Elation as Kenya exports Oil; what does it mean for Oil rush in East African region

On 1st of August 2019, President Uhuru Kenyatta announced that Kenya had joined the list of world oil exporting Countries by selling its first crude oil at a cost of 12 Million United States dollars.

While the news reverberated across the Country and the region with elation, it is also possible that Kenya’s announcement could trigger a contagious rush to the bottom with East African Countries jostling to outcompete each other by signing off deals and agreements locking off future markets with potential buyers. Some of these deals may not be necessarily good.

By Moses Kulaba; Governance and Economic Analysis Center

Addressing the cabinet and media in Nairobi, President Kenyatta said Kenya had sold its barrels of crude oil to a buyer whose identity still remained a secret.

“We are now an Oil exporter. Our first deal was concluded this afternoon with 200,000 barrels at a price of USD 12 Million.  So I think we have started the journey and it is up to us to ensure that those resources are put to the best use to make our Country and to ensure we eliminate poverty, said Kenyatta.

The news reverberated in the region and globally with a new player on the market. Obviously there was more excitement and elation in the Lokichar Oil fields where Tullow Oil and its joint partners continue to explore more blocks with more vigour and determination.

Kenya discovered its first Oil in 2012 and since then, explorations have continued in the Lake Turkana basin region with deposits being reported and more projections made to increase. In its previous reports Tullow estimated some 560 Mln Barrels in possible reserves and these are now projected to increase as prospects for more discoveries are higher than before.

This would translate into 60,000 to 10,000 barrels per day of gross production, which is said to be insufficient to warrant the construction of a refinery locally hence the export plans

The sold consignment was delivered by truckers at the Kenya Petroleum Refineries facilities in Changamwe, Mombasa since July last year, under what the government described under the early oil project

What does this mean for Kenya and the East African region?

The deal concludes that Kenya once ruled off as an oil novice in the region, with the lowest volumes of discovered oil is running a head of its East African neighbors in reaching exporting oil country status many months before any of its East African neighbors can sell a drop of oil.

For Kenya, this is game changer in regional geopolitics as not only does the oil revenue bring a new line of foreign exchange earnings into its economy and thus consolidating its position as the regional economic superpower.

Galvanizing on its early market entry status, Kenya could tap the available markets and seal off any available contracts beating off any potential competition from its neighboring countries.

The oil revenues could also breathe some life into its Lamu Port South Sudan Ethiopia Transport (LAPSSET) Corridor development plan which has stalled for among others lack of partners. With oil revenues flowing, Kenya can go alone developing the ambitious infrastructure projects along the corridor all the way to the Ethiopian boarder.

Contrary to nay Sayers, the oil export could be a window to emboldened security in the Turkana area as the government seeks to protect vital oil installations and export routes to the coast.  For many years, Lake Turkana basin has been one of the most volatile and insecure areas in Kenya as marauding armed warriors move from one village to another raiding for cattle. Civilians and military installations have been attacked and people killed.

In June, 2018 Turkana residents stopped five trucks from ferrying crude oil to Mombasa over rising insecurity along the border with Baringo. The resident complained of insecurity in the area but also complained of what they call consider unresolved issues on oil sharing benefits between the National governments, County governments and local communities over the 5% share which they wanted channeled to their bank accounts rather than for development as rallied by a section of leaders.

There is no way we can be a security threat to the oil we have protected and guarded for years. So the specialized and additional security personnel (protecting oil) should head to Kapedo and secure people.

Kenya’s oil export announcement could trigger a contagious rush for oil in the East African region, with each country racing to drill to bottom in search for oil. In an effort to outcompete each other, those already with oil discoveries such as Uganda and South Sudan could race to the market sealing off deals and contracts with potential buyers and agreements for future markets. Some of these deals maybe bad.

 Uganda was the first to strike oil around its Albertine graben in 2005. According to Uganda’s Ministry of energy the petroleum deposit discovered so far were estimated at 6.5barrels of which 1.5bln are considered as recoverable.

