Review oil agreements to enable Kenyans to gain from resource

What you need to know:

  • First developed in Malaysia in 1966, production sharing agreements (PSA) remain the most commonly used type of contract between the government and oil exploration companies.

  • 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.

  • The remaining 40 per cent, also known as profit oil, is then shared equally between the government and the company. Some countries share 51 per cent of revenues.

  • The PSC model allows the setting up of a joint committee between the government and the investor to monitor the production operations.

The verdict by the International Energy Agency, informed by volatile Asian trade, a global oversupply of oil, and a slowdown in the world economy, indicates that oil prices will remain subdued.

For Kenya, the discovery of oil deposits in Turkana had boosted her prospects of attaining a middle-income status by 2030.

However, given the plummeting global petroleum prices, achieving this goal will require critical thinking.

Perhaps the recent redrafting of the model product sharing contract and the revision of tax gains on extractives is an indication of the government’s efforts to protect the country from the effects of fluctuating global oil prices.

In fact, the country stands to lose billions of shillings from the extractive industry if existing contractual agreements with exploration companies remain. 

PRODUCT SHARING AGREEMENTS

First developed in Malaysia in 1966, production sharing agreements (PSA) remain the most commonly used type of contract between the government and oil exploration companies.

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.

The remaining 40 per cent, also known as profit oil, is then shared equally between the government and the company. Some countries share 51 per cent of revenues.

The government then subsequently takes between 50-78 per cent on a sliding scale.

The draft energy policy proposes a 75:20:5 sharing ratio between the national government, county governments, and local communities respectively.

THE PSC MODEL

What makes PSC agreements unique is twofold.

First, the government owns all natural resource and related installations.

Second, the oil company undertakes the initial exploration risks and recoups its costs if and when oil is discovered and extracted.

The government has an option to participate in different aspects of the exploration and development process.

The PSC model allows the setting up of a joint committee between the government and the investor to monitor the production operations.

Kenya’s negotiations are led by the National Fossils Fuel Advisory Committee (NAFFAC), formed by members appointed from public institutions.

As it stands, the PSC framework presents a myriad challenges.

RENT-SEEKING BEHAVIOR

The conflicting objectives between the investors and the government explain the susceptibility of rent-seeking behaviour among negotiating parties.

More worrisome is the problem of information asymmetry as oil companies have the upper hand over NAFFAC during negotiations as they have relatively more information on the oil stock and expected revenues.

The dominance of public sector representatives in NAFFAC and the opaque operations of the committee do not guarantee optimal benefits to the citizenry.

In theory, PSC is meant to retain ownership of oil reserves in the government.

This, however, is not the case as experience shows that the exploring firm directly manages and operates the oil fields.

Furthermore, the basis of determining the actual cost incurred by the exploration company upon which the revenue sharing is based remains unclear.

The non-disclosure clause in the PSC means that only NAFFAC and the government are privy to what revenue allocations have been negotiated, which contravenes the spirit of transparency.

To minimise the nuisance of production sharing contracts and maximise the oil revenues, some countries have taken the approach where the government absorbs part of the exploration risk while others have established a fund that channels financial support to local private companies as well as their national oil corporations.

However, the caution is that if the government redrafts the sharing framework, the cost of retracting or breaching these contracts would be too high for both entities.

However, revising the contracts should be considered, within appropriate legislative mechanisms, to ensure that Kenya does not get a raw deal and also to avoid antagonising investors. 

Those charged with managing these resources must ensure that Kenyans get maximum benefits from whatever benefit-sharing agreement the country adopts.

The writers are policy analysts at the Kenya Institute for Public Policy Research and Analysis and Kenyatta University.