Kenya Exports Oil for the First Time: What Can We Learn from Other Countries?

Oil Exploration and Production Journey

Kenya exported 200,000 barrels of crude oil to ChemChina, a Chinese company, at a cost of Ksh 12 billion in August 2019. This marked yet another milestone regarding Kenya’s oil exploration and production journey which begun in the 1950s. The first milestone in this journey was made in 2012 with the discovery of commercially viable oil deposits in the Tertiary Rift basin in Turkana. The discovery was made by Tullow, a British Oil Company. Since this discovery, the oil company has dug about 86 wells within four oil basins namely: Lamu, Tertiary Rift, Mandera, and Anza. Tullow oil considers the Tertiary Rift as the most promising among the four basins. The company estimates that Lokichar sub-basin within the Tertiary Rift has about 4 billion barrels of crude oil.

The exportation of this crude oil was also an indication of progress made regarding the Early Oil Pilot Scheme (EOPS) launched in June 2018. The scheme was an experimental research project undertaken during the first phase of oil exploration with the objective of informing full field development of oil in the next phase of commercial production. Specifically, EOPS has been instrumental in collecting data on oil reserves, building technical capacity and experience for national and county governments, and in providing information on progress of oil exploration in Turkana. Since its inception, EOPS has overseen transportation of about 2,000 barrels of crude oil daily from Turkana to Mombasa using trucks. The 200,000 barrels of crude oil exported in August 2019 was as a result of reserves built from this daily transportation. Transportation of crude oil is still ongoing, with the objective of building up reserves for subsequent exportation.

To move from oil exploration phase into the next phase of commercial production, Kenya needs to sign the Final Investment Decision (FID) agreement with Tullow Oil and its partners. So far, Kenya has signed two key deals as a precursor to FID. The deals include:  Head of Terms of agreement with Tullow oil for the development of a crude oil processing facility in Lokichar sub-basin and building of a pipeline from Lokichar to Lamu to transport crude oil; and Information Memorandum with multinational oil companies to finance infrastructure development in Lokichar. Once FID is signed, it is expected that it will take approximately 3 years to complete the construction works before the onset of commercial production of oil. If everything goes as planned after the start of commercial production, then it is expected that Kenya will start large scale oil exportation in the second half of 2023.

Should Kenya start exporting oil in 2023, it is estimated to receive about Ksh 150 billion annually in export revenue.  As such, oil exportation is expected to be the second highest source of revenue after tourism, which currently stands at Ksh 157.4 billion. The possibility of oil being a major source of revenue by 2023 has been met with mixed reactions amongst citizens and has further ignited the inconclusive debate on the potential impact of oil and gas discovery on a country’s economic growth.

The first school of thought in this debate borrows from the experience of Norway, Switzerland and Botswana. They link abundance of mineral resources such as oil and gas in a given country with inclusive economic growth. In particular, the school postulates that if mineral resources are well managed, they can positively transform the economy of a country. Botswana, for example, has recorded impressive GDP growth which has been supported by its mineral resource base. Today, the country is one of the world’s fastest growing economies with an average growth rate of 3.6 per cent per annum over the past decade and a GDP per capita of US$ 8259 in 2018.

The other school of thought is guided by the resource curse theory. In their view, countries rich in minerals especially oil and gas, tend to perform poorly in terms of economic growth and good governance in comparison to countries without minerals. For instance, between 2012 and 2018, the annual GDP growth of the top ten oil producing countries in Africa has on average been 2.6 per cent compared to the 5.0 per cent recorded by other ten non-oil exporting countries in Africa (Malawi, Mozambique, Burundi, Benin, Burkina Faso, Kenya, Malawi, Rwanda, Tanzania, Uganda).

The experience of Sudan shows how discovery of oil affects productive sectors such as agriculture. After Sudan started exporting oil in 1999, the structure of its economy changed from heavily relying on agriculture to an economy dominated by oil exports. Most specifically, Sudan recorded an increasing contribution of the oil sector to GDP from 2 per cent in 1999 to 21 per cent in 2007, and further a declining average of 9 per cent from 2008 to 2010. In contrast, there was a significant decline in the contribution of agriculture to GDP from 50 per cent in 1999 to 31 per cent in 2010. With the secession of South Sudan from Sudan in 2011, Sudan experienced a huge blow since oil revenue constituted an increasing share of its GDP. As such, Sudan has shifted its focus on reviving agriculture by enhancing agricultural efficiency and promoting agricultural exports to gradually recover the contribution of GDP to the economy.

