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As hinted here earlier, sub-Saharan frontier markets may be distinguished in part by their monetary prudence and overall macro policies.  While foreseeing an impending rise in Eurozone related global market volatility earlier this fall (and by extension the SSA region’s near-term growth prospects), for instance, we theorized that commodity exporters such as Ghana would enjoy enhanced terms of trade, augmenting FX reserves as well as tempering price stickiness such that capital costs remained controlled while the option to ease interest rates remained relatively viable–all in contrast with net importers such as Kenya and Uganda (a notable exception to this ongoing thesis remains South Africa, for reasons outlined here, while Nigeria’s disappointing reserves accumulation YTD and hitherto pesky inflation have in turn brought about six different attempts to normalize rates during the year).  That said, a tipping point does exist even in the most price sensitive of countries such that once inflation pressures lessen (a function, it should be pointed out, not only of supply side factors but also demand side ones such as private sector credit expansion) monetary policy can remain static or even perhaps loosen such that local bonds look a bit more palatable.  Absa Capital noted yesterday, for instance, that following the deceleration in November’s headline inflation to 29% from the previous 30.6%, the Bank of Uganda’s (BoU’s) MPC left its central bank rate (CBR) unchanged at 23% (up 300 basis points from the last hike in October) at its policy meeting‘last Friday while observing that “prospects for lower annual inflation rates have strengthened”.  At the same time, Bank Governor Emmanuel Tumusiime Mutebile pointed out commercial bank lending to the private sector declined by 20.9 per cent between September and October, a trend he expects to continue as “the slowing down of bank credit growth will help to ameliorate inflationary pressures over the coming months”.  All this bodes well for fixed income, though an always mindful eye on domestic food prices wouldn’t be for naught.

My November Business Diary Botswana submission:

Italian energy giant Eni S.p.A, which also owns interests in the Republic of Congo, Nigeria and Ghana, announced in late November its acquisition of stakes in six Ugandan oil fields (a 50% interest in Blocks 1 and 3A in the Albert Basin) from Canadian-based Heritage Oil PLC for $1.5 billion–a deal that “underscores the intense interest the world’s major oil companies are showing in Uganda, one of sub-Saharan Africa’s most promising hydrocarbon provinces,” opined the Wall Street Journal. According to Tullow Oil PLC, Heritage’s London-based partner in the sold stakes that wholly owns another block in the same area, in addition to the 700 million barrels of oil that have already been discovered so far in Uganda’s Lake Albert Rift Basin, there are potentially six billion barrels yet to be discovered–a sum that theoretically would make Uganda one of the top 50 oil-producing countries in the world by 2015. Furthermore, Eni’s venture into Uganda is just the beginning of a long-term commitment to renovate the country’s energy infrastructure, points out Thomas Pearmain, African energy analyst at IHS Global Insight. The company is poised to build a pipeline eastwards towards the Kenyan port of Mombasa for exporting, as well as invest “much-needed financial resources and expertise for development of energy infrastructure, such as refineries, terminals and pipelines, in order to fully exploit [the region’s] deposits.” Any sort of vested-foreign interest in Uganda will reverberate strongly in the country’s rapidly maturing capital markets, particularly in bond markets where the success of nascent corporate offerings still depends in large part on further development of the long end of the risk curve by the the country’s central Bank of Uganda, which itself is a function of the country’s fiscal policies and ability to fund borrowing while containing inflation. Moreover, subscription rates may ultimately lag, despite the current uptick in liquidity due to foreign inflows and diaspora remittances, until additional reforms are realized, argues Mary Katarikawe, the Bank’s director of research: “What is needed in developing and deepening Uganda’s financial market is liberalization of the pension sector such that it can pave way for more fund managers, insurance companies and other institutional investors to actively participate in the fixed income market.”

