It was recently reported in one of the dailies that a 2022 presidential aspirant has pledged to deliver an oil refinery to monetise the oil resources in the Turkana county.
An opinion article in a business daily also suggested by a leading petroleum expert that this maight actually be a credible option in light of the delayed investment decision by the joint venture partners comprising of Tullow Oil (50 per cent), Africa Oil (25per cent) and Total Energies (25 percent).
To give a little background, Kenya discovered commercial oil in 2012 in Lokichar basin. The commercially extractable volume climbed to 585 million barrels from the previous estimate of 433 million barrels, according to an audit by British petroleum consulting firm Gaffney Cline Associates.
Tullow expects to recover 585 million barrels of oil from the project over the full life of the field.
In the mid-stream, the joint venture partners had proposed to build an 825km heated-pipeline to transport the crude oil from the Lokichar oilfields to Lamu, which would be the off-take.
Kenya had set a December 2021 deadline for Tullow to present a comprehensive investment plan for oil production in Turkana or risk losing concession on two exploration fields in the area.
Tullow and its partners had initially planned to reach a final investment decision in 2019 and production of the first oil between 2021 and next year. It has since presented its long-awaited revised development plan for oil production in Kenya for approval.
According to the revised plan, the construction of the pipeline is expected to take about three years at a higher gross budget of about $3.4 billion (Sh373.6 billion) owing to changes in its initial design to incorporate a bigger processing facility and oil pipeline.
However, and in the meantime, there have been suggestions from various quarters that Kenya should build its own refinery to commercialise its oil resources.
REFINERY ECONOMICS
Building an oil refinery is a very risky investment that would require huge capital. For many years, the cost of building a refinery cost was about $10,000 to a barrel before increasing to about $20,000. Today, it could be upwards of $35,000 to a barrel.
Uganda's oil refinery will cost about $4 billion for about 100,000 barrels per day at peak – if you factor in an inflation adjustment for the present, along with adjustments for the location since there would be need for new infrastructure and other ancillary facilities to support and run alongside the refinery.
For capital investment in new refineries to be desirable, certain market conditions should prevail.
An important prerequisite is an expectation of growth in demand, especially in the transportation fuels, gasoline and distillates. The availability of stable, affordable crude oil supplies, and certainty with respect to the regulatory environment, are also important.
It is proven the world over that a refinery would be economically justifiable only when it has refining capacity of at least 400,000 barrels a day. Kenya's expected production capacity will be between 80,00 barrels to a peak of 100,000 per day.
Refineries economy depends less on the oil price and more on “crack spread”, which is the difference between the cost of a barrel of oil and the value of a barrel of the refined product (gasoline, diesel, jet fuel, etc). This is the figure that tells you if a refinery is going to be profitable or not. The larger, the better.
The crack spread value depends on each product price (which may diverge) because of demand, offer, speculation, etc. of each product.
Refineries use crude oil as their raw material. So, in general if crude oil prices rise, refinery net cash flows decline, and if crude oil prices fall, net cash flows rise. However, refining is a margin-based, highly competitive commodity business, so the sales prices of refined products move quickly in tandem with crude oil prices.
While there may be (very) short-term cash flow changes with crude oil price movements across the quarter or year, the cash flows will be fairly constant, despite crude price.
Refineries and gas processing plants make their money on the spread between the products sold and the cost of the raw stock. They vary in how fast these prices move.
If the price of natural gas or crude rise but the end products haven't yet, the refinery or gas plant processing upgrade narrows.
If crude or gas stay low and the end products rise, the processing upgrade widens. They are all commodities traded on the free market so the prices move independently of each other in the short run. In the long run they depend on each other.
Other than what has been highlighted above, a lingering question exists on how Kenya would finance the 'proposed' refinery.
From an economic point of view, Kenya simply can't afford it given the level of indebtness we find ourselves in. As it is, the numbers don't add up. How will the refinery attract financial investment/ funding?
Big banks have been accused of having epically failed to respond to the climate crisis. Fossil finance is seen as climate damage, and year over year, global banks have cut-back on funding fossil fuel projects to address the root causes of climate change, and protect people from its impacts.
It will, therefore, be an extremely tall order to attract funding for a refinery.
