet nominated by the president and approved by parliament. The president is directly elected by the citizens, and presidential elections are certified by the National Election Commission.
The geopolitical changes which took place in the Horn of Africa in the past 25 years have brought about new sentiments in dealing with the challenges in the region. For example, the political reality of what was the Somali Democratic Republic has dramatically changed since 1991, when the union collapsed and the country was split into three major zones of influence: the Republic of Somaliland, Regional Administration of Puntland, and the rest of Somalia.
In Somaliland, clan reconciliation meetings were convened between 1991 and 1997. This provided the foundations for state building which led to a peaceful country run by a functioning government. At the turn of the century, Somaliland embraced multi-party democracy and to date held two presidential, one parliamentary and two local council elections between 2003 and 2012. Though not diplomatically recognized by any country, Somaliland enjoys de-facto respect as a state and openly deals with the international community. Its experiment in building a modern government derives from traditional, tribal power sharing, mediation and sovereign state structures.
Somaliland now has informal relations with Ethiopia, Djibouti, and with many member countries of the African and European Unions. Somaliland’s economy is in developing stages, as is the region. The Somaliland shilling, while stable, is not an internationally recognized currency and has no official exchange rate.
3. Somaliland Geology, Exploration and Hydrocarbon Potential
Published and unpublished geological data (mainly private corporate data) of the area indicate that oil and gas exist in favorable reservoirs and in structural stratigraphic traps. The traps are in basins across the Gulf of Aden matching the hydrocarbon-producing Marib-Hajar and Say’un-Al Masila basins of Yemen. This has raised the hydrocarbon prospect of Somaliland .
The sedimentary rock surface of Somaliland includes post-Triassic continental and marine strata which accumulated in basins. Jurassic sediments that occur on the surface of the country are found in extensive tracts of territory lying to the north of Borama, in smaller areas to the south and south-east of Berbera, and in the north-east of Ceerigabo [Erigavo], south of the Golis escarpment and extend eastwards along it. The Cretaceous sequences occur in the central area, south and east of Sheikh and extend eastward along the escarpment. The other Cretaceous rock outcrops occur in the area of Hargeisa and the mountainous zone in north-east of Ceerigabo. By the end of the Cretaceous Period, a westward marine transgression permitted shallow-marine, Paleocene – lower Eocene limestone (Auradu Formation) deposition throughout Somaliland. This is succeeded by thick anhydrite strata (Taleh Formation) overlain by Middle to Late Eocene shallow-marine limestone (Karkar Formation). The latter is the youngest stratigraphic unit straddling the Gulf of Aden. Younger strata of syn- and post-rifting, continental to shallow-marine origin are confined in discrete basins along the coast of the Gulf of Aden.
According to studies dating back to 1980s, only 21 wells were drilled in Somaliland (19 onshore and two offshore). Many of them were experimental wells as modern seismic reflection surveying was rarely used in Somaliland. Although many prospective petroleum systems in the onshore and offshore regions of the country remain relatively unexplored, some of the wells drilled have positively indicated the hydrocarbon potential of the country, and the type of prospects in areas where wells were drilled.
Also, regional and nearby continental discoveries reinforce the predictions of Somaliland’s hydrocarbon potential as many nearby countries (Yemen, Oman, Saudi Arabia, Egypt and South Sudan) produce hydrocarbons. Ethiopia, Uganda, Tanzania and Mozambique have made recent significant discoveries of gas.
It is probably on these premises and others that the Somaliland Minister of Mining, Energy, and Water Resources, Mr. Hussien Abdi Dualeh, recently declared that, “We have similar geology to Yemen, and Yemen has so far proven reserves of about 9 billion barrels of oil, and it hasn’t looked at all at its prospects. We are very hopeful that we have a similar potential.”
4. Exploration in Somaliland by Genel Energy
Genel Energy (http://www.genelenergy.com) is an Anglo-Turkish exploration and production company listed on the London Stock Exchange. It was incorporated on April 1, 2011 and acquired its ﬁrst trading business, Genel Energy International Limited (“GEIL”), on November 21, 2011. The reported results and ﬁnancial statements reﬂect the trading of GEIL from November 21, 2011 but include corporate and other costs incurred from April 1, 2011.