On the fiscal side, 60 per cent of the top oil producing nations in Africa (Republic of Congo, Equatorial Guinea, Gabon, Sudan, Ghana, Chad and Cameroon) underwent debt restructuring under the Heavily Indebted Poor Countries (HIPC) programme. HIPCs are a group of 37 developing countries with high debt levels and high poverty rates; as such, they are eligible for financial aid from the International Monetary Fund, and the Word Bank.

A plausible explanation for this is that over 80 per cent of government expenditure in these countries comes from oil exports. As such, price fluctuations in the international market means that government revenue is likely to rise and fall in tandem with international oil prices. However, governments are reluctant to reduce their expenditure during declining oil and gas revenue. Therefore, they borrow from international markets to smoothen their expenditure pattern, ultimately increasing their debt burden. Ironically, even during periods of high revenue, most oil exporters still resort to borrowing against expected future oil prices to augment their government expenditure. This eventually increases their indebtedness in comparison to other countries that do not export oil and gas.

Furthermore, there is increasing tendency for governments in oil rich countries to expand expenditure on politically motivated public projects which end up as white elephant, which involve massive financial expenditure but do not deliver as expected. In Nigeria, for instance, the government set up Ajaokuta steel mill manufacturing industry as a way of gaining political leverage with the Yoruba community. The multi-billion project, started in 1979, is yet to produce steel 40 years later despite the government spending over US$ 3 billion on it. In Chad, the 5 per cent revenue set aside for the development of Doba oil producing region was used to build a university in Doba, yet the region has a low number of students who pass entry exams for enrolment into universities. In as much as the university was built, it has low enrolment, lacks enough sitting space for the enrolled students and very few books in the library for students.

Additionally, countries that are rich in oil and gas are leading in terms of poor governance and high levels of corruption. According to Acemoglu & Robinson (1999) this phenomenon is referred to “good economics, bad politics”. Transparency International’s Corruption Perception Index (CPI) validates this phenomenon as it shows that oil producing countries have relatively low scores, indicating high levels of bad governance and corruption. Subsequently, the World Bank 2016 Country Policy and Institutional Assessment (CPIA) rating on transparency, accountability, and corruption in the public sector is higher at 2.7 for non-resource rich Sub-Saharan Africa countries in comparison to 2.2 for resource-rich Sub-Saharan African countries that export oil.

Figure 1: Production and exports of oil in Africa

Source:  ITC Statistics and UNCOMTRADE (2019)

To cushion the economy from volatility in revenue stream, sound fiscal policy is crucial in restricting overspending during periods of boom and borrowing during periods of busts. Kenya can learn from the successful sound fiscal policies adopted by Botswana that: promote a culture of government saving during periods of economic boom by  investing in offshore accounts; increasing local government investment on critical areas such as infrastructure, health and human capital; and enhancing government saving through use of funds such as Public Service Debt Management Fund, and Revenue Stabilization Fund.

Establishing sovereign funds could insulate the economy from windfalls by putting aside some part of the oil revenue in a stabilization fund to smoothen budget expenditure, and another part of the revenue in a saving fund to ensure that a share of revenue from oil and gas exploration exists for future generations. Even though the stabilization and savings funds collectively make up sovereign funds, there exists a fundamental difference between the two funds. Revenue is deposited into a stabilization fund to avoid overspending when oil prices are high and withdrawn to cater for budget deficits when oil prices are low. On the other hand, the revenue in the savings fund is meant for the future generation, hence it cannot be withdrawn for current spending at any point in time but can be wisely invested to benefit future generations. A good example of a successful sovereign fund is the Norway Sovereign Fund which through effective management has in excess of about US$ 1000 billion.

Section 4 of the Kenya Sovereign Wealth Fund Act, 2019 proposes to establish a Sovereign Wealth Fund.  The fund borrows immensely from Nigeria’s sovereign fund  and has three components: a stabilization component to insulate government expenditure estimates from fluctuations in resource revenue and to manage other shocks that might affect Kenya’s macroeconomic stability; an infrastructure development component to provide finance for public sector infrastructure development aligned to the national development priorities and encourage inclusive growth; and an Urithi component to save some of the resource revenue for use by future generations when oil deposits get depleted. Additionally, the Act outlines that windfall revenue will be used to reduce the country’s national debt burden and for supporting essential services such as healthcare and education.

A key source of funds for the proposed Kenya Sovereign Wealth Fund is the national government’s share of profits derived from upstream petroleum operations (exploration, development, and production of crude oil and natural gas). The other revenue sources for the fund include: petroleum and mining royalties payable to the government; bonus payments on grants or issuance of petroleum license; annual license fee from upstream mining operations; and earnings from participation of the government in mineral and petroleum operations.

