Investment Decisions and Project Risks in Kenya-2018

Introduction:

Making investment decisions in the field of hydrocarbon exploration and extraction can be daunting and expensive. The oil market is highly volatile, and prices can fluctuate significantly, impacting the profitability of such ventures (Inkpen & Moffett, 2011). This is exemplified by the excitement surrounding oil exploration and production when prices surged in 2012, followed by a dramatic drop to nearly $30 per barrel in 2014-2016.

In 2010-2012, a UK oil and gas company named Tolluw initiated an exploration mission in the semi-desert region around Lake Turkana in Kenya. This region had remained unexplored until then. The initial discovery revealed estimated reserves of approximately 600 million barrels of recoverable crude oil, marking Kenya’s first-ever oil discovery (Karasalihović-Sedlar et al., 2017; Kyra Bos & Joyeeta Gupta, 2016). Subsequent explorations led to additional discoveries, with an estimated total reserve value of $25 billion from just four explored wells (Okoth, 2012; Mkutu, 2014).

However, during these discoveries, Kenya lacked updated oil and gas tax guidelines, relying on an outdated mineral and mining bill from 2012 (Karasalihović-Sedlar et al., 2017; Kyra Bos & Joyeeta Gupta, 2016). Furthermore, Kenya’s sovereign credit rating was poor due to entrenched corruption (Trade Economics, 2018), and the Lake Turkana region experienced sporadic terrorist attacks and uncontrolled banditry. To ensure project success, the government needed to restore security, revise the tax regime, and invest heavily in upgrading its refinery, which would require over $2 billion.

Operational Uncertainties Impacting Investment Decisions:

Despite the promising discoveries, operating these wells and transporting crude oil over 800 kilometers in an insecure and volatile environment proved challenging for prospective investors and local communities. Banditry, cattle rustling, and community unrest were persistent issues (Karasalihović-Sedlar et al., 2017; Kyra Bos & Joyeeta Gupta, 2016). Poor infrastructure and a hostile environment hindered negotiations between stakeholders and further exploration efforts.

High oil prices during this period attracted significant interest from oil and gas companies, even though Kenya lacked prior experience in this industry. This rush of interest prompted the need for swift action before potential competitors entered the market. Additionally, other discoveries, including coal and titanium in Lamu Basin, added to the region’s appeal (Okoth, 2012; Mkutu, 2014).

In response to these discoveries, the International Finance Corporation (IFC), an arm of the World Bank, proposed an investment of over $60 million in the UK-based firm Delonex Energy to fund further exploration and well equipment (Africa Research Bulletin, 2012). However, neighboring countries such as Sudan, Ethiopia, and Somalia contested the territorial boundaries, claiming that oil reserves extended into their territories, thus prohibiting drilling on the Kenyan side. This was compounded by institutionalized corruption in Kenya (Karasalihović Sedlar et al., 2017; Kyra Bos & Joyeeta Gupta, 2016), which strained international funding. The international community pressured Kenya to combat corruption, address its sovereign rating, and enforce fiscal discipline.

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Main Project Risks and Their Impact on Stakeholders:

The risks associated with the project in Lake Turkana and its neighboring regions can be categorized as follows:

1. Security Risks: Northern Kenya faced security challenges, with militant groups from Somalia using the area as a base for raids and livestock theft. These groups were better armed and trained than government forces, posing a significant threat to businesses (Karasalihović-Sedlar et al., 2017; Kyra Bos & Joyeeta Gupta, 2016). The government had to mobilize security measures before oil and gas companies could establish a permanent presence. Hostile local communities further complicated exploration and discouraged potential investors.
2. Lack of Infrastructure: The Lake Turkana region had inadequate infrastructure, including roads and transportation facilities. Additionally, there were no refineries nearby, and the closest government-owned refinery was over 800 kilometers away. Due to security concerns, transporting crude oil via road tankers was deemed dangerous. The government’s refinery also needed substantial upgrades, costing over $2 billion, which was challenging given Kenya’s existing debt burden (Mkutu, 2014).

The Demand and Supply of Contract Markets and Their Impact:

Oil prices were volatile during the project’s timeline. While they were high in 2012 (Omari, 2011; Okoth, 2012), they later fell dramatically in 2015-2016. During this period, oil and gas discoveries in Kenya were in the appraisal phase, coinciding with OPEC countries pushing for production cuts due to low prices. To leverage this situation, Lake Turkana investors aimed to negotiate favorable terms in anticipation of rising oil prices. Despite lower demand for oil and gas, the project’s viability remained positive, and organizations like the World Bank supported the government in using the potential revenue to reduce poverty in the region (Africa Research Bulletin, 2012).

Ownership, Financing Configuration, and Credit Rating Challenges:

Kenya adopted two fiscal regimes, namely concession and Production Sharing Contracts (PSC) (Sammy Lutta, 2018; Deloitte, 2016). Due to Kenya’s fiscal constraints and low credit rating (Trade Economics, 2018), equity configuration funding models were employed as the government was not in a position to secure loans. China was approached for unsecured borrowing, although this decision faced criticism (Trade Economics, 2018). Kenya’s credit rating had been consistently low, below investment grade, due to its high debt levels, which limited the government’s borrowing capacity.

In conclusion, investing in hydrocarbon exploration and extraction projects in Kenya, particularly in regions like Lake Turkana, involved complex challenges related to security, infrastructure, fluctuating oil prices, and fiscal constraints. The project’s success depended on addressing these risks and uncertainties while fostering collaboration among stakeholders and ensuring equitable benefits for all parties involved.

References:

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