Increased participation, moreover, is critical to the development of a secondary market, whose relative absence to date further distorts the type of “information sharing” that increasingly developed yield curves fundamentally supply. Furthermore, say analysts, future economic growth and increased domestic and foreign investment depends on a more varied basket of financial products. Per Andrew Owiny, CEO of East Africa’s Merchant Bank, “Uganda still has room for more institutional investors to develop its bond market while on the equity side there is need for more companies to list their shares,” a testament to the fact that since the country’s capital markets began operating in 1997, only six domestic firms have been listed in addition to five cross-listed ones from Kenya. Could oil be the requisite impetus that accelerates a positive regulatory feedback loop within Uganda’s economy whereby domestic growth is underpinned and reinforced by greater share liquidity through increased institutional participation in the equity market, as well as more flexible debt management strategies via a deepened credit market? Indeed, observed one reporter, “if managed well, petrodollars could transform the economy of the landlocked country, potentially doubling the state’s revenues, create thousands of jobs and help realize President Yoweri Museveni’s dream of industrializing the country.” Mindful of the mistakes made by other resource-rich countries such as Nigeria, where vast reserves did little to alleviate widespread poverty and in fact directly fueled rampant state corruption, a shocking deterioration of environmental standards and an ongoing and vicious struggle waged by domestic “rebel” groups in the Niger Delta region to voice their dismay and to secure Government-funded remuneration, Ugandan officials seemed determined not to repeat them. “Why must people always look at the bad examples and say we will suffer the same curse?” Fred Kabagambe-Kaliisa, permanent secretary in the ministry of energy and mineral development, told the UK’s Guardian paper in August. “Why not mention the good ones, like Norway?” With a per-capita income of $65,509, Norway ranks second only to Luxembourg in global rankings, with much of the wealth derived from North Sea oil and the lion’s share of export revenue reinvested in a fund “to ensure that oil and gas receipts will also benefit future generations.” However, when Norway first began extracting oil in the 1970s, overly-profligate fiscal policy lead to high inflation and an eventual currency collapse when the oil price plummeted in 1986. Politicians quickly passed legislation mandating that future receipts be managed more soundly, ultimately resulting in what’s now labelled the Government Pension Fund, one of the world’s largest sovereign wealth vehicles valued at $350 billion. Yet, cynics mused, is such success and fiscal prudence probable in a country that, unlike Norway at the start of its oil-founded boom, lacks transparent institutions, an educated population and a long history of democracy with little corruption?

Ugandan officials, looking to move down the political, economic and social learning curve as quickly as possible, certainly thought so, and enlisted Norway, which is also subsidizing a feasibility study on whether to build a large refinery near Lake Albert, to advise them through its energy, finance and environmental ministries. Additionally, officials note, to date negotiations with foreign firms, which habitually seek to export the petroleum in order to expediently recoup their fixed investment costs–have all allegedly incorporated a “value addition” philosophy founded on President Museveni’s stated desire to ensure a greater share of profits remains in the country, to help stem reliance on Kenyan ports for imported fuel, and also to help reduce the state’s hitherto over-reliance on foreign aid, which accounts nearly one-third of the government’s annual budget. That said, critics argue, what is to prevent President Museveni, who has been in power since 1986 and will stand for a fourth term in 2011, from holding on to an increasingly precious position at society’s expense? Per Godber Tumushabe, executive director of Advocates Coalition for Development and Environment, a local think tank, oil discoveries historically “encourage political longevity”. Further muddying the analysis, posits Taimour Lay, a journalist and researcher for Platform, a UK-based environment and governance watchdog, is that despite President Museveni’s value-added rhetoric, the [profit sharing] agreements (PSA) in practice are still “dangerously skewed in favor of the international oil companies and represent a significant diminution of this country’s sovereign control over its own natural resource. In particular, the deals fail to capture economic rent–the benefit to be gained from escalating oil prices–for the government.” In a column written for The Monitor in November, Lay showed that the very discounted cash flows explicitly forecasted by the PSAs, assuming “medium-level oil prices for the next 25 years,” would net the oil companies an internal rate of return (IRR) of between 30-40%. As oil prices rise, however, the companies net a greater percentage of profits since the state’s share is ultimately capped at around three-quarters–a clause that allegedly cannot be renegotiated across the duration of the contract. “Compared with comparable deals around the world, from northern Iraq to Libya, Uganda’s government has signed deals that leave it worse off in real cash terms,” Lay concludes. Apparently, even the Norwegians were appalled: a review of Uganda’s PSA model commissioned by the Norwegian Agency for International Corporation (NORAD) and carried out by Arntzen deBesche, a Norwegian law firm, opined that the model “cannot be regarded as being in accordance with the interests of the host country.

The enormous increase in oil prices during the last five years have fully demonstrated the need for production sharing models that adequately protect the interests of the host country by securing the economic rent for the country. The economic rent should be for the benefit of the host nation owning the petroleum resources, and not the oil companies, which should only be secured the fair return on their investments.” That said, what have been the opportunity costs to date of not having an integrated company of Eni’s expertise and capitalization–cash that will build the pipelines, terminals and refining capacity that Uganda’s oil industry has always sorely lacked? The cost of the pipeline to Kenya alone will drastically squeeze Eni’s short-term margins, analysts note, as it will need to be heated since the oil in question is waxy. Additionally, the government also wants a refinery to be constructed to meet increasing domestic demand. Shouldn’t such sunk costs be incentivized? Politics and arguably inequitable revenue splits aside, however, Uganda is undoubtedly in a unique position that could be a boon for not only its domestic production levels, but also for the breadth of its capital markets. The true tragedy would be if the state, perhaps already duped once at the bargaining table, failed to make amends by revamping and liberalizing its financial markets.

