Sharp drop in crude prices busts Kenya’s oil sector boom

An oil rig in northern Kenya. Kenya uses a production sharing contract (PSC) framework where the oil company, after making royalty payments to the government, is entitled to a 60 per cent share of production for cost recovery for a period of five years. PHOTO | STEPHEN MUDIARI | NATION MEDIA GROUP

What you need to know:

  • To date, more than 600 million barrels of crude deposits have been discovered in the northern part of Kenya.
  • $111: Cost of crude oil a barrel when Kenya discovered its deposits in 2012. This has dropped massively to around $50.
  • According to industry estimates, activities in the oil and gas exploration have dropped by more than half since mid-last year when the prices of crude oil nose-dived to below $50 a barrel
  • Analysts predict that the situation could get worse, at least in the next two years, before the affected firms return to some measure of profitability.

In March 2012, Energy Minister Kiraitu Murungi set the country on a frenzy when he announced that Kenya had struck oil.

Holding a small bottle half-full of a black substance, Mr Murungi’s announcement changed the country’s profile in an instant.

Addressing the country immediately after the announcement, President Mwai Kibaki said the discovery was Kenya’s first step towards becoming an oil producer.

Tullow Oil had sunk only one well and made the discovery at Kodekode Village in Nakukulas Location in Turkana East District; a rare feat in oil exploration.

The discovery set in motion what would change not only the face of Turkana Country by unlocking vast business opportunities.

CHANGED FORTUNES
Things have, however, changed dramatically in the last two years.

The global crude oil prices have dropped sharply, touching a six-year low of below $50 a barrel.

When the good news about Kenya’s discovery of the black gold was made, crude oil was going for $111 a barrel.

Following the substantial change in fortunes, the flurry of activity witnessed after Kiraitu’s announcement has all but lost its steam.

In fact it is as good as the sector’s boom has gone bust.

Consequently, exploration companies have been hit hard.

According to industry estimates, activities in the oil and gas exploration have dropped by more than half since mid-last year when the prices of crude oil plummeted below $50 a barrel.

Analysts predict that the situation could get worse, at least in the next two years, before the affected firms return to some measure of profitability.

SPENDING FREEZE
International oil and gas companies have been compelled to slam brakes on their activities.

Some have announced plans to freeze fresh spending in exploration and instead redirect their funds to projects where oil production is already taking place.
By so doing, according to Mr Patrick Obath, a consultant in the energy sector and former non-executive director at UK’s Afren Plc, it is expected that a majority of projects that oil and gas companies operating locally had committed to undertake will be rescheduled.

“The level of activity in the upstream sector at the moment is between 40 and 50 per cent. We expect to see a lot of negotiations between the government and exploration companies to extend commitments that had been made earlier due to lack of finances for their implementation,” said Mr Obath in an interview with Smart Company.

DRILLING POSTPONED

Earlier in the year, Swala Energy, Tullow Oil’s partner on block 12B in Kisumu, announced that it had postponed drilling of its first well to early next year.

The move, Swala said, would allow the company to make savings expected to come from the drop in the cost of drilling services currently being experienced globally. The reduction in costs is driven by muted interest in drilling.

The Australian firm also announced that it had transferred some corporate functions from the head office to its East African operations office to cut travel costs.

FUNDING REDUCTION

In January, Afren Plc of the UK, which holds 100 per cent stakes in blocks L17 and L18, said it would concentrate on the development of its resources in Nigeria to reduce spending.

The firm was expected to drill two exploration wells on the blocks this year but it announced a reduction in its funding and rescheduling of its debt to deal with cash flow challenges.

On Friday, UK’s Tower Resources said it had given notice to withdraw from block 2B in Anza basin where it has 15 per cent interest after drilling if Badada-1 exploration well on the block failed to show any crude oil or natural gas deposits.

“We have now refocused our portfolio and resources to areas predominantly on the Atlantic margin where we are confident we can add value even in this difficult market. Accordingly, we have withdrawn from areas where we feel there is no medium-term likelihood of commercially worthwhile success,” said Towers’ Chief Executive Officer Graeme Thomson in a statement.

TAMING OPERATION COSTS

Africa Oil Corporation and its partner Tullow Oil have been reducing the number of drilling rigs to tame operation costs.

“We are working with our partners Tullow Oil to put a reasonable budget so that we achieve what we need to achieve. We are in the process of releasing two rigs. The idea is to go down to one rig at the end of this year,” Africa Oil’s President and Chief Executive Officer Keith Hill told investors at a conference in January.

TULLOW OIL

In an email interview, Tullow admitted that it has reduced its drilling operations globally and carried out a restructuring process that resulted in job losses and termination of contracts for service companies due to weak oil prices.

“We have reduced our staff and contractor numbers in line with reduced drilling activity as we come to the end of the exploration and appraisal phase in South Lokichar. We have also undertaken a global restructuring and efficiency programme that has resulted in a significant headcount across the group including Kenya,” the UK company said in a statement.

Tullow and Africa Oil are the companies behind most of the oil discoveries locally.

600 MILLION BARRELS

To date, more than 600 million barrels of crude deposits have been discovered in the northern part of the country.

With the government currently in talks with Uganda to set up a joint crude oil pipeline at a cost of $4 billion, there are indications that crude deposits discovered to date are in sufficient quantities for commercial production.

Tullow did not provide specific names of employees or contractors laid off nor their number.

Sources within the industry revealed that the undertaking has affected “big” names in exploration business such as Weatherford Drilling and

Sakson Group that have since relocated to Dubai and Egypt respectively.

Weatherford operated two outfits; Weatherford drilling and Weatherford services. The latter is still operating.

Attempts to get further clarification from the company were unsuccessful as the country manager was said to be in a meeting.

REVENUE HIT

James Mbote, chairman of Oil and Gas Contractors Association of Kenya, says that firms offering support services to the oil and gas companies have been experiencing reduced revenues as a result of the slowdown in drilling.

“Since the price of crude started reducing there has been a decline in the level of activities. We expect that the industry will rebound, probably post-2016 but we cannot give an exact period at the moment,” he said in an interview with Smart Company.

There is also fear that the erratic crude prices could delay planned infrastructure projects such as the pipeline and consequently affect timelines for commencement of oil production that is currently set at 2020.

“With the prevailing oil prices, there is no much appetite for investment in projects such as pipelines by oil companies and other investors because of uncertain returns. As a result, we may see a delay in sanctioning of these projects, probably by two or more years,” said Mr Mbote.

CRUDE OIL PRICES

Brent Crude traded at a mean of $47.81 a barrel on Friday while West Texas Intermediate (WTI) was slightly lower at $45.34.

The mean prices for September last year were $98.92 and $92.58 respectively.

In a report released last month, ratings agency Moody’s predicted that cash flows of oil and gas companies will shrink by 20 per cent this year with only a modest recovery expected next year due to the plummeting crude prices.

“This view reflects expected ongoing cash flow declines for companies as global crude oil prices have fallen by more than 50 per cent since 2014 putting a major squeeze on their earnings,” said Moody’s.