The Ugandan oil is supposed to be exported to the global market through a 1,443 electric heated East African Oil Pipeline (EACOP) via Tanzania. The East African Crude oil pipeline is expected to unlock East Africa Oil potential by attracting invest and companies to explore the potential in the region.

According to the project schedule available on the EACOP website the detailed engineering and procurement and early works were supposed to have been made in 2018 and construction started in 2019. The first oil exports were expected in 2020. But it appears all these are behind schedule.

According to Ministry of Uganda expected to conclude its financial deal for its joint pipeline with Tanzania by June, 2019, opening for the way for its construction. According to the information provided by then, Stanbic Bank Uganda, was supposed to be the lead arranger for USD2.5billion funding for the 1,455 km (EACOP) project. The deal was expected to have been concluded in June, 2019.

Kampala was also expecting that the Final Investment Decisions (FID) between the government and the oil partners to determine when funds for the project will be made available, the terms of the financing and when the project execution will commence with a projected timeline between 20 and 36 months

The pipeline was expected to jointly develop the USD 3.5 billion pipeline, described as the longest electrically heated crude oil pipeline in the world. The balance of USD 1billion is expected to come from shareholders in equity

However, by the time Kenya announced its export deal in July, the earth breaking ceremony commencing the start of the EACOP pipeline construction had not started. Negotiations were reported as ongoing. In June 2017, the Daily Business Newspaper carried an article with a headline ‘Uganda’s Oil may not flow by 2020’ as the required infrastructure may not be complete  by then[i]

What this means for Uganda is that time is of essence and the sooner the EACOP project construction takes off the better for its potential oil market.

Figure 3: The Government of Tanzania and Uganda sign the Inter-Governmental Agreement (IGA) for the East African Crude Oil Pipeline (EACOP)  in May, 2017

 

So why do some oil projects like take long to materialize?

Lack of astute leadership, effective institutions and canning ambition to drive the projects to fruition. In some countries the political leadership and responsible institutions can be weak, whereby the essential operational process surrounding the oil projects can be clogged in political rhetoric and undertones which make decision making quite cumbersome, inefficiently slow and less assuring to the investors

Technical aspects such as Quality of crude oil discovered

High Sulphur crude oil can such as the Ugandan and Kenyan crude oil can be waxy and costly to transport via pipeline as it requires constant heating along the route.  This explains why the 1,433 km EACOP is described as the longest electric heated pipeline in the world. This adds to complexity in technology and costs on heating required to operationalize the project. Investors may

Oil reservoir behaviors and recoverable volumes – The discovered oil reserves are not always the same as the recoverable volumes. In some projects the reserves can be large yet due to geological and technological factors the recoverable volumes are low.  The behavior of the oil reservoirs is therefore a significant factor in determining whether the recoverable volumes will be consistent with the early projections and economic models over the plateau period. A change in the recoverable volumes can trigger massive losses and may lead to complete closure of the oil project. Investors are happy to rush projects where recoverable volumes will be sustained

Financing aspects such as financing structure -Lack of financing for some reasons or high interests on the investment loans secured from investment-lending institutions can be a delaying factor.  The decision to invest may therefore take long as the investors or partners to the oil project juggle and weigh the available financial options viz a vis the current and future costs of the project on the country and the investors

Economic metric considerations such as the Net Present Value (NPV), Rate of Return (RoR) and Internal Rate of Return (IRR) of the project.

These are calculations undertaken to determine the economic and financial viability of the project. They are used to determine how much return and how long it will take to recoup the initial investment and starting generating profit.

According to online sources such as Investopedia, the Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. NPV is used in capital budgeting and investment planning to analyze the profitability of a projected investment or project.

The Rate of Return (RoR) is the net gain or loss on an investment over a specified time period, expressed as a percentage of the investment’s initial cost. This simple rate of return is sometimes called the basic growth rate, or alternatively, return on investment, or ROI. If you also consider the effect of the time value of money and inflation, the real rate of return can also be defined as the net amount of discounted cash flows received on an investment after adjusting for inflation.

The rate of return is used to measure growth between two periods, rather than over several periods. The RoR can be used for many purposes, from evaluating investment growth to year-over-year changes in company revenues. Its calculation does not consider the effects of inflation.

