In mid-March, South Sudan said it was suspending talks with Khartoum, accusing President Omar al-Bashir of plotting to overthrow the government in Juba.

Following January’s referendum in favour of secession, South Sudan is to become independent in July. This will leave the Arab-dominated North shorn of some three-quarters of the country’s oil and gas acreage.

The key challenge will be to negotiate a new revenue-sharing model … satisfactory to both the north and south

Hydrocarbons wealth is central to the viability of an independent South Sudan. But with the existing revenue sharing agreement between the north and south due to expire, there is concern the country could yet be struck by the African ‘resource curse’, a economic paradox in which countries with large natural resources are prone to become failed states.

Peace agreement

Since the signing of the 2005 Comprehensive Peace Agreement (CPA) that brought an end to the 22-year civil war between the government of Sudan based in Khartoum and the Sudan People’s Liberation Movement, the country has defied the resource curse stereotype. The CPA contained an innovative deal under which the once warring factions in Khartoum and Juba agreed to split the country’s oil wealth.

The $10bn in revenues that have since flowed from north to south have proved to be the glue that has kept the peace. Barring isolated mishaps, the deal has stuck.

Now that formalised institutions of independence will have to form for the southern’s state-in-waiting, the durability of the revenue-sharing formula will be tested.

Currently, at least 80 per cent of Sudan’s oil production is pumped from fields located in the south, but piped through the north to Port Sudan. The security of this arrangement will have to be reassured if the new state in the south is to emerge as a credible entity that meets the aspirations of its people.

Sudan has an estimated 6.7 billion barrels of proven crude oil reserves and output has been rising. The country produced 490,000 barrels a day (b/d) in 2009 and hit 500,000 b/d in November 2010. 

Lacking any other source of revenue generation, South Sudan will be overwhelmingly dependent on the oil income derived from production on its territory.  

The key challenge will be to negotiate a new oil revenue-sharing model that will be satisfactory to both the north and south. The geographical separation between oil resources and infrastructure has created an environment of mutual dependence that will be the foundation of a new post-referendum oil deal.

Both North and South must also face the reality that oil output is likely to peak within the next couple of years

The government of South Sudan’s desire to accrue a share of revenue that reflects the fact that 80 per cent of Sudan’s oil reserves are in its territory, is constrained by its reliance on the North’s export infrastructure to bring that to market.

If a worst case scenario transpired and the flow of oil were to be shut down with the outbreak of civil war, then Sudan would immediately lose 10-20 per cent of its gross domestic product, according to an assessment by analysts at London-headquartered consultancy Frontier Economics. For the first 10 months of 2010, Sudan earned $3.7bn in oil revenues.

Oil revenue sharing

“They haven’t got much choice,” says Roger Middleton, a fellow and Sudan expert at UK think-tank Chatham House. “[The government of South Sudan] is 90-per cent plus reliant on revenue from oil and the northern government is 30-40 per cent reliant on that same oil for its revenues, so neither can afford to lose that revenue stream. So the reality is that they have to reach some kind of agreement on this.”

Both sides compromising on this will not resolve everything. Much still remains to be sorted out. South Sudan went to the polling stations on the 9 January uncertain of the ownership of key blocks, with 20 per cent of the border areas including oil-rich areas, still to be delineated.

The two sides will also have to resolve thorny issues such oil fields that do not neatly lie in one or other of the newly divided country. The large Paloich field, for example, straddles both sides of the planned divide. Another concern is Abyei, an area along the border. A second referendum is expected for residents in Abyei to decide whether to join the north or south. Home to the Defra field operated by a China National Petroleum Corporation (CNPC)-led consortium, the decision will have a decisive bearing on the oil sector.

The revenue-sharing mechanisms are perhaps the most important building block for the new two-state Sudan. Under the CPA arrangement, revenues from South Sudanese crude are shared on a rough 50-50 split between the two sides. However, southerners have complained of discrepancies in the way the national unity government has calculated the revenue-sharing deal.

Misleading oil figures

A study published by UK-based non-governmental organisation Global Witness in January raised questions about the implementation of the current oil wealth-sharing agreement. The report’s key concern was why CNPC’s figures for oil production were significantly larger than the official figures published by the government. Many southerners believe officials in the north are skimming off oil revenues, depriving the south of its rightful inheritance.

