Kenya sees increased oil and gas reserves, and a shift in energy consumption

With commercial-scale resource discoveries in Kenya in recent years – of both oil and solid minerals – the country’s energy and mining sectors are expanding. Kenya is now poised to join the ranks of commodity exporters, which is a significant reversal from the country’s historic dependency on imports. Authorities are currently overhauling related regulatory frameworks and working on large-scale infrastructure projects to help solicit investment in upstream extractive industries, with an eye to boost both exports and domestic sales (see analysis).

Current State

Kenya stands out on the African continent as a major economy that has grown over the past several decades and attracted foreign investment independent of any resource production. Today extraction of all types of natural resources accounts for just 1% of GDP, with all current output in solid minerals as opposed to oil, liquids and gas.

Downstream, domestic energy consumption is dominated by the traditional use of biomass. Burning wood and other matter accounts for 68% of overall energy consumption, according to the National Oil Company of Kenya (NOCK). Modern petroleum products compose 22% of overall use and electricity holds a 9% share. For the future, however, Kenya aims to increase access to modern energy as demand grows. Total petroleum consumption is expected to triple from 4.5m tonnes as of 2015 to 12m by 2030.

Infrastructure in the country is currently limited but large capital expenditures are planned for the near future. Kenya has one oil refinery, which has suffered from underinvestment and may be repurposed as a storage facility for petroleum products, along with a small network of pipelines to transport fuel products from Mombasa to the interior regions of the country. However, several billion shillings worth of investment is currently on the table as the country explores the potential construction of export pipelines – for product from Kenyan fields as well as South Sudanese and Ugandan fields – storage facilities, shipping terminals and refineries.

New Laws

Kenya’s 2010 constitution mandates a sharing of responsibility regarding the energy sector between the national and county-level governments. For now, upstream regulation of energy is taken on by the Ministry of Energy and Petroleum, and downstream matters are handled by the Energy Regulatory Commission (ERC).

Two new energy bills were sent to Parliament in 2015 and remain under review. If passed, the Energy Bill and the Petroleum (Exploration, Development and Production) Bill would establish a new, independent regulator for exploration and production; provide an outline of the fiscal terms on offer through production-sharing contracts (PSCs); mandate levels of disclosure and local content of investors; and enhance the ERC’s enforcement powers.

In the mining segment a new bill was passed in May 2016. Updates in the Mining Act 2016 include expanding the definition of those who can be issued a prospecting right, obligations of the state in regards to the environment and the legalisation of artisanal miners. Still, concerns have been raised over of the extent of obligations for revenue sharing, particularly with local communities (see analysis). Some private companies are actively participating in the sector’s evolution, including Base Titanium, a local mining firm. “The company continues to work closely with the government of Kenya to promote further growth of the nascent mining sector,” Joseph Schwarz, general manager of external affairs and development at Base Titanium, told OBG.

Growing Reserves

Oil exports have been on the table since 2012 when UK-based Tullow Oil, in partnership with Africa Oil, a Canadian oil and gas company, made discoveries in two separate blocks of the Lokichar Basin in the sparsely populated northern interior. Tullow has since declared the discoveries large enough for commercial exploitation, and in the company’s 2016 annual report it announced proven reserves of 750m barrels, up from an earlier estimate of 600m. It is speculated that the basin’s potential reserves could top 1bn.

Kenya has signed two PSCs with Tullow, however, a date for first oil had yet to be announced as of early 2017. Additional exploration undertaken with Africa Oil led to a January 2017 press release stating the company had discovered oil had migrated to the northern border of the South Lokichar Basin, further solidifying the commercial potential of the area.

Financials

Oil from the Lokichar Basin is expected to cost $25 per barrel to extract and transport, Tullow said in February 2016. However, with the issue of transportation not yet settled, overall costs remain in question. Another factor in determining costs is the relatively high wax content in the oil, which makes it less valuable, and suggests that Kenyan oil may trade at a discount to global benchmarks such as Brent crude. A study by NGO Oxfam International pegged the break-even price for Lokichar oil at $42, indicating profits above and beyond that cost. The price assumes a pipeline tariff of $10.70 per barrel, although Andrew Kamau, the principal secretary in the State Department of Petroleum, told local media the figure was closer to $34.

