Oil and Gas industry to enrich foreigners and a few well-connected people at the expense of Ugandans
Lately, ‘local content’ has become topical issue, and many countries are enacting laws to make it mandatory for all stakeholders of specified industries. But, what is ‘local content,’ and why has it become such a hot issue in the natural resource industry in general and the oil and gas sector in particular?
Local content is the development of local skills, technology transfer, and the use of local manpower and local manufacturing in the industry. For a more practical definition, one could say that local content is building a local in-country workforce that is skilled and building a competitive local supplier base.
It has become a very important issue due to the fact that in this day and age, every country in theory would like its citizens to capture the commanding heights of its economy and in that way keep its wealth within its borders, as well as providing jobs to the ever-increasing populations in many of these resource-rich developing countries. This can be achieved through capacity building, creating and supporting SMEs as well as building a local products and services pool.
In brief, when a foreign company makes products in a country, the expertise; knowledge; materials; parts etc that have been contributed from or made in that country rather than imported comprise what is called local content. A minimum level of local content is sometimes a requirement under trade laws when giving foreign companies the right to participate in a particular economy or territory.
Essentially, local content is about securing direct and indirect opportunities for employment and procurement to home nationals, at the same time as fostering the development of local skills, technology transfer, and use of local manpower and local manufacturing in capital projects.
The theory behind this is laudable, but in the words of Willy Olsen, the former advisor to the President and CEO of Statoil, “Maximizing the benefits of local content is not the same as to maximize local content.”
Globally, experts are continuing to tighten the bolts on investors in the oil industry in regard to local content. A recent Accenture report stated that, “the golden era of easy oil is over.” It added, “Today, the rules of the game have changed: Developing local economies, stimulating industrial development, increasing local capability, building a skilled workforce and creating a competitive supplier base—also referred to as local content —are minimum requirements for doing business with host countries and national oil companies.»
Also, governments are setting up policies and legal frameworks in order to bolster local content. Experts are also trying to examine what exactly makes a good Local Content Policy and how local communities and regional businesses can benefit from national hydrocarbon wealth in resource-rich developing countries – where most of the focus is at the moment.
According to the Baker III Institute, about 90% of new hydrocarbon production in the next 20 years will come from developing countries. Many of these nations have understandably introduced ‘local content’ requirements into the regulatory frameworks governing natural resource developments. The aim is to create jobs, promote enterprise development and acquire new skills and technologies.
But there is also a realization that new local content regimes pose both risks and opportunities for oil and gas companies. For example, operators and international contractors may face unrealistic expectations or targets from host governments or communities seeking quick results. The opportunities come from longer-term efforts focused on helping to develop local businesses and employees.
In Uganda’s emerging oil and gas sector, debate is raging as to whether or not the sector will or can provide equal opportunities for all. Before the discovery of oil and gas in Uganda, there was no specific legislation or deliberate policy drive to promote local content. And this is not peculiar to Uganda. Local content has therefore almost become synonymous with oil and gas, though it should be broader in coverage for it to be meaningful and create real in-country value for all stake-holders.
Countries like Ghana and Nigeria now have stand alone legislation on local content and Statutory Regulatory bodies that oversee and enforce the local content provisions. In Uganda, the process is still “on-going.” The closest Uganda has come to legislating for local content is in the Petroleum (Exploration, Development and Production) Act No.3 of 2013. Section 125 (1) and (2) stipulate that, (1) “The licensee, its contractors and subcontractors shall give preference to goods which are produced or available in Uganda and services which are rendered by Ugandan citizens and companies.”
(2)”Where the goods and services required by the contactor or licensee are not available in Uganda, they shall be provided by a company which has entered into a joint venture with a Ugandan company provided that the Ugandan company has a share capital of at least forty eight percent in the joint venture.”
However, our view is that in its current wording, the law may impose significant challenges and limits in the realization of the intended objectives of local content promotion. For example, it introduces a rather vague manner - a ‘slippery’ concept of ‘local content’ - without defining what it is and what it is not. Also, the law does not define what constitutes a “Ugandan company.”