Suspicions over the sharing of oil revenues under the current peace deal have greatly added to the mistrust between the two parties, says the report. A post-referendum oil deal will need to detail the exact volumes pumped from the south, as well as the exact price of oil sales and the split between government and oil firms.  

“The percentage of investment costs that companies get back is quite high so if it gets that wrong, it can easily mislead as to how much oil revenue is to be shared between Khartoum and Juba,” says Global Witness campaigner Rosie Sharpe.

The Khartoum government has now established a committee to select an international company to undertake a review on how much oil Sudan produced in 2005-10.

The south is landlocked and the only way out for the oil is through a pipeline in the north. For the north, there is a need to shore up long-term revenues by ensuring the smooth functioning of the oil industry.

Although the Khartoum exchequer might see some reduction in revenues, the immediate impact from a post-referendum deal was expected to be minimal, with a phased reduction in oil earnings from southern oil. But the flare-up in tensions between the two sides threatens to prevent a smooth transition.

With nearly $5bn a year of oil revenues, there is much at stake for the two sides. A stable management of the oil sector is essential, with the largely Asian foreign operators, comprising Malaysia’s Petronas, CNPC and India’s Oil & Natural Gas Corporation continuing to invest in exploration and production. Sudan Petroleum Corporation (Sudapet) is the national oil company operating in the north, while Nile Petroleum Corporation (Nilepet) will manage resources in the south.

Both Sudapet and Nilepet will need to ensure exploration and production activity continues throughout the difficult separation process. The good news is that production is rising. The north has added 30,000 b/d to its production, with the commission of new wells at Block 6 in December 2010, operated by CNPC and Sudapet. It takes total northern output to 110,000 b/d.

About 45,000-50,000 b/d of the northern production is from wells in Blocks 1, 2 and 4 that lie in north Sudan and 60,000 b/d from Block 6. Sudapet hopes that discoveries in the western part of Block 6 will increase output by a further 40,000 b/d within two to three years.

Energy Minister Lual Deng announced in November 2010 that Sudan’s total oil production capacity would rise to 600,000 b/d in 2011. Khartoum plans to raise this to 1 million b/d within three years.

Sudapet is looking to new technology to improve the recovery factor by 30 per cent and maximise reserves by an additional 1 billion barrels by 2010. The south, under Nilepet, will be looking to match that increase. Foreign oil companies are already looking to develop South Sudan acreage, with France’s Total in talks with Qatar Petroleum International (QPI) over the formation of an upstream joint venture in the south. QPI could be in line for a 20 per cent stake in the 118,000 square kilometre Block B concession in South Sudan.

Both north and South Sudan must also face the reality that oil output is likely to peak within the next couple of years. Long-term forecasts see the Nile Blend continuing to decline and the newer Dar Blend peaking as early as 2011. This could have a decisive impact on the south in particular, in its ambitions to create new oil infrastructure that would rid itself of its dependence on northern export routes.

Building infrastructure in Sudan

South Sudan has less than five kilometres of paved roads, preventing the trucking of oil by road and there are no export pipelines.

It would take years for the south to build an alternative pipeline through Kenya.

There are also questions as to whether there is enough oil in the South to justify building such a pipeline. In 2007, Chinese President Hu Jintao met with his southern counterpart Salva Kiir to discuss building a link running from Juba to Lamu in Kenya, but nothing substantive has emerged since then.

More realistic are plans for South Sudan to build its own refining capacity. Last year, Akon Refinery Company, a joint venture of Khartoum-based Eyat Oilfield Company and Nilepet, invited bids for the construction of a 50,000 b/d plant at Akon, to be supplied with crude by pipeline from the southern Unity field. Another two refineries are planned in the south.

The importance of getting its oil arrangements right goes beyond ensuring a steady supply of export revenues to both north and south. Oil is central to the viability of the entire project, from settling border areas to resolving grazing rights. The likelihood is that the danger of doing without billions of dollars of oil export revenues will force both sides to pull back from the brink.

“Some southern politicians threaten that they fought for 20 years without any oil and can go back to that again and burn the oil fields if need be,” says Middleton. “But the truth is they would find it difficult to go from having billions of dollars at their disposal to not having much at all.”

With tensions mounting in Sudan, it is that fear that should focus minds in both Juba and Khartoum as they contemplate their new, separate, but connected futures.