Extracting Somali oil: is the risk worth the reward?

New research by seismic services company Spectrum Geo has confirmed significant hydrocarbon potential in the seas off the Somali coast, especially oil, which is easier to extract than natural gas. The government is keen to exploit the reserves, but is the threat of piracy and geopolitical instability too high to nurture an offshore industry?

In 2015 Spectrum Geo set out to conduct the most advanced seismic testing to date in the little explored waters offshore Somalia. The company later announced the potential presence of hydrocarbons at a depth where crude is usually found.

“Analysis is suggesting offshore Somalia stands as a beacon on the East African margin, offering the potential for the next giant oil discoveries in the future,” says Dr Neil Hodgson, executive vice president of geoscience at Spectrum.

Spectrum’s analysis came as a surprise to the industry because the area further south along the coastline, by Tanzania and Mozambique, holds abundant gas reserves but little confirmed oil. Oil is more sought after than gas as it is easier and cheaper to extract, compared to the billions that would need to be secured to set up liquefied gas production for export.

This newly discovered natural resource wealth could benefit Somalia greatly. Some 73% of the population in the state live below the poverty line, which is unsurprising after over two decades of political unrest and war.

But since 2012 the country has experienced increased levels of stability under a new internationally backed government, which has attracted some Western investors, including Soma Oil and Gas chaired by former UK political party leader Lord Howard. In 2013 the company became the first western firm to sign a contract to collect data offshore Somalia in exchange for the right to apply for up to twelve oil blocks.

But it wasn’t all good news. At the time a UN panel of experts voiced concerns that oil production could lead to conflict between rival groups and threaten the peace in a country struggling to rebuild itself.

Subsequently Soma Oil and Gas faced corruption allegations by the United Nations’ Somalia and Eritrea Monitoring Group. An investigation by  the UK’s Serious Fraud Office and later dropped due to a lack of convictable evidence.

Repeated delays of an anticipated presidential election in Somalia – which, at the time of writing, is underway several months late – have sparked concerns of under-hand tactics and vote buying as voiced by Michael Keating, the United Nations’ special representative for Somalia.

Corruption capital

Given that Somalia ranks last out of 176 countries on the 2016 Transparency International Corruption Perception Index, to suggest corruption is a risk factor for oil and gas companies operating in the region is an understatement.

In addition, attacks from both armed piracy groups and Islamist-terrorist organisation Al Shabaab make Somalia one of the most challenging states to invest in.

Regardless, Somalia’s government has confirmed it is keen to push ahead with exploration plans after announcing its first offshore hydrocarbon licensing round in November 2016, with detailed plans, documents and data sets to be made available by March 2017.

The blocks on offer will include areas off central and southern Somalia but will exclude shallow water block concessions signed in 1988 with Shell and Exxon Mobil before the government collapsed.

Western companies are clearly interested, but is the risk worth the reward?

“It depends entirely on your level of risk appetite,” says Ed Hobey, a senior analyst at Africa Risk Consulting & ARC Briefing. “The more adventurous oil juniors will consider the potential commercial returns outweighing the political risks and the Spectrum data will help executives make an effective case to their risk committees.”

Oil companies are not known to shy away from unstable African nations if the rewards are high enough, but they might find raising capital a challenge in the case of Somalia. Anyone seeking investment to do business in the area will need to provide detailed risk-mitigation plans and guarantees.

“When the Somali National Oil Company is eventually established, it will hold a stake in all hydrocarbon ventures. Investors will need reassurances the national oil company has the capacity and will to pro-actively address the risk of corruption,” says Hobey. “Without efficient monitoring and controls, national oil companies are vulnerable to the misappropriation of funds. This will not be a quick process, and will require continued donor engagement.”

Local issues

Furthermore, project financing is a significant issue in Somalia as the country lacks a functioning conventional financial system.

Investors will be concerned about the access of funds and repatriation of profits, says Hobey.

“Money transfers, while providing a platform for broad sustainable growth, have insufficient international anti-money laundering and financial terrorism provisions for investors,” he adds. “There are also issues about the enforceability of contracts, human resources capacity and protection of property rights.”

The government is yet to publish its overdue Petroleum Law, creating uncertainty about petroleum resource rights and income sharing arrangements between it and its federal member states.

“Even once clarified, there is a significant risk of violence around resource ownership, particularly offshore between Puntland and the federal government,” says Hobey, “It may be necessary for the private sector to preach caution and put the brakes on.” [Puntland, officially the Puntland State of Somalia, is a region in northeastern Somalia which was declared an autonomous state in 1998.]

The ongoing election in the country will, no doubt, also cause further uncertainty.
It’s worth noting that Hodgson says neither Spectrum’s nor Soma’s teams experienced any difficulties related to piracy working offshore Somalia despite working continuously at sea for several months. “We thoroughly planned the security and liaised with locals, demonstrating that operations can be undertaken safely and efficiently,” he adds.

The benefit to Somalians

There is certainly great potential for foreign companies and Somalians but expectations need to be managed, at least for now

“Although there are indications of potential hydrocarbon traps observable directly from the seismic [testing], work is just beginning to model and understand the hydrocarbon system on this margin,” cautions Hodgson.

Increased revenue from hydrocarbons could lead to investment to bridge the infrastructure deficit and increased human development spending in Somalia, but caution must be applied. The current government lacks technical expertise and policy efficiency when it comes to public finance management.

“There is a risk that oil revenues will be lost to corruption and mismanagement. Much will depend on the capacity and transparent management of the Somali Petroleum Authority and Somali National Oil Company,” concludes Hobey.

SOURCE:OFFSHORE