It makes the erroneous presumption that a company locally registered in Uganda is a “Ugandan company” rather than taking into account the nature of ownership and the degree of control of such a company and the actual degree of in-country value addition (i.e. how much of whatever such company inputs is strictly speaking, local) plus the levels of participation (management, ownership and employment) by Ugandans. From the onset therefore, the local content clause obscures what the objective of the local content provision in the law is.
By making reference to a “Ugandan company,” the law does not state whether such a company must be a “citizen” within the meaning of the Land Act and the Companies Act but simply makes a vaguely confusing reference to a “Ugandan Company,” which within the strict interpretation of the law is any company locally registered in Uganda regardless of ownership or control. Indeed, the requirement of at least 48% share capital holding can easily be evaded by a very simple but smart and effective cross-shareholding scheme.
The more ‘unrealistic’ and presumptive implication of the provision is based on its unwritten capital budgeting implications. Not many ‘Ugandan companies’ can afford to buy a 48% stake in a foreign company worth say $1 billion (about Shs 2.55 trillion) and what’s more, many of these foreign companies are listed companies so entering such joint ventures would require jumping over complex, exhausting and expensive regulatory hurdles.
The oil and gas business is of a very capital intensive nature, requiring companies that have large reservoirs of investment capital or strong and supportive financial institutions. With the existing barriers of access to affordable credit, it is easy to see that the last requirement is far from being the answer to the capital requirement gap.
The alternative is to create synergies with foreign companies that have the financial muscle. But the contradiction is that this would be promoting exactly what the spirit of the law seeks to stop.
The other obviously visible obstacle in the realization of the local content policy is that the IOCs have well established supply chain networks. They therefore prefer to deal with global suppliers or to award major service contracts to international specialist firms such as Baker Hughes, Halliburton, Wood Group, Abbot Group, Schlumberger etc whose financial strength, reputation and technical capabilities have been time-tested and proven. The oil and gas industry is no place for taking a gamble with any service provider who comes along.
The joint venture option may not be the best way of encouraging or enforcing local participation. This is because joint ventures by their very nature are a synergy between “equals.” So the presumption that a “Ugandan Company” with no experience at all would enter into a venture with Halliburton for instance to provide a service that for all intents and purposes, is financed and technically-supported by Halliburton but the sharing is almost equal, is a desirable but far from achievable shot.
This is because it would practically be difficult to have foreign investors who are willing to participate in a ‘joint venture’ where they contribute all the value inputs – ranging from technical know-how to plant and equipment to training - and at the end of the day cede nearly half of the rewards to a local partner who contributed nothing. Besides, in framing the law, the legislators did not take into account the possiblity of dilution of the local partner by use of capital calls, a tool frequentlyand lawfully employed by multinationals to edge out "undesired" partners.
The risk Uganda then faces due to the insufficient current local content regime is that joint ventures could be established just to meet the legal requirement. Foreign companies could for instance elect to offer “free stakes” of up to 48% to a “local trusted partner” complicit in the avoidance of the hard task of realizing local content requirements. The locals and the foreign entities would effectively be subverting the law and engaging in “subversive compliance” but complying within the meaning of the law. This will undoubtedly enrich a few well-connected people at the expense of Ugandans. That would be counter-productive.
Turning to Sections 126 and 127 of Act No. 3 of the Act, which touches on training, employment and technology transfer to nationals, one has to ask if or not the foreign partner in the joint venture (JV) will be exempted from these requirements on the basis of their venture proportion.
And what is the fate of a foreign licensee that produces the goods or provides the services in question from its respective home country; will it have to enter a separate joint venture solely for this purpose? What about foreign firms with local partners such as PwC, KPMG, Ernst & Young among others currently active in the Ugandan oil and gas services sector; are they also categorized as ‘local’ to partner with another foreign company in a JV?
The Act is surprisingly silent on procurement policy and on crucial issues like ‘supplier development’. Local firms’ participation in the supply chain—with strengthened capacity to compete—is crucial to the promotion of local content. Two key strategies can help achieve this: the modification of procurement systems and the use of dedicated supplier or ‘enterprise development’ programmes. Experts say there are two mechanisms by which local enterprises can enter supply chains.