Calculations of revenue expectations for the Kenyan government by the Kenya Institute for Public Policy Research and Analysis suggest annual income of KSh660m ($6.4m) if the oil were to fetch $40 per barrel. This figure would rise to KSh790m ($7.7m) at $60 per barrel, and KSh1.8bn ($17.6m) at $100 per barrel. The figures assume reserves at 600m barrels and production of 100,000 barrels per day (bpd).

Tullow disclosed some of the details of its own expectations for the two 25-year PSCs in a 2014 bond prospectus: “Tullow’s share of profits will range from 22% to 50% of total production, and cost recovery is allowed at a rate of 20% per year.”

Tullow operates six onshore blocks in Kenya – which are part of the company’s larger regional strategy of exploring around the East African Rift Basin – and it struck oil in its first seven wells drilled in the country, as disclosed in a 2014 bond prospectus. Gas exploration is also under way but results have not been as encouraging. Two separate gas deposits have been discovered, but as of end-2016 there have been no announcements of intent by the companies involved to begin commercial production.

Widening Cast

A total of 38 wells were drilled in the three years after the discoveries of 2012, 34 of them by Tullow. However, participation in the sector is broadening. In a May 2016 report by Oxfam, the NGO stated that Kenya had marked 46 petroleum blocks and licensed 41 to oil exploration and production companies. The NGO noted that ownership information is difficult to come by, but reported that some 35 companies, whether operators or joint venture partners, held a stake in at least one block in the country as of January 2016.

NOCK, historically the government’s downstream distribution company, is a partner in a block under exploration by ERHC Energy and Compañía Española de Petróleos. The first quarter of 2016 saw several companies exercise farm-in rights, suggesting a positive investment sentiment. Research by Standard Investment Bank suggests that this has largely been based on the low costs of exploration and production inland which, for now, is overshadowing the question of how to get the crude to export facilities. In late May 2016 the Ministry of Energy and Petroleum announced the creation of 17 new exploration blocks, bringing the total to 63. The ministry also disclosed plans for a first-ever bidding round for the new acreage, to be held in 2017.

Across Borders

Transportation and logistics infrastructure for the energy sector are of key importance in Kenya, as the nation serves as a gateway for its inland neighbours. This has been highlighted by the emphasis on building pipeline infrastructure to handle both Kenya’s domestic production and the exports of neighbouring countries like Uganda and South Sudan.

The most prominent example of this was the plan for a pipeline linking Hoima, Uganda – where Tullow currently has production facilities – through the Lokichar Basin to a new port facility at Lamu, on Kenya’s northern coast. The pipeline could also have been extended further inland to South Sudan, giving that country a second option to carry its crude to market. The project was envisioned as part of a larger transportation-corridor project called the Lamu Port Southern Sudan-Ethiopia Transport (LAPSSET) project. However, in spring 2016 Uganda announced that it would instead pursue an alternative pipeline route through Tanzania.

Financing for that option is expected to come from the French supermajor Total, which preferred the southern route vis-à-vis Kenya’s proposal to finance through a public-private partnership, which could take longer. The southern route may also be cheaper – a reported $4bn as opposed to $5bn going through Kenya, with transit fees at $12 per barrel instead of $17 for the Kenyan pipe. Security concerns were cited, given the proximity of the planned pipeline to the Somali border, as was the likelihood of higher costs and a more difficult land acquisition process. In response, Kenya said it would pursue its own domestic pipeline instead, although efforts to revive the original plan are still ongoing. Tullow Oil will begin to lay the groundwork for a pipeline between Turkana and Lamu in 2017.

Surface Transport

While the exact cost of a domestic pipeline will not be determined until the completion of the Front End Engineering Design phase, Charles Keter, the cabinet secretary for Energy and Petroleum, suggested that it would cost approximately $2.1bn. The economics of the pipeline were more attractive with both Kenyan and Ugandan oil generating transit fees, and Kenyan oil alone may not be enough to justify construction. “The cost of the pipe would be much greater than just using trucks and trains to get [the oil] out,” Kwame Owino, CEO of the Nairobi-based Institute of Economic Affairs, told OBG.

Preliminary considerations for above-ground transport indeed included the use of rail, which was speculated to heavily involve Rift Valley Railways (RVR), as the company was included in the logistics planning. However, in October 2016 the state decided it would only move barrels by truck until a pipeline decision was made, citing RVR’s 110-year old tracks and locomotives that often broke down – a cause of concern regarding delays and spillage. The railroad, which as of 2014 transported just 1% of petroleum products from Mombasa inland, lost out on a KSh4m ($39,000) per day deal.

