By Ian Mutibwa, Partner; Tax, banking and Finance- Signum Advocates
Two developments have shaped Uganda’s economic outlook: the discovery of oil and gas and the inclusion of Islamic Finance/Banking products in the country’s Financial Institutions Act. The two developments have had an impeccable timing and the correlation may enable Uganda have good proceeds from the vibrant oil and gas industry. It is a little ironic that despite the world’s biggest suppliers of oil and gas being Islamic States, little attention has been given to Islamic financing in the significant industry.
For a while, oil and gas has been the talk of Uganda, and the discovery is that the country has 6.5 billion barrels of oil reserves, of which 1.4 billion barrels are economically viable or recoverable. Such developments have, however, been stalled by the fact that the Oil Companies have not made Final Investment Decision (FID). FID means the point at which everything is in place for a project to say “yes, let’s go ahead”.
It’s when the project execution phase begins and the big money starts being spent on project construction. To reach FID, a project has to have a wide range of contracts and permits in place which have allowed it to agree its investment structure and terms with its finance providers (both debt and equity financiers).
It is the point at which contracts for all major equipment can be placed, allowing procurement and construction to proceed and engineering to be completed. It is understood that FID is expected to be finalised in June this year (2019). The delay has partly been the reason why the government shifted the time for the First Oil from 2020 to early 2022.
Should this happen as currently anticipated, in the next two to five years, close to USD 20 billion will be invested in the country, particularly in the development of more than 15 fields, construction of the refinery, East African Crude Oil Pipeline and in supporting related infrastructure.
This means that the investment in the next phase of oil and gas industry is more than 60 per cent of Uganda’s GDP. Once FID is finalised and communicated, there shall be huge capital investments, until the first oil is drilled from the ground. At the moment, only conventional banks have made and are planning to make investments in the oil and gas sector. This therefore begs the question whether Islamic finance can be one of the solutions to satisfactorily supporting the significant sector.
Islamic Finance in Uganda
Islamic finance came into place in Uganda after the Amendment of the 2016 Financial Institutions Act. The Financial Institutions (Islamic Banking) Regulations 2018 were then enacted, to regulate Islamic finance in the country’s banking sector. The regulations allow for the Bank of Uganda to issue a licence to operate an Islamic bank or for a conventional bank to do Islamic finance business through an Islamic banking window. The law also created Sharia Advisory Council and Sharia boards to allow for product evaluation and compliance with Sharia.
Islamic bank simply, is a deposit-taking institution, which provides all currently known banking products, except for borrowing and lending based on interest. The Bank mobilizes funds based on Islamic modes of financing such as Mudaraba, Murabaha, and Musharaka. The Bank may also accept demand deposits from clients, which are treated as interest-free loans and are guaranteed.
The Financial Institutions Islamic Banking Regulations 2018 provides for three major ways for funding of projects in Islamic financing, which include; equity partnership financing, lease- based financing and sale- based financing. It is important to understand these products to appreciate their relevance in the Oil and Gas sector.
Equity partnership financing (Musharaka)
In the Musharaka contract, there is agreement as to both parties’ share of the capital, on the term of the Musharaka and on how the withdrawing company’s share is to be paid up. How administration and settlement is to be carried out and how profit and loss is to be distributed.
Profit can go in accordance with what has been agreed, while loss is borne in proportion to the capital share. Such an arrangement encourages companies to achieve profits so as to be in a position to withdraw, and thus to have a speedy transfer of ownership, particularly if the Musharaka contract contains a promise by the banks and Islamic financial institutions to sell their share in full to the company if it has paid off its own share.
Sale Based financing (Murabaha)
In this method, banks and Islamic financial institutions can fund the commodity needs of companies in the oil and gas sector against a profit margin on the price for which a commodity was bought.
Lease based financing (Ijara)
Under this product, assets may be purchased by a financial institution and leased to its customer. With this method, the Islamic financial institutions can purchase the assets needed by the oil and gas companies, lend them out to them through a lease funding contract and the companies use the leased assets against payment of a fixed rental amount. The oil and gas companies will be able to meet their asset needs at any stage of production or distribution. Lease based financing enables oil and gas companies to have their capital asset requirements met at one or more stages of production and distribution without needing to set aside part of their own funds for the purchase, thus to put a burden on their budgets. As a result, they have greater liquidity and therefore better chances of using their funds for the most worthwhile of their other activities and, by doing so, securing further good investments.
The missing link for the Oil and Gas sector financing
Oil demand forecasts indicate that the world will need 92 million barrels per day (mbpd), after a peak of 93 mbpd in 2010, then rising to 110 mbpd by 2020. Uganda can contribute to this demand and profit from it as a country. From my understanding, Islamic financing offers good options for the Financing of the capital investments in the oil and gas industry. Perhaps one of the biggest benefits for Islamic finance is the unique products that they offer. As seen above, the products are more than just financing but also involve profit and loss sharing.
The banking sector in Uganda is relatively small to absorb the capital investments needed by OICs. This therefore calls for more and better financing options to get Uganda to the first Oil drops in 2020. These financing options are possible with Islamic Financing. It is important to note that through the 2008 Financial crisis, Islamic Banks were least affected. There are many arguments fronted for and against this. The major note is that the products were safe from the crisis.
There are various ways the Islamic Finance products may be structured to meet the specific needs of the OICs. Some of the notable oil and gas projects financed through Islamic finance include; USD 100 murabaha financing of Petronas Trading Corp, a subsidiary of the Malaysian Government oil company PETRONAS; USD 92.5 million murabaha derivatives contract for Turkey’s Petrol Ofisi; the Ijara and murabaha financing of Equate, a Kuwaiti company dealing in petrochemicals. Equate managed to obtain credit facilities amounting to USD 600 million for its activities by way of joint financing spread among Islamic and conventional banks.
Challenges for Islamic Finance in Uganda
The Islamic Finance regulations although regulated by the Bank of Uganda, have taken a snail- paced to be operationalised. The FID is expected to be made in June this year (2019), and the operationalisation of the Islamic Finance regulations should simultaneously be achieved. This will enable the Conventional and Islamic Banks plan for the huge capital investments in the Oil and Gas sector. As observed, there can be a mix of both Islamic and Conventional facilities to finance these huge investments.
The market is still sceptical about the operation of Islamic finance. The Ugandan market/populace believes that the financing may only be available to Muslims or persons of Islam faith and as such are challenging the applicability of the same in a predominantly Christian population. There is also a vast cry for sharia compliance which may be linked to the Muslim faith.
The regulations also provide for a limited product selection for Islamic finance. The law as it stands allows for three (3) major ways for Islamic financing for projects. There may be need to expand on the products offered over time to ensure maximum utilisation of Islamic Finance option. The law should allow for more options for financing in Islamic Finance. Suffice to note that the broad categories of financing under Islamic financing will depend on the economy of Uganda and the appetite for the financing.
Whereas the Oil and Gas sector is highly specialised and requires huge Capital investments, and whereas there are still challenges in accepting Islamic Finance in Uganda, the government of Uganda needs to provide and operationalize the regulatory environment that Islamic Finance operates in to boost investors’ confidence that the huge capital investments can be financed through Islamic Finance.