The first is ‘direct procurement,’ which refers to goods and services procured by the oil and gas company itself. Direct procurement gives the company greater control over the procurement process, with the right to reserve contracts solely for local enterprises. The drawback to this approach is that the number and size of contracts suitable for direct procurement are generally limited.
A more realistic opportunity for local firms usually lies in the supply chain of large contractors. This is ‘indirect procurement’. Where the existing incentives for larger contractors to engage local enterprises are weak, the oil and gas company’s procurement system can be put into play to mandate or provide incentives to contractors to engage local enterprises. But this has to be made an unequivocal, measurable, routinely ascertainable and enforceable requirement rather than the current non-mandatory nature of the language of the enabling legislation.
This brings us to the issue of empowering Ugandans as the engine for their own wealth generation - the ultimate sustainable economic development model, which would be the local content regime’s core objective. Uganda needs a local content model that can plausibly measure how much, in sustainability terms, the regime can offer. Short of that, ‘local firms’ that are all but foreign in outlook save for their residence in Uganda, will continuously win local bids; have their foreign experts execute the work and earn proceeds under the pretext of being ‘local.’
For instance, one of the IOCs operating in Uganda recently raised many eye-brows when it applied for over 5,000 work permits for its foreign nationals. It is hard to believe that all these jobs cannot be done by Ugandans.
Of course local content should cut across the economic spectrum and it is precisely because it has been presented as though it is a new concept, that Uganda’s law and policy makers have paid less-than-enthusiastic attention to the issue and only made passing mention of it in the law meant to be the ‘Bible’ of the oil and gas industry in Uganda.
But we must always be realistic that our societies inform the nature of laws that govern our dealings whether social, political or economic. Uganda like most developing countries has over the years embraced, by learned passivity, the culture of “business cartels” or what some political actors have rather clumsily termed “the Mafia.” A few powerful and well-connected business players have taken the country an economic hostage in the sense that the same names appear in every public procurement and any “outsiders” stand virtually no chance against this oligopolistic cartel.
In a way, they have been the face of “local content” in Uganda and there is every indication that they will continue to be the major players in any “local content” regime for some time. In instances where the interests of these cartels are threatened, as for example where a genuinely robust local content law seeks to spread the benefits of economic empowerment, we could likely see an “alliance of rivals” if only to protect their privileges and sense of entitlement.
And the foregoing is buttressed by the surprising preferential treatment by many African governments for foreigners, even where the locals would render the same quality of output/services or even better. These ‘race-based’ preferences must be checked because they are not only an oddity but also violate the very notion of local content.
The seminal point here is that ‘local content’ and ‘protectionism’ are synonymous - no Golden Thread benchmark separating the two exists.
Contrary to the seemingly accepted thinking that the local content conversation is new to Africa, this has been going on for a while. The most notorious local content policy on the African Continent is the ANC’s Black Economic Empowerment (BEE) in South Africa.
Because few blacks had been able to accumulate capital under Apartheid, the ANC government justifiably sought to empower black South Africans by enacting “positively discriminative” laws otherwise called ‘affirmative action’ to influence the participation of black South Africans in the economy.
So stakes in white-owned entities or state-owned enterprises were typically sold at a discount and financed by loans, often from the companies themselves, many of which judged it wise to woo influential black shareholders. The transfers were originally voluntary, but the ANC, impatient at the slow pace of change, now uses state power to speed them up.
One of the accelerators is the award of licenses in mining, telecoms and other regulated sectors. If a firm is not sufficiently “empowered”—i.e., if too few of its shares and jobs are in black hands—it will not win or retain an operating license.
Various laws add to the pressure. The Employment Equity Act of 1998 obliges biggish firms to try to make their workforces racially “representative.” Those that employ more than 50 people are required to report at least every other year on their progress towards making their staff 75% black, 10% colored (mixed race), 3% Indian, and so on, at every level from floor attendants to the boardroom members. Failure to show “reasonable” efforts at compliance can result in fines of up to $97,000 (Shs 250 million.
It is interesting to note however that the lot of poorer blacks, however, has not improved much despite all these legislative efforts. Many are frozen out of the workplace altogether. The unemployment rate among blacks is 28.5%, compared with 5.6% for whites. If those who want work but have given up looking for it are included, the jobless rate is a whopping 41.6% for blacks compared with 7.5% for whites.