Some markets which I would classify as “frontier” may be even too frontier to really invest in.  Uganda, for example, has only a dozen securities listed on its exchange, and typical volume is dominated largely by one of them—Stanbic Bank Uganda, whose market cap dwarfs that of any of the other country’s firms, and which made headlines earlier this year when it slashed its prime lending rate to a record low 15%, following the central bank’s own rate cut.  The firm is also intriguing, however, because it recently expanded into Kabale, a rapidly growing district (with a growing demand for financial services) in the southwest and very near the Rwandan border.  It also has an ongoing relationship with MTN Uganda, a telecom firm, to provide a Mobile Money Transfer service, which kicked off in March.

One way to get exposure to Uganda without being constrained by its exchange’s tepid liquidity, however, would be on a more macro level.  Timber plantations, for example, offer such an opportunity.  The country is in the midst of a sawn timber (two species dominate the plantation areas established to date in Uganda – namely, Pinus caribaea var. hondurensis and Eucalyptus grandis) shortage—due to a lack of planning or planting during Idi Amin’s tenure–that forestry experts opine is likely to persist for the next two decades as demand increases and the number of hectares of plantations meant for growing (as opposed to natural, or tropical high, forests, which are preserved) has only relatively recently begun to be replenished via EU support.  While there are currently around 20,000 hectares of tree plantations, it is estimated that Uganda will need at least 60-70,000 just to meet the country’s projected timber demand by 2025.  In the meantime, the shortage has had wide-ranging effects: most notably, and on a commercial level, it handicaps the country’s growing construction industry (second only to telecoms in terms of growth rate), whose response has thus far been to import from Congo and Tanzania.  But increasing transport costs and price for wood means that said reaction may not be viable in the long-run. 

Over 50% of Uganda’s timber is currently imported, and at this pace the country will be a net timber importer in the next five years.  But Uganda Tree Growers’ Association (UTGA) secretary Ms Sheila Katamara points out that Uganda is in a “strategic position” to be a regional supplier, given its vast land.  Commercial tree growing is just starting to gain a foothold, thanks to the Sawlog Production Grant Scheme (SPGS), an EU-funded initiative offering subsidies to help establish private growers.  “We already have an association of Uganda Timber Growers Association (UTGA) whose membership comprises of investors in trees and those intending to become forest lords,” said Allan Amumpe, the SPGS project manager.

Conditions for growth could hardly be more ideal.  The region is widely regarded as having better soils than most countries in Eastern and Southern Africa.  Additionally, it is a well-watered country that is richly endowed with renewable natural resources.  Finally, with a temperature range of 15-30 degrees Celsius, and an annual rainfall range of 750-2000mm, the country is highly suited for forest production. Finally, vis a vis yields (m³/ha/yr), Ugandan plantations can match, or often exceed, some of the best growth rates in the world, including those in Australia, South Africa and Tanzania.

That said, political complications arose last December that should cause investors to be cautious—namely President Yoweri Museveni’s brouhaha with the National Forest Authority (NFA), which manages 15% of Uganda’s remaining forest cover (70% is located on private land).  Museveni expressed dissatisfaction with deforestation projects that he said reeked environmental havoc.  The scuttled deals in question, however, involved an Asian sugar cane plantation company and palm oil developers, not plantation or timber production per se.

Last month Peter Bartlett’s Exotix Limited secured financing for UK-based New Forests Company’s sustainable forestry operation in Uganda.  The New Forests Company is a plantation timber firm with operations in Uganda and Mozambique.  It has become the largest tree planter in Uganda and expects to plant almost 4.5 million trees this year. The company combines sustainable commercial forestry and the protection and promotion of biodiversity with community participation.  Commenting on the deal, Exotix’s Sanjeev Chhugani said, “Early stage forestry businesses have low cash flows in the initial years, but once the trees reach a certain age, the picture changes dramatically. Not only do the assets literally grow, so does the holding value of these assets. With increasing global demand for timber, investing in sustainable forests is essential. New Forests’ impact on the surrounding communities will be phenomenal. While many of our alternative investment clients are focused on assets that can be marked to market on a short term basis, we had to find a strong investor with a long term outlook, a passion for Africa and a pragmatic approach to ‘green’ investments. Money can grow on trees.”

Julian Ozanne, CEO of New Forests, commented that “with our institutional round of funding concluded, we can focus on planting more trees and extending our biodiversity and community development initiatives. We have a solid team of very experienced and passionate people who are extremely knowledgeable about forestry and are committed to successfully and profitably expanding our operation within Uganda and across Africa.”

JGW

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