In 2012, Genel Energy acquired a portfolio of offshore exploration assets in Morocco, Côte d’Ivoire and Somaliland. These exploration blocks cover some 62,000 square kilometers. The Genel management believes that this acquisition could yield 3.3 billion barrel oil equivalents (BOE) net of unrisked prospective (2P) resources and plans to assess the African potential reserves within three years and $400 million capital program, targeting ﬁve wells per year starting in the last quarter of 2013.
In August 2012, Genel was awarded an exploration license for onshore blocks SL-10-B and SL-13 in Somaliland, with a 75% working interest in both, and projects to find over 1.0 billion barrel oil equivalents in these blocks. In November 2012, Genel extended its interest in Somaliland by acquiring a 50% participating interest in the Odewayne Production Sharing Agreement which covers blocks SL-6, SL-7, SL-10A. The Odewayne block has a similar resource potential and an extensive 2D seismic campaign is planned for all the blocks in 2013, with the first exploration well targeted for the second half of 2014. The total gross area is about 40,300 square kilometers, approximately equivalent to the entire Kurdistan region of Iraq, where, incidentally, Genel reports that it is the largest independent oil producer and the largest holder of reserves.
It is noteworthy that Genel was encouraged to acquire the plots in Somaliland based not on the results of exploratory work but on (a) the indications of onshore oil seeps and (b) geological data that show favorable conditions for hydrocarbons to have accumulated in numerous large tilted fault blocks and sub-basins, and (c) most likely significant corporate data privately obtained and held. In August 2013, Genel pulled out of Somaliland, but it apparently plans to resume its exploration in 2014.
5. Will the Hydrocarbon Resource Be a Curse or Cure for Poverty-ridden Somaliland?
The answer to the question depends on how the oil and gas resources are exploited and managed. The industry can generate significant revenues contributing to the economic growth and social development of countries. But without good governance, the exploitation of these resources can contribute to the poverty, corruption, strife and conflict.
Therefore, Somaliland must first adopt international standards such as the Joint ISO/IEC Standards and Extractive Industries Transparency Initiative (EITI). These essentially provide the framework and guidelines to improve the governance and accountability of extractive companies and host governments to ensure sustainable development for communities impacted by the decisions of governments or companies.
Fundamental to attracting meaningful investment and developing beneficial relationships for all stakeholders in Somaliland depends on sound legal and robust regulatory frameworks in which oil and gas projects are designed, negotiated, implemented and managed. This means having appropriate and reasonable investment guidelines, taxation regimes, labor laws and environmental guidelines and enforcement mechanisms. In this context, three key factors underpin the facilitation and promotion of the oil/gas exploration and production: resource prices (crude oil and gas), technology, and the petroleum regime of the country.
The petroleum regime is the set of rules that govern how a state regulates and manages its petroleum assets. It is comprised of four components: a constitution, petroleum laws, petroleum regulations, and host government contracts.
The detail tends to increase from the constitution which sets out the principles regarding petroleum resources through the petroleum laws, regulations and the contracts. The competitiveness of the petroleum regime is an essential determinant of the amount of investment in exploration, discovery and production by MNOCs. All others being equal, the legal framework and the fiscal regime under which oil companies operate make a country or region more or less attractive for investors. Somaliland is no exception to this conventional wisdom.
The potential income or “rent” from crude oil and gas exploitation is often sufficiently large for the stakeholders to share, i.e. the host country, the MNOC and the market (competitive price for end consumers) provided the discovery is technically feasible, commercially and economically viable and environmentally sound. The “resource rent” is the value of the resource minus all the necessary resource production costs. Traditionally, the sharing of this rent has been contentious under the concession agreement models prevalent in the 1970s. Today, a variety of upstream arrangements exist for producing countries to adopt which include three major types of contractual upstream arrangements, namely: a license and concessions, joint ventures (JVs), and production-sharing agreements (PSA).