The policy while essential, has been largely flawed. But the gains must be weighed against the policy’s unintended consequences. What the BEE has succeeded in doing is creating a small impenetrable circle of super-rich black South Africans.
Pitifully, few black South Africans have grown rich by creating entirely new businesses, perhaps because it seems so much easier to make money by acquiring stakes in existing firms. In the case of Uganda, the locals will only incorporate companies for the sake of entering JVs with foreign companies. To this end, local content requirements could kill the growth of small business plus creativity and could create a super-rich class of “economic vultures” rather than creative entrepreneurs.
In BEE deals, political connections often matter more than business skills. A costly bureaucracy has grown up to enforce racial targets, which even black-owned firms have to contend with. Posts are left vacant for want of qualified black staff. Some businesses re-employ white professionals as freelance consultants to plug skills shortages without falling foul to the law.
The key binding constraint on greater black participation in the economy is education, says Lucy Holborn from the South African Institute of Race Relations, a think-tank that has called for BEE to be scrapped. The proportion of professionals who are black is 36%, fairly close to the share of degrees held by blacks, which is around 40%. But the think tank argues that that falls short of the 75% share of the total workforce who are black. It is no good setting quotas if there are not the skilled workers to fill them, says Holborn.
In summary governments will have to:
- Make local content a core part of business planning and strategy
- Consider local content within overall fiscal/commercial negotiating terms
- Break down the silos and align internal incentives
- Partner with key contractors to share risks
- Align community investment with local content goals
- Drive supplier competitiveness through capacity development
- Accept a higher level of complexity in the supply chain
- Take a life-cycle approach to enhancing employment opportunities
- Leverage partnerships with peers and other institutions to scale impact
- Invest in internal capacity building at corporate and site levels
Following these steps is not a guaranteed win for countries like Uganda in the local content field, but sticking to the precepts outlined above will certainly help light the way on the dark path to future prosperity. Decision makers therefore, should be conscious and highly realistic in devising local content regulations because capacities building for the locals to boost performance levels and supporting international investors make good profits, are both prerequisites.
Hence, realism and pragmatism dictate that policy makers may well often need to take a view that for some areas of work, local content targets must be realistically modest where there is good reason for them to be and rabidly robust where it must.
Blueprint for Local Content success
There is a fear that a badly enforced local content policy may be the anathema to economic growth. So for countries like Uganda to get it right they would do well to make sure that a number of boxes are checked
Ensure transparency and openness in the tendering process
To guarantee accountability, safeguard against bias and stave off tensions, there must be total visibility in the criteria for award of contracts, basis for the award, contract costs and itemization of activities. Closely following the guidelines of the Extractive Industries Transparency Initiative (EITI) will go a long way to meet this end.
Create a neutral agency for the apportioning and outlay of oil revenue
Currently, the proposed Petroleum Authority of Uganda, under Section 9 of the Act is responsible for the promotion and enforcement of local content provisions of the law. The Authority under Section 13 of the Act, takes directions from the Minister responsible for Petroleum activities. An approach akin to Norway’s Achilles organization, working outside of government, would be an ideal way to promote objectives without suffering from allegations of corruption and cronyism.
Follow the example of Brazil and actively foster the development of SMEs
You can’t boost local content unless the businesses are there to support it. In Brazil, Petrobras has set up two funds to stimulate SMEs, of which there are now 14 million, accounting for 21 per cent of the nations GDP. To become a positive example in the African oil and gas sector, Uganda would benefit from doing the same.
Invest in infrastructure
The often poor infrastructure in Uganda could be a major stumbling block in making sure that local content potential is realized. Countries like Angola have taken stock of this and spent much in recent years to make sure that their infrastructure is in tip top condition.
Training and skills development
An effective local content programme usually features training and skills development elements to help local populations achieve the minimum standards required by the company—either in terms of general education or specialist skills.
Such training can be an in-house initiative, or the company can look to local institutions to provide any necessary training. In either case, the programme should be based on a detailed analysis of local capabilities and a schedule of the skills requirements over the life of the asset.