What Kenya must now do as emerging oil producer

The role of the government in the sector is to enhance the commercialisation of discoveries

In Summary

• Newly emerging producers thus face several major challenges

•The  coronavirus-related market turmoil is likely to further accentuate these problems.

TWICE LUCKY: Weatherford engineers at the Tullow Oil Ngamia 1 ring in Turkana
TWICE LUCKY: Weatherford engineers at the Tullow Oil Ngamia 1 ring in Turkana
Image: FILE

There’s a Norwegian proverb that says, "necessity teaches the naked woman how to knit.”

It was recently reported in one of the local dailies that Kenya is seeking to purchase idle oil production equipment as lower International crude oil prices could offer an opportunity to procure cheaper equipment.

Petroleum Principal Secretary Andrew Kamau is quoted as having said, "The country will now speed up the process of acquiring crude oil production equipment during the current down time to maximise on the cheap purchases."

“The current fall in the international crude oil prices will continue to leave most equipment idle as oil wells close, presenting an opportunity to cut favourable equipment hiring deals for Kenya," he added.

Presumably, the government intends to do this through the National Oil Corporation of Kenya, which is involved in all aspects of the petroleum supply chain covering the upstream oil and gas exploration, midstream petroleum infrastructure development and downstream marketing of products.

NOCK is among the few African national oil companies directly involved in the search for oil and gas and operates its own exploration acreage in Block 14T located within the Tertiary Rift Basin. It runs from the shores of Lake Bogoria down to Lake Magadi Basin on the border of Kenya and Tanzania.

Its formation was precipitated by the oil crises of 1973-74 and 1979-80 and the correspondent supply disruptions and price hikes that resulted in the country’s cost of oil hitting the all-time high of over one third of the total import bill. This made petroleum the single largest drain of Kenya’s foreign exchange earning.

The energy sector in general is experiencing significant shifts in strategies, business models and ways of working. It is against this backdrop that NOCK’s future must be addressed.

Many of the national oil companies that dominate today’s oil and gas production – Saudi Aramco, the Iraqi National Oil Company and the Kuwait Oil Company – trace their origins back to partnerships forged with foreign investor-owned companies at the turn of the century to develop local resources.

History appears to be repeating itself,with the only difference this time being that national oil companies are striking new energy partnerships with investor-owned oil and gas companies and other national oil ventures. This is to attain the global size, industrial scope and technical expertise required to manage the energy industry’s rising risks.

In recent months, Saudi Arabia’s national oil company, Saudi Aramco, bought a 28 per cent stake in a South Korean oil refining and marketing company for $2 billion. State-owned Turkish Petroleum Corp. announced it will acquire a 10 per cent interest in Azerbaijan’s Shah Deniz field and the South Caucasus pipeline from Total SA for $1.5 billion.

These transnational agreements are being triggered by the fact that drilling for oil and gas is becoming an exponentially higher-cost, hypercompetitive, technology-intensive business. It is estimated that more than 70 per cent of the world’s hydrocarbon supply growth will come from complex resources such as deepwater shelves like Lamu.

Most oil exploration projects will have budgets of more than $5 billion. Currently, only about one-third of exploration projects are in excess of this budget.

To thrive in this unforgiving environment, national oil companies must hedge their bets by developing all-encompassing global footprints in businesses, ranging from offshore oil and gas exploration projects to gasoline stations.

This target is achievable. China National Petroleum Corporation is active in 27 countries and has production-sharing agreements with Shell to explore, develop and produce oil and gas in China and in West Africa.

But as the industry reshapes itself, national oil companies are being forced to partner with investor-owned oil businesses to reach the level of efficiency and returns on research needed to deliver on multibillion dollar projects globally.

Many traditionally slow-moving national oil companies such as NOCK, will have to overhaul their organisations by managing more diversified businesses. To achieve this, they must first create robust governance structures that can manage the accompanying risks appropriately. To realise greater value across all their assets, operations will need to be more globally integrated.

The crash in oil and gas prices, triggered by the coronavirus pandemic and the slump in economic activity has dealt a massive blow to the plans and public finances of major oil and gas producing countries.

However, a group of countries in sub-Saharan Africa once designated as “prospective or emerging oil producers", of which Kenya is one, are facing different challenges.
For emerging producers in the pandemic era, some licensing rounds are likely to be cancelled, and production for countries such as Kenya and Uganda, has been pushed back once more, given Tullow oil company's financial woes.

Newly emerging producers thus face several major challenges: Delays in first oil production, reduced fiscal revenues, weak hiring of local people and companies, and dissatisfaction among citizens about diminished returns of a complex new industry.

The sector has always been inherently unpredictable, but these disappointments highlight the dangers of the 'Presource Curse' — the economic risks a country faces from discoveries before the first drop of oil is produced.

The  coronavirus-related market turmoil is likely to further accentuate this trend. By any metric standard, it is simply unattainable for Kenya to purchase oil drilling and production equipment at present.