For the revenue from upstream operations, before allocating the national government’s share of profits to the Fund, 20 per cent of this profit is to be excluded to take care of the allocation made to the county government, and another 5 per cent is to be excluded for allocation to support the local community as stipulated by the Petroleum Act, 2019.  What remains is deposited into the Fund. The fund also accumulates revenue from other sources. Collectively, the total sum is known as resource revenue. The Kenya Sovereign Wealth Fund Act, 2019 sets out floors for allocation of resource revenue into the components as follows: at least 15 per cent is to be apportioned to the stabilization component, at least 60 per cent for infrastructural development, and at least 10 per cent for Urithi component. This means what remains (5%) can be reallocated to any of the three components when need arises.

The division of Kenya’s Sovereign Wealth Fund into three components borrows immensely from Nigeria’s Sovereign Fund which also has a stabilization component, an infrastructure development component and a future generation fund component. However, there is a difference in how revenue is allocated among the funds. Nigeria allocates savings gained from the difference between the budgeted and the actual market price for oil while Kenya intends to allocate all its resource revenue into the fund. Another fundamental difference between the two funds is on the per cent allocation on the 3 components. Nigeria allocates 20 per cent to the stabilization component. Infrastructure development component and future generation component each receive 32.5 per cent of the allocation while the remaining 15 per cent is assigned to either of the three components on a need basis.

To improve on transparency and accountability in the extractives sector, Kenya can consider joining the Extractive Industries Transparency Initiative (EITI). This is an alliance of governments, companies and civil societies who collectively work to promote transparency and accountable management of revenues from oil, gas and mineral resources.  It is made up of 52 countries. From the EITI Standards 2019, for a country to join EITI, it must undergo five sign up steps before applying to become an EITI country. These steps entail: government commitment, company engagement, civil society engagement, the establishment of a multi-stakeholder group, and an agreement on an EITI work plan. After a country completes the sign up steps and wishes to be recognized as an implementing country, the government should submit an EITI application, endorsed by the multi-stakeholder group. The application should give details of the activities that have been undertaken so far while providing evidence that all the sign-up steps have been successfully completed.

Currently, 50 per cent of members of EITI are from Sub-Saharan Africa. Out of the top ten oil producing countries, six of them (Nigeria, Republic of Congo, Equatorial Guinea, Ghana, Chad, Cameroon) are members of EITI. Tanzania is the only member of EITI within the East Africa region. However, Uganda has formed a multi-stakeholder group to see to it that the country submits its application to become a member of EITI before the end of 2019.

In 2015, Kenya made a joint commitment with the US, during the Barack Obama’s visit to the country. From the commitments, Kenya pledged to: join EITI and establish a government central point for EITI implementation within six months. Despite this commitment being made in 2015, Kenya has neither joined the EITI nor established a central point for EITI implementation.

The EITI standards requires member countries to disclose to citizens information about the extractive industries value chain from upstream extraction activities, to how revenues make their way through the government. Transparency and accountability as advocated by EITI is based on the idea that citizens are the owners of a country’s natural resources. Therefore, it is of utmost importance to have openness to ensure that the benefits of natural resources extraction accrue to all. The EITI process also brings tangible financial benefits to implementing countries by helping member countries recover oil and gas revenues owed to them by oil and gas companies involved in upstream oil operation. Nigeria, for instance, through the help of EITI, was able to recover about US$ 442 million in back taxes and royalties owed to the government by oil and gas companies operating in Nigeria.

Conclusion

As Kenya prepares to start oil exportation in the second half of 2023, it is imperative for the government to establish a framework that promotes implementation of sound fiscal policies and enhance good governance. This is based on the experience of Botswana, which shows that a combination of these two (sound fiscal policy and good governance) are essential in avoiding the resource curse phenomenon.

The proposed Kenya Sovereign Wealth Fund Act, 2019 calls for the establishment of Sovereign Wealth Fund. Operationalization of this fund will be instrumental in insulating the country from risks associated with volatility in oil prices, improving investment in infrastructural development, and in promoting sustainability in oil and gas exploration by ensuring that we save some part of oil revenue for use by future generations.

Joining the Extractive Industry Transparency Initiative will be good for Kenya as it will promote transparency and accountability in the extractives sector and give citizens an avenue to monitor how the government spends the revenue from the extractives sector. More specifically, it will ensure that oil producing companies publish what they pay, and at the same time the government publishes what it receives and that these receipts are independently audited then released to the public.  It will also ensure that the government is able to recover any outstanding amounts owed by oil exploration companies involved in the upstream oil section.

By Sabina Obere and Samuel Kataa

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