Can we design, modify and downsize a refinery to suit our needs?
To make this general and qualitative, simple, smaller refineries/ 'tea-pot' refineries do poorly, unless they have some special economics - where local crude can give refiners an advantage.
The complexity of the crude oil defines the upgrading capacity, ie how much of the crude can be converted into gasoline and distillate (jet and diesel fuels).
There are three basic, co-products possible: Fuels, lubes, and petrochemicals. The ability to shift volumes (based on the prevailing market prices) can enhance the refiners' bottom line. Each product has its own economic drivers: "fuels" mode is throughput (max barrels/day), "Lubes" mode is primarily defined by quality specifications ("buy it by the barrel, sell it by the litre"). "Petrochemicals " mode is a bit of both drivers.
Most multinationals also understand and use "economies of scale". Quite simply (maybe an oversimplification) is that costs go up by the "six tenths" rule, as opposed to a linear cost.
Many refiners today will build the largest units as feasible, limited only by materials of construction, practical limits (eg how to get the equipment to the site), current and projected demand, etc.
Uganda’s decision to build a refinery has been discouraged on the basis the facility is not only an expensive venture but also lowers the value of the East African Crude Oil Pipeline. This is according to a report by UK-based think tank Climate Policy Initiative.
“Because of the complexity required to refine Uganda’s waxy oil, capital costs of $4 billion for the Kabaale refinery are very high for a refinery which is of very small scale compared with the global market,” the report titled “Understanding the Impact of a Low Carbon Transition on Uganda’s Planned Oil Industry” said in part.
The report adds that building the refinery will result in a $1.8 billion loss of potential value to the upstream oil reserves at EACOP, with $400 million of the loss accruing to international investors and $1.4 billion to the Uganda government.
This is based on the fact that the refinery will buy crude oil at a netback price — the price that the oil would earn on its way to export at the point it enters the EACOP pipeline. In effect, this complicates the situation for upstream investors because of uncertainties on whether they sell to the refinery or to export markets.
Kenya's case is similar to Uganda's. The oil discovered in Turkana is also waxy in nature, which certainly presents technological-engineering challenges.
Looking at Crude economics, some crudes are known as opportunity crudes, a euphemism for low quality - maybe high in sulfur, heavier (more residual crude with associated contaminants), higher corrosion potential (measured by "acid number", among other specifications).
What alternatives other than building a refinery can Kenya explore?
It needs to be pointed out that the oil refinery route is not the only option that Kenya can use to take full advantage of its pending oil wealth. One of the options is the possibility of Kenya becoming adept at international trade of crude products.
The country can explore the possibility of selling and buying crude at an appropriate economic price and ensuring that the market price for both sales and purchases are maintained.
Other than this, there is also the possibility of Kenya swapping the crude oil for refined oil products at a predefined exchange rate or entering into a tolling agreement or processing deal with major oil refiners.
Kenya can reach an agreement with a refiner and negotiate to pay a certain fee per barrel and have a certain slate of products as a result of that process. It is something that is done every day in the oil market.
Another option that I propose is for Kenya to actualize the proposed Sovereign Wealth Fund in readiness for the oil dollars. This fund can be used to invest in oil companies’ stocks in future. This essentially protects Kenya in case of volatility in the prices of oil.
Let’s say the price of crude went down and the products went up, you could compensate that by having stock in an oil company and receiving dividends.
The trillion-dollar Norwegian Sovereign Fund is a good example of how a country can invest for inter-generational gains. The viability of scaling down a refinery in size, is certainly not a viable option.
If you scale it down, there'll be very high infrastructural cost. The fact that you scaled down hurts the project instead of helping it because you are going to have to build docks, tanks, water treatment facilities, an energy facility to supply power, steam and all sort of ancillary facilities to make the refinery viable.
The problem with these massive investments is the cost of building a refinery and the infrastructure, which is not necessarily proportional. The bigger you build it, the lower the unit cost.
There's simply no economic justification to support an oil refinery at the moment.
This is unless some political and other considerations are superimposed like in other parts of the world, where, refineries may not be turning an economic profit but are providing other benefits such as ensuring oil sufficiency to avert an oil-like crisis seen in the 1970's.
Duncan Ogwang is a petroleum, gas and energy economist