The internal rate of return (IRR) is a measure used in capital budgeting to estimate the profitability of potential investments. The internal rate of return is a discount rate that makes the Net Present Value (NPV) that makes the Net Present Value (NPV) of all cash flows from a particular project equal to zero.  It is mathematically calculated as IRR=NPV=t=1∑T (1+r)t −C0 =0)

IRR is the rate of growth a project is expected to generate. The IRR is used in capital budgeting to decide which projects or investments to undertake and which to forgo.

Generally speaking, the higher a project’s internal rate of return, the more desirable it is to undertake. Assuming the costs of investment are equal among the various projects, the project with the highest IRR would probably be considered the best and be undertaken first. IRR is sometimes referred to as “economic rate of return” or “discounted cash flow rate of return.”

Social factors such as land acquisition and due diligence for compensation– The nebulous and intricate balancing act between the local laws and the international standards as guided by the International Finance Corporation can be a hindrance. Quite often the local standards for compensation can be law, corrupt unfair yet the IFC standards requires fair and equity

Negative diplomacy: The oil projects could delay or fail to take off all together due to negative diplomacy. Whereby disgruntled actors such as activists, companies, politicians who may not be excited or about the project may quietly lobby, urge, convince or cajole the financing institutions not to finance the project.

Security Risk:  Oil projects cost lots of money in investment and thus require assurances that financial investments and their installations will be guaranteed.  Oil projects can stall as investors and their partners gauge the security risks

Some or all of these factors could be now at play in the East African region and could be explanatory factors as to why some petroleum projects are progressing at a snail’s pace or stalled all together. Perhaps Kenya’s early oil export could be trigger for its neighbors to start thinking ahead.

 

 

 

[i] https://www.businessdailyafrica.com/economy/Uganda—oil—2020-Standard–Poors-Tanzania/3946234-3982464-j7rbsq/index.html

Why Rules of Origin (RoO) should not be used exclusively to pursue trade policy objectives

This article shades light on a major instrument in international trade and customs management, which has been used by states to achieve multiple trade objectives. The concept of RoO has become controversial in the current interconnected global trading system where the point of production and sale across have become quite seamless and yet international trading rules requires that the definite origin of goods are identified for preferential treatment, statistical and tax purposes. The article argues that despite the implicit functions they play RoO should never be used a tool for negative trade pursuit rather a conduit for trade facilitation. The paper defines rules of origin and trade policy, outlining the objectives of trade policy, explaining the linkages between the two and discusses other instruments which can be used to achieve trade policy objectives

By Moses Kulaba; Governance and Economic Policy Analysis Center

Rules of origin (RoO) are common defined as laws, regulations and administrative criteria applied by a country to determine the country of origin of goods, for tariff preference purposes, subject to specific conditions as defined in WTO agreements and Regional Trade Agreements (RTAs)[i].  The East African Customs Union has summarized the rules of origin as ‘the vital link between the goods and country where they are produced’[1][ii] RoO are categorized as Preferential and non preferential depending on their characteristics and objectives.

Preferential RoO aim at determining whether goods qualify for preferential treatment and while Non Preferential RoO used to determine goods for trade statistical purposes. Rules of origin have significant relation and influence on a country’s trade policy or member countries which are contractually related or mutually obliged under a given contractual or non contractual trade arrangement. Rules of origin also may determine or assist the countries in understanding their comparative and competitive advantage. They are commonly used as a trade policy tool to protect local markets, give preferential treatment and a measure against unfair trade.