6. International Standard Petroleum Contracts
Although petroleum contracts can vary widely in details, they must establish two key issues: how rents (income/profits) are divided between the government and participating companies (MNOCs) and how costs are to be treated.
Typically, neither the MNOC nor the host government knows with certainty at the time of signing the contract, how much it will cost to explore and develop a field, whether future oil or gas prices will justify those costs, or how much oil or gas there is in a field. Although modern oil exploration methods are better than previous ones, they still have only a 10-percent success rate for finding new oil fields, i.e. ninety percent of exploration efforts result in a loss . Notwithstanding this uncertainty, it is simply illogical to leave hydrocarbon resources buried underground while most of the citizens wallow in poverty, ignorance and ill health.
What often complicates negotiations among stakeholders is the high level of uncertainty caused by incomplete or even erroneous information. MNOCs will inevitably seek to protect themselves against possible losses which will increase MNOCs’ or any investors’ internal costs. Therefore, contract negotiations require experience and skillful bargaining to find a reasonable and mutually acceptable balance between the interests of an investor and a host government. This forces them to turn to international financial and legal experts to advise them during negotiations. Professional referees are often employed by host countries. Therefore, Somaliland will be well advised to seek their services.
7. Typical Features of “standard” Petroleum Production-Sharing Agreements (PSAs)
The PSA was first used in 1966 in Indonesia. It is a commercial agreement in which the state that owns the natural resources (oil and/or gas) negotiates a profit-sharing arrangement with MNOCs. PSAs spread globally and are now commonly used in the oil business, especially in the Persian Gulf, Central Asia and the Caucasus. Today, there are many different PSAs versions resembling each other only in the basic concept of sharing profits. The variations are not new. They are a product of intense negotiation of concerns and interests of parties that differ in their circumstances and objectives.
The complexity of a PSA depends on the robustness of the legal system and the infrastructure of the state that owns the resources. For example, if a country does not possess basic rules governing petroleum operations, the issues normally covered by such a law will have to be addressed in the PSA. In short, the less reliable and/or predictable a state’s legal system is, the more issues that must be covered and specified in the PSA. At a general level, the following are some typical features of PSAs: ownership of the natural resources rests in the State, MNOC is permitted to manage and operate the development of the oil fields; MNOC carries most of the financial risks of exploration and development; the state also faces some risk and often a national oil company (NOC) joins the MNOC as an interest holder in the PSA first and later as contributor of some of its profits as “share capital” as a member in the consortium that is developing the area granted under the PSA; the host government usually has the cost of its initial contribution “carried” by the MNOC. This cost is to be repaid to the MNOC from the host government’s future profits under the PSA. If the government does not agree to contribute to the capital investment, the MNOC will try to negotiate a greater share. The exact split is a result of bargaining as there are no scientific determinants of what a reasonable split should be.
The financial terms of the PSAs are similar to those of a concession or a license agreement, although the different structures may lead to different commercial results. Again, the following are generally typical financial terms:
MNOC is first entitled to cost recovery for both the operating expenses (e.g., materials consumed or used in the year in which they were acquired) and capital investment (expenditures for assets such as buildings, equipment [light and heavy]), and auxiliary equipment such as computers (hardware and software). Cost recovery for current expenditures is immediate, in the year in which the expenditure is incurred, and cost recovery for capital investment is spread over a number of years. There are gray areas and accountants can reasonably reach different conclusions as to whether certain items such as books and tools (that include drill bits) should constitute an operating expense or a capital cost. What remains after companies have used annual earnings to repay themselves for their operating expenses and their capital investment, as depreciated in that year, is shared according to the agreed percentage division with the host government. The MNOC is required to pay taxes on its share, but these are often waived by the host government and included in the company’s portion of the agreed percentage split. The host government often earns a signing bonus, although this is regularly waived or traded for a greater share of future profits.
The above may give the impression that there are many deductions and little remains by way of profit for the MNOC and the host government. However, a divisible profit is usually generated provided the discovered resource is of a sufficient quantity.