DAR ES SALAAM. TANZANIA, like other developing countries, is witnessing the biggest increase in demand for oil and natural gas. Investors and global energy companies are thus moving their attention from Continental Europe, the United Kingdom, and North America to Tanzania, where world-class natural gas reserves are located and where more business opportunities in the natural gas sector are anticipated in the future. Indeed, the market prospects of Tanzania and its more than 57 trillion cubic feet (tcf) of natural gas reserves, combined with recent regulatory, legal, and fiscal developments have stimulated substantial interest in the country’s burgeoning hydrocarbon sector, whose benefits in the economy have included, in 2013 alone, Foreign Direct Investment (FDI) inflows of US$ 618.3 million following increased natural gas exploration activities as well as various gasfield support services, according to the 2013 Tanzanian Investment Report. Moreover, the share of the natural gas sector in the economy of Tanzania will quickly grow as a result of the completion of the 532-km gas pipeline from Mtwara to the commercial capital Dar es Salaam and the accelerated development of the natural gas deposits and of the proposed US$ 15 billion Liquefied Natural Gas (LNG) processing plant in the country's southern region of Lindi. These projects – and many new others being formulated – could offer significant long-term benefits for Tanzania such as domestic gas, tax revenues, jobs and local content, and contribution to Gross Domestic Product (GDP) growth and positive trade balance.
As business opportunities in the natural gas sector of developed countries dwindle, some global energy companies are significantly changing their focus to the energy investment needs of Tanzania, where offshore blocks and deepwater acreage will continue to drive exploration. However, the conventional system of financing oil and natural gas projects in Tanzania by global energy companies, via cash flow, has been ripped to shreds since the 1970s, when the Tanzanian government became heavily engaged in the petroleum sector to quell apprehensions about the reliability and sustainability of oil supply. Subsequently, these projects were funded out of the government’s budget and borrowing from International Financial Institutions (IFIs) and Multilateral Development Banks (MDBs), as well as from global energy companies. In the decade of the 1990s, importance was placed once more towards private sector financing, as the Tanzanian government started restricting its participation in, and budgetary contributions to, the oil and natural gas sector. Nevertheless, global energy companies have been and are less willing to finance oil and natural gas projects independently and prefer to embrace a wide spectrum of partners in the projects, including a requirement for local content and risk apportionment. Hence, the financing of natural gas projects in Tanzania has become intricate, involving public and private sector investors and financiers as well as a variety of funding sources, namely shareholders’ own funds (equity), cash flow, debt finance, farm-outs/investments, limited partnerships and listing on the Dar es Salaam Stock Exchange (DSE) – as in the case of Swala Oil & Gas (Tanzania) Plc.
Capital-intensive and highly risky upstream and midstream natural gas projects undertaken by the Tanzania Petroleum Development Corporation (TPDC) – as the National Oil Company (NOC) – and with global energy companies have been funded by way of equity raising or farm-in arrangements. For instance, in 2010 Statoil Tanzania farmed-out 35% interest in Block 2 to U.S. supermajor ExxonMobil; Petrobras Tanzania farmed-out 50% interest in Blocks 5 and 6 to Shell Deepwater Tanzania BV in 2011 and a further 12% interest in Block 6 was farmed-out to Statoil Tanzania in 2013, the same year that Ophir Energy Tanzania farmed-out 20% interest in Blocks 1, 3 and 4 to Pavilion Energy for a maximum consideration of US$ 1,288 million. More deals can be expected as new license rounds are opened up in the future. Farm-in/out activities have been and continue to be driven by the need for risk sharing and the desire for continued natural gas exploration and development activities. This would make the natural gas sector in Tanzania one of the most active for merger and acquisition (M&A) activities. After farm-outs, equity is viewed as a superb means of availing cash flow necessary to fund natural gas projects without obtaining more expensive credit accommodations. That said, equity funding has, according to some industry voices, become more challenging to access; although it is expected to resume soon as investors again eye Tanzania after the peacefully concluded presidential election of November 2015 ushered in a landslide victory for Dr. John Pombe Magufuli, and despite shortcomings in the current regulatory, legal, and fiscal framework for the oil and natural gas sector.
Besides equity raising and farm-in arrangements, a number of debt financing sources, from within and outside Tanzania, are also needed to finance natural gas projects, particularly in the downstream segment that is less capital-intensive and less risky. Some of these sources, which are unrelated to shareholders’ equity, include loans from Tanzanian domestic banks, the government-owned TIB Development Bank, and international banks; issuance and listing of bonds on the DSE; floating of Eurobonds (like Pakistan did in September 2015, raising US$ 500 million); finance from business and joint venture partners and natural gas purchasers; venture capital (VC) funds; as well as, financing from OECD export credit agencies (ECAs) and IFIs like the East African Development Bank (EADB), the African Development Bank (AfDB), the European Bank for Reconstruction and Development (EBRD), the Asian Development Bank (ADB), and the World Bank. Right now, it is difficult to fund a natural gas development on a debt financing basis unless, perhaps, if a bankable offtake agreement with a creditworthy offtaker is in existence. Banks in Tanzania would need to be more confident with the extraction technology and management of risks, both from an environmental and reputational perspective. They may also be comfortable with guarantees created in their favour by parent entities having strong credit scores. The good news is that the Oil and Gas Fund, established under the Oil and Gas Revenues Management Act 2015, will guarantee the financing of investments in oil and natural gas. This should help to boost the capacity of local companies in Tanzania’s natural gas sector.