Trade policy can be defined as a collection or law, rules and practices aimed at achieving a country’s trade objectives. Tanzania’s trade policy aims to contribute to raising per capital income to levels targeted in National Development Vision 2025, trade development measures to stimulate and expand domestic demand through product and market diversification and limited interim safe guard of domestic economic activity threatened by liberalization, while building economic competitiveness[iii] It seek to achieved sustainable growth rate in trae of not less than 14% and long-term share of exports to GDP  of about 25%, double fold increase in manufacturing and raised value of merchandise export earnings in absolute terms to USD1,700 in the next five years[iv]

The Tanzania government recognizes the importance or Rules of origin as a tool for implementing trade policy objectives and has committed towards using the RoO in a manner that can strengthen the country’s industrial and trade potential. The Tanzanian clearly articulates this position in its trade policy where it states:

The Government of Tanzania will undertake measures to observe RoO preferences requirements prevailing in the different trading arrangements with a view to maximizing benefits accruing in the cause of implementation…with priority focus on building national capacity for effective utilization of this instruments[v]”

While RoO are a common factor in Trade policy, because of the challenges that RoO have in relation to international trade, they are considered as not the tools of most preference in achieving trade policy objectives. Indeed, increasingly governments are being advised that RoO should not be used to achieve trade policy objectives for the following reasons.

Firstly, they can be distortionary and work contrary to trade policy objectives especially where there is no harmonization of trade policy objectives. “If Clear, predictable, transparent and fair, rules of origin and their application facilitate the flow of international trade. Nevertheless, RoO can create unnecessary obstacles to trade and nullify or impair the rights of members in regional and multilateral trading arrangements including the EAC, SADC and WTO. Consequently, RoO have to be applied in a transparent, predictable, consistent and neutral manner so as to avoid their negative effects[vi].

Secondly, rules of origin is also important in facilitating international trade where the objective is free flow of goods, irrespective of trade policies or various countries

It can be sometimes difficult for countries to achieve trade targets in situations where it is a member to multiple contractual obligations which may conflict with its own national trade objectives. This is a common challenge for countries like Tanzania which belongs both to the EAC and SADC and has therefore a challenge in determining or applying RoO for goods originating from both economic blockings

Implementation of rules of origin is sometimes cumbersome and sometimes can be distortionary especially where there is need to determine various technical dimensions to the items for preferential purposes.

Rules of Origin are also not the only instruments for achieving trade policy objectives. They are just one instrument and other instruments could be effectives. These instruments include a combination of other trade policies, which can be elaborated as below:

Trade policy instruments are described as measures taken by governments to influence the direction and pattern of trade development. The application of these instruments in Tanzania is guided by the need to stimulate domestic production, promotion of exports, safeguard domestic industry against dumping practices and protection of consumers. Tanzania exercises these trade policy options in line with its international obligations. These instruments include: Tariff Based (Advalorem) Instruments, NTBs: Trade defense mechanisms; trade development instruments; and international trade policy instruments.

Tariff based instruments, include;

Tariffs, which are major trade instruments for trade policy implementation which are used to achieve duo objectives of revenue generation and protection of domestic industry. Heavy import substitution protection regimes can harm unprotected industry and ultimately reduce consumer welfare. It is for this purpose that Tanzania has been reforming its tariff band structure to a current four band structure (0,10,15 and 25)

Duty Draw Back Schemes (DDB) which are tools for export promotion through refund of import taxes on imported inputs that go towards production for exports. Tanzania has implemented a DDB scheme, although the scheme faces multiple challenges, including difficulties in technical verification. This also includes the mechanisms for VAT refund

Taxation, which comprises of   tax regime characterized by different taxes and levies imposed by the central and local government to achieve a duo purpose of revenue collection and protection used for administration of quota restrictions

Export Taxes which are levied as instruments to discourage export of raw materials in favour of value added products. In Tanzania the use of export taxes has been gradually reduced, with restrictions currently imposed on export of geological or mining products and raw hides and skins.

Non Tarrif Barriers/Measures these are measures aimed the protection of industry that work on the basis of restriction of imports. These instruments include;

Import licenses which is aimed at both controlling and regulation of the volume of imports and also taking track of importers, automatic licences issued automatically without discretionary powers and non-automatic licenses

Reshipment Inspection requirements (PSI) which are sets of activities aimed at the verification of quality, quantity, price, exchange rates, financial terms and customs classification of goods undertaken in the exporting countries

Trade Related Investments Measures (TRIMS)-Local Content Requirements, falling within the WTO TRIMS agreements, which cover a number of restrictive issues on foreign investments in view of their restricting impact. These include conditionalities on local content, local equity, foreign exchange balancing, import obligations and others that are specifically prohibited. This is aimed at enabling local industry to gain the necessary capacity and competence in developing its competitiveness.