Domestic Infrastructure

The country’s existing network of domestic pipelines, managed by the state-owned Kenya Pipeline Company, includes four main lines, each of which can transport end-user fuels such as petrol and diesel. The primary line is 14 inches in diameter and stretches 450 km from Mombasa to Nairobi. Plans are in the works to replace it with a 20-inch pipe along the same route, according to the ERC. Lines two and four run together from Nairobi north to Eldoret, and line three carries products west from Nairobi to Sinedet and then on through a branch to Kisumu.

Outside of pipelines, further investment in midstream logistics is necessary for Kenya and the region, according to an energy supply analysis of East Africa by Ecobank. Most of the region’s fuels go through Kenya, and exports were expected to rise by 14% in 2015 and 2016. This implies the need for more storage capacity in Mombasa and elsewhere in Kenya. A fuel shortage in the first half of 2015 was partially blamed on a lack of storage near the port, for example. Roughly 70% of Kenya’s storage capacity is in Mombasa, holding about 70 days of supply. Nairobi, at 11% of the country’s total, is considered short on storage and reliant on the regular flow of products from the coast, as the capital accounts for around 25% of the country’s energy consumption.

Regional Role

Similar pressures are found elsewhere in the region, Ecobank found. Rwanda and Uganda had storage capacity of less than one month’s supply at the end of 2014, for example – 28 days and 23 days, respectively. That compares to 130 days in Burundi and 113 days in Tanzania.

Kenya’s neighbours are currently engaged in a push to expand their own midstream and downstream facilities, which may impact estimated demand for planned projects in Kenya. One such facility is a planned refinery in Hoima, Uganda that would process the country’s domestic crude. Hoima is also the proposed starting point of the Uganda-Tanzania pipeline that may replace Uganda’s role in the LAPSSET project.

Kenya itself is looking to overhaul its shipping facilities for petroleum products to ensure it can meet the expected increase in domestic and regional demand. Two port facilities at Mombasa – the Kipevu Oil Storage Facility and the Shmizani Oil Terminal – cannot accommodate ships with a capacity of more than 80,000 tonnes, so an estimated five deliveries per month are required. Storage capacity is considered inadequate for Kenya to continue in its role as a regional re-export centre, according to the state’s 2015 national energy policy, suggesting the need for further infrastructure investment. That could include further dredging at Mombasa to deepen the port from 13.5 metres to 16 metres, allowing larger crude carriers to dock.

Refinery

Plans surrounding the LAPSSET project include the construction a refinery, as currently the sole facility is the shuttered one in Mombasa owned by the state’s Kenya Petroleum Refineries. The refinery was, until recently, a 50/50 partnership between the government and India’s Essar Group, and had a capacity to process about 35,000 bpd. Production under this model ceased at the end of 2013, and the facility was producing at less than half its capacity leading up to the close. Essar Group announced the sale of its stake back to the state in July 2016 for $5m. Now as the sole owner, the government may opt to rehabilitate the refinery to working order or convert it into a storage facility.

The LAPSSET project’s planned refinery would have a capacity of 120,000 bpd, with production oriented towards northern neighbours in keeping with LAPSSET’s envisioned role as a northern corridor. The proposal includes connections to Ethiopia, South Sudan and Uganda.

Distribution

Getting fuels to consumers is the job of oil marketing firms, with both government and commercial companies playing a role. In FY 2014-15 the ERC issued 754 licenses for the importation, refining, exportation, wholesale and storage of petroleum products. With the mothballing of the refinery in 2013 Kenya’s import profile no longer includes crude oil, but end-user fuels are filling the gap. Imports of petroleum fuels totalled 4.4m tonnes in 2015 and re-exports of petroleum fuels stood at 752,800 tonnes, according to a June 2016 study by the National Bureau of Statistics and the Directorate of Renewable Energy.

Outlook

The need for new infrastructure is largely based on the expectation that Kenyans – and East Africans overall – will trade up from burning biomass to consuming modern fuels as disposable incomes rise across the board. Demand could be met with local oil if the state elects to rehabilitate its old refinery or build a new one, or Kenya could equally choose to export its crude oil and import finished products. For now, however, the government is primarily focused on upstream production and improving its regional distribution capacity.