Lack of capacity and technological know-how, coupled with attendant costs associated with procuring the relevant equipment, makes this a very lofty dream. Many lenders and equity investors are significantly more skeptical of financing new oil projects in light of the lower prospective returns. Some projects that looked viable during the boom may not be developed for many years. 

An alternative to hiring/ purchasing oil producing equipment, as the government intends to, is for the Ministry of Petroleum and Mining, through the National Oil Corporation to seek partnership with major oil equipment manufacturers such as Baker Hughes.

This would present a win-win scenario for both parties — The government acquires the relevant equipment and technology, in exchange for profit-share.

The views presented here does not necessarily hand Kenya a fait accompli, but rather reinforces the need for Kenya to first create and empower the relevant institutions as envisaged under various acts of Parliament.

What must Kenya do now?

The role of the government in the sector is to enhance the commercialisation of discoveries, develop the requisite skills and infrastructure for production and secure supply of petroleum products through formulation and strengthening of policy, legal and institutional framework.

A review, for example, of the current framework, reveals a disconnect between intent and what is on the ground. It is important for Kenya to establish and to strengthen the capacities of institutions in the sector before it achieves the status of an emerging oil producer.

It  must radically rethink its approach to the oil sector.
 Some of the immediate steps that Kenya must take, include making public the Petroleum Sharing Agreement it signed with Tullow Oil Company, disclosing the revenue earned from the Early Oil Pilot Scheme (EOPS). It should also disclose the results of the audit done on Project Oil Kenya.

Government officials, development partners and other public policy professionals should also conduct scenario analysis on the prospect of future discoveries, timelines and government revenues.

The government must also reset and manage public expectations. With the current crisis, citizens should be aware of the turmoil facing the sector, which provides a critical opportunity for governments to reset previous expectations. Development partners should support such efforts, including by working with civil society organisations and media.

The government must also avoid a “race to the bottom”. Countries should not relax regulatory terms to attract interest in licensing rounds or encourage final investment decisions without rigorous modelling of their impact on investment prospects and long-term benefits for the country.

Best practices established in successful petroleum-producing states represent the international ‘gold standard’ in the oil and gas sector. It is important for government policy to be guided by a clear vision for the development of the country and for the role of the petroleum sector therein.

Governments should base this vision on an analysis of available resources and capacity, as well as opportunity costs and risks associated with the chosen development model.

Emerging producers should design Petroleum Sharing Agreements that are aligned with the national vision. Tax obligations should be included in the tax code rather than in contractual agreements. This includes provisions for taxing capital gains earned by companies that sell or assign their rights or part of their rights before or during production.

It is particularly important for developing economies to devise petroleum-sector policies that maximise national development. For this purpose, governments must have clear local content objectives, which are set within a broader national vision. For instance, they should strategically target which skills and supply chains to develop.

The Local Content Bill, 2018, provides for a framework to facilitate the local ownership, control and financing of activities connected with the exploitation of gas, oil and other petroleum resources; to provide a framework to increase the local value capture along the value chain in the exploration of gas, oil and other petroleum resources; and for connected purposes .

Part 111 of this Bill provides for the establishment of the local content development committee to oversee, co-ordinate and manage the development of local content in the country.

Local content means the added value brought to the Kenyan economy from extractive industry through systematic development of national capacity and capabilities, as well as investment in developing and procuring local work force, services and supplies, for the sharing of accruing benefits.

The Local Content Development Committee must be
formed immediately.

Producers at an early stage of development should start by establishing credible institutions to manage all aspects of the sector.
The Energy and Petroleum Regulatory Authority has already been established as the successor to the Energy Regulatory Commission under the Energy Act, 2019 with an expanded mandate of inter alia regulation of upstream petroleum and coal.

The Petroleum Act, 2019, on the other hand, provides a framework for the contracting, exploration, development and production of petroleum; cessation of upstream petroleum operations to give effect to relevant articles of the Constitution in so far as they apply to upstream petroleum operations, regulation of midstream and downstream petroleum operations; and for connected purposes.

It is envisaged in the act (sub-section 12), that the National Upstream Petroleum Advisory Committee will be formed.
Its functions will be to generally advise the Cabinet Secretary on upstream petroleum operations, advise the CS during the negotiation of and entering into of petroleum agreements and on the suspension, revocation or termination of a petroleum agreement or the recall of a security given under the terms and conditions of a petroleum agreement. This Committee must be also formed without further delay.

This  should introduce checks and balances, while building up capacity in other branches of government. Governments should immediately introduce key mechanisms for public accountability, including audits of agencies and state-owned companies and regular disclosure of information to the public.

If Kenya undertakes the above steps, it will knit its way to becoming a successful new oil producer and will avoid the resource curse that has bedevilled many resource rich nations.

Ogwang is a petroleum and energy economist