It needs to be underscored that funds required for financing of Tanzania’s upstream and midstream natural gas projects far outstrip the local banking industry’s balance sheet. According to media reports, some banks in Tanzania reviewing the trend and acquiring sectoral knowledge, insights, awareness, and experience; while others are defining plans and strategies for venturing into the natural gas sector. By virtue of their parent banks’ international networks, foreign-owned banks operating in Tanzania, for example, Barclays Bank, Citibank, Stanbic Bank (a part of the Standard Bank Group), Standard Chartered Bank, etc. have access to technical expertise and international financial sources for financing upstream and midstream natural gas projects. They also have leading forex capabilities to support the flow of funds into Tanzania. Tanzanian domestic banks would focus on the downstream segment, given that the upstream and midstream segments are the most costly and highly risky. Local companies, suppliers, contractors and consultants providing goods and services to global energy companies are raising operating capital through expensive debt from banks under very stringent demands for financial statements, cash flow projections, collateral security, and very high interest rates. This is why, in part, the level of debt financing of the natural gas sector in Tanzania is still extremely low.
To appreciate properly the future direction of financing natural gas projects in Tanzania, it is important to consider the key factors which limit lending to the natural gas sector by Tanzanian domestic banks and the current challenges being experienced. One of the factors is the high interest rates, charged in what is a seemingly competitive banking and financial services industry with over 40 banks and a number of non-bank financial institutions, of up to 15% and 25% respectively to attract capital in US dollar and Tanzanian shilling currencies. As a matter of fact, it’s the short-term transactions that can tolerate such high borrowing costs, while most of the long-term natural gas projects cannot withstand such costs. Among the core drivers of high interest rates in Tanzania is inflation, which has been shooting in double digits. In order to safeguard the value of money that banks lend, they have to charge inflation-adjusted interest rates; therefore, the higher the inflation, the higher the interest rates (other factors staying constant). The short tenor of credit accommodations granted by Tanzanian banks also constrains lending to natural gas projects as the deposit base of these banks consists largely of the short-term deposit funds. This is one of the reasons why the banks prefer short-term lending for tenors of up to one-year. The meager lending capacity of Tanzanian banks is a challenge that the natural gas sector is also grappling with. Natural gas projects are, for the most part, very expensive and; at the same time, even the biggest Tanzanian banks like NMB Plc cannot lend, directly or indirectly, to a single borrower funds in excess of 25% of their core capital. This is in accordance with the Banking and Financial Institutions (Credit Concentration and Other Exposure Limits) Regulations 2014. Consequently, Tanzanian banks could strategize to finance the development and implementation of natural gas projects in the downstream segment, which is less expensive and less risky.
In the face of all of the foregoing limitations and challenges, some positive developments have occurred. By way of example, inflation – a core cause of high interest rates – eased to 5.4% in March of 2016 from 5.6% in February, according to the Tanzanian National Bureau of Statistics. Also, there’s inflow of liquidity in the Tanzanian banking market due to syndicated loans provided by foreign banks and growth of deposits, which grew by 6.7% in September 2015, notes a recent Bank of Tanzania Financial Stability Report. These developments are likely to reduce interest rates. Taken together with the growth of the banking sector, bank mergers in the offing will increase the size of loans which can be granted by a bank to a single borrower. With these trends, the role of Tanzanian banks in financing downstream natural gas projects will intensify. Yet, the capacity of Tanzanian banks in financing larger upstream and midstream natural gas projects will remain insufficient. Last year, in 2015, we saw the emergency of a new source of debt financing: the Public Issue of the first-ever retail bond in the Tanzanian securities market by Exim Bank Tanzania to raise up to TZS 15 billion. In the past, there have also been corporate bonds issued by the East African Development Bank/EADB (TZS 15 billion), the Eastern and Southern African Trade and Development Bank/PTA Bank (TZS 15 billion), Barclays Bank Tanzania (TZS 10 billion), and Standard Chartered Bank Tanzania (TZS 8 billion).