Customs Valuation; which involves determination and ascription of value to items based on WTO customs compatible valuation procedures, guided with principles of fairness, uniformity and certainty

Standards-Technical Barriers to trade (TBTs) such as sanitary and phytosanitary (SPS) measures and other standards, used as instruments of trade policy to authenticate the quality and specification of imports and exports in conformity with the international safety requirements and regulations aimed at consumer protection.

State Trading Operations which are undertaken by both Government and Non Government enterprises, including marketing boards, which are granted exclusive special rights or privileges including statutory or constitutional powers in the exercise of which they influence through their purchases or sale the level or direction of imports or exports.  State Trading is clearly different from government procurement.

Government Procurement: This refers to a system which governs or regulates government procurement, requiring it to procure goods and services through a centralized international and national procurements process. It requires this process to be fair, transparent and allow competitiveness amongst suppliers and thus lowering costs. In pursuing trade objectives, the policy of transparence and open competitiveness has to be balanced with considerations for protection or stimulation of local industry.

Administrative procedures. These are other instruments that can be used to achieve trade policy objectives. Administrative procedures prevail in developing economies as a response to difficult situations at times of natural disasters such as the need to ensure food security when grain shortages are envisaged due to shortfalls in production yields. These may applied from one region to another as a way of balancing out the shortages. In Tanzania, this instrument has been used from time to time, especially in the control and regulation of export of maize and coffee to neighboring countries.

Trade Instruments

Trade policy objectives are also achieved through other trade defence instruments which are allowed by the WTO for safeguarding specific economic activities within a limited time-frame through application of  a set of instruments. These include:

Safeguard Measures aimed at protecting a sector or subsector of the economy or domestic industry from suffering from certain consequences. These normally take the form of raised tariffs and temporary relief measures

Antidumping aimed at protecting a country’s economy or industry from being flooded by cheap goods, which have no significant economic value. The WTO prescribes action against dumping

Subsidies and Countervailing duties: These include measures that confer benefits to producers and exporters and exist where a public body or government provides financial contribution to producers in the form of grants, soft loans or equity etc. These subsidies can be categorized into permissible and non specific subsidies that are non-actionable, permissible but actionable subsidies and prohibited subsidies. Currently Tanzania has not developed an export subsidy regime although it is permissible under the WTO arrangement.

Rules of origin are a combination of laws, regulations and administrative criteria used by a country to determine the origin of goods and determines how specific goods should be treated for tax purposes.

Trade Development instruments include:

Export Process Zones–This refers to trade development instruments used to stimulate export oriented economic activities through inculcation of a value addition and import culture, acquisition of appropriate technology

Investment Codes and rules which work through compensation for distortions which impede the flow of foreign investments largely due to market imperfections

Export promotion and market linkages which entails provision of support services to exporters with the objective of expanding trade for existing product lines

Export Facilitation which is pursued through the simplification of trade procedures and reduction of high costs involved through measures such as provision of export credit

International Policy Instruments can also be achieved to achieve trade policy objectives and these include

  • Bilateral Cooperation initiatives amongst willing countries depending on the variant agreements between contracting partner’s states
  • Regional Trade Agreements (RTAs) which have evolved through the growth and expansion of Economic Integration arrangements like the EAC
  • WTO agreements and Multilateral trading system which aims at stimulation of sustainable economic growth through trade expansion, encouraging specialization and opening up of national economies through elimination and reduction of Non Tarrif Barriers (NTBs)

Conclusively, despite the limitations, rules of origin still play an important role in driving trade policy objectives. However, for them to be effective, they need to be applied in a transparent, fair and predictable manner to avoid causing distortionary effects to international trade.

[i] URT: National Trade Policy for a Competitive economy and export led growth, Ministry of Industries and Trade, February, 2003

[ii] East African Community Customs Union Rules of Origin, September 2005

[iii] ibid

[iv] ibid

[v] ibid

[vi] ibid