This option would enable Tanzanian banks to provide loans for natural gas projects for comparatively long tenors of 5-7 years, which could be increased to over 10 years, thanks to the growth of the Tanzanian pension sector, which is seen to be keen on investing in corporate bonds and other debt securities. It’s hoped that Tanzanian banks could issue bonds for financing of a single downstream natural gas project in excess of TZS 30 billion. The bond market in Tanzania would also be inspired by the inflow of funds from insurance businesses and would be far more stable and less sensitive to changes in investor sentiment towards Tanzania as a developing country. Nevertheless, the Tanzanian bond market would replace Tanzanian banks in financing natural gas projects. The DSE, under the leadership of Mr. Moremi Marwa, is already doing well in raising awareness among local companies about the benefits of issuing and listing corporate bonds on the bourse. But the issuing and listing process, it should be noted, is costly and long-drawn-out; hence, only suitably big companies (by Tanzanian standards) can justifiably issue and list bonds. For smaller local companies, contractors and consultants supplying goods and services to global energy companies undertaking natural gas projects in Tanzania, bank loans would remain a critical debt financing source.
In the same way, shareholder loans aside, the level of foreign debt finance (in the form of project finance) to Tanzania’s natural gas projects sponsored by global energy companies and the TPDC is quite low. The explanations for this include the plunging price of gas which has fueled a reduction in risk-taking; the delay of 1-2 years in arranging project finance, the uneasiness about giving up considerable operational freedom as well as disclosing commercially sensitive information; and the difficulty in coordinating the diverse views of several partners on the need, agreeable structure and costs of project financing. One of the largest foreign debt financing deals in 2015 was a US$ 1.25 billion loan, carrying a 33-year maturity and 2% interest rate, accorded by the China EximBank for financing the construction of the Mtwara – Dar es Salaam gas pipeline. However, theories around possible amendments of agreements that the Tanzanian government entered into with global energy companies may increase risk exposure for shareholders in these companies and eventually encourage them to arrange for non-recourse project financing so as to minimize their own risk exposure in Tanzania. Growth of the syndicated loan market and the existing political stability in the country may also buoy up project financing deals in the natural gas sector, with involvement of foreign banks, bond investors, ECAs, IFIs and MDBs.
Although the Tanzanian government has invited local investors to participate in power and energy investments, foreign debt financing for 100% local Tanzanian owned companies in the natural gas sector has yet to happen. Most of these companies understand the requirements of Tanzanian banks, which they time and again infer to foreign banks; yet, the discernment of risks and credit standards, for instance, of foreign banks repeatedly differs from those of Tanzanian banks. Local companies would need to become more transparent by conducting audits in accordance with internationally accepted standards and disclosing a lot of information about their activities. By the same token, the TPDC should become more transparent to enable it attract syndicated loans from foreign banks, and to issue bonds in the international capital markets. In addition to this, the development of Tanzania’s natural gas deposits should help local companies to maximize on the immense opportunities for establishing joint ventures with global energy companies and gain first-hand experience and a good understanding of the capabilities of these companies and foreign banks. Unfortunately, at present, a fall in oil prices may slow progress in these areas, but local companies can still look to improvements in the macroeconomic environment of Tanzania, and a better perception of the country risks in the international financial market. This should allow local companies to raise good-sized financing for natural gas projects in the international financial market in the future. The successful acquisition of a US$ 200 million syndicated loan by local conglomerate Mohammed Enterprises (Tanzania) Limited (METL) from a group of global bankers confirmed an important change of direction. Local companies could expect syndicated loans for downstream natural gas projects from foreign banks for tenors of 1-5 years and in the amount of US$ 50 - US$ 200 million per transaction.
Overall, the natural gas sector can look forward to a robust and vibrant future in Tanzania. The development of the country’s huge natural gas reserves would bring many benefits e.g. tax revenues for insistent needs in health, infrastructure and education; and assist to widen access to energy. As the proposed LNG processing plant could take 7-8 years to plan, design, approve and construct, Tanzania could potentially generate US$ 5 billion annually by 2025 from LNG exports, creating over 80,000 job opportunities. Even though these prospects would positively transform the economy of Tanzania, there are limitations and challenges, which must be dealt with as they would definitely impact the viability of natural gas projects. To take advantage of domestic and foreign debt financing opportunities, the Tanzanian government needs to further improve oil and gas regulations, embolden monetization of assets, and eradicate markedly restrictive legislation and uncertainty over the policy and regulatory environment as the natural gas sector develops. Borrowers in the natural gas sector of Tanzania should understand the idiosyncrasies and requirements of local and foreign banks and financial institutions, and develop an appropriate financing strategy supported by rigorous legal structures. Moreover, it would be necessary for 100% local Tanzanian owned companies to establish strategic international alliances for the purpose of bidding for exploration blocks and for contract opportunities with global energy companies. This would help to build the case for debt financing. In the same vein, Tanzanian domestic banks looking for a piece of the natural gas discoveries should establish and manage properly partnerships and collaborations with international banks interested in financing natural gas projects as a way of risk sharing and reducing the very high interest rates charged on the TZS denominated borrowings.