THE CHALLENGES FACING THE OIL AND GAS SECTOR IN KENYA AND THE

WAY FORWARD

VELLAH KEDOGO KIGWIRU

1.0 Background

The discovery of oil and gas in Kenya in 2012 by Tullow Oil provide a great opportunity to

Kenya to reposition itself as an economic hub. However, the discovery comes with a number of

challenges ranging from lack of capacity, political activism, and weak revenue collecting system,

corruption, negative environmental concerns amongst others. Oil exploration in Kenya began in

1950s before Kenya’s independence.1 Earlier drills turned out to be dry and between 1960 and

1984, 16 wells were drilled mainly in Lamu and Anza basins.2 The recent development in the oil

and gas industry comes along with its own challenges and opportunities.

The petroleum industry in Kenya is broadly divided into three segments namely: upstream,

midstream and downstream.3 The upstream segment primarily involves the process of

exploration development and production of crude oil and natural gas. As there is no production

in Kenya today, this segment is primarily involved in exploration. The midstream segment

involves the process around storage, refining and transportation of the crude oil into consumable

oil and gas products. There is only one refinery in Kenya today which is Kenya Petroleum

Refineries Limited in Mombasa. The downstream segment involves the process by which refined

products are made available to the customers through supply and distribution for example at

industries and petrol

1
Energy Information Agency, ‘Emerging East Africa Energy’ (23 May 2013)
2
Kenya Civil Society Platform on Oil and Gas, ‘Setting the Agenda for the Development of Kenya’s Oil and Gas
Resources: the Perspectives of Civil Society (Nairobi, July 2014).
3
Ibid.

Electronic copy available at: https://ssrn.com/abstract=3534983

stations. There is a fairly well developed network of transport pipelines storage and retail outlets

in Keya today with a multiplicity of players.4

The interest in Kenya’s upstream oil and gas sector developed significantly following oil

discoveries in Uganda and recent gas discoveries offshore East Africa. In 2012, Tullow Oil

announced the discovery of an oil potential of 300 million barrels of oil in Turkana rekindling

Kenya’s prospects of becoming an oil producing nation. 5 Since 2012 Tullow’s successful

exploration and appraisal drilling campaigns in Kenya have resulted in the opening of a second

new tertiary rift play in the South Lokichar Basin. An accelerated exploration and appraisal

campaign is nearing completion in the basin to better define overall oil resource potential ahead

of a development project that will share technology and infrastructure with Uganda.6

The key legislations relating to the upstream sector includes the Constitution of Kenya 2010

(CoK). The CoK provides for equitable distribution of natural resources and utilization of natural

resources for the benefit of the people. The Petroleum (Exploration and Production) Act Cap 308

Laws of Kenya, regulations made under the Act and the Ninth Schedule to the Income Tax Act

Cap 470 Laws of Kenya also provide a statutory framework. The Constitution vests the

administration of minerals and mineral oils in the National Land Commission. 7 It is not clear

how this will affect the powers of the Cabinet Secretary in charge of Energy and Petroleum

under the Petroleum Act.

The key institutions regulating the oil and gas sector are currently the Ministry of Energy,

National Oil Corporation of Kenya Limited and the Energy Regulatory Commission. The

Petroleum Act

4
Rift Energy, ‘Overview of Upstream Oil and Gas Industry in Kenya’ pg.1 available at
<www.riftenergycorp.com>files>library> accessed on 1st December, 2015.
5
Cordaid, ‘Oil Exploration in Kenya: Assessment of Community Perceptions of Oil Exploration in Turkana County
Kenya (Report August 2015).
6
PwC Consortium,’ Towards Petroleum Sector Master Plan For Kenya’ (Nairobi,2015) pg. 18
7
See Chapter Five, CoK 2010.
empowers the Cabinet Secretary to divide Kenya and continental shelf into blocs. No person may

engage in any petroleum operations without the Cabinet Secretary’s permission. The Cabinet

Secretary also has powers under the Petroleum Act to enter into petroleum agreements and

petroleum exploration agreements on behalf of the government and to make ancillary

regulations. The Petroleum Act permits the government to conduct petroleum operations either

through oil company for example the National Oil Corporation of Kenya or through private

contractors that are licensed by the government (acting through the Cabinet Secretary in charge

of Energy) under petroleum agreements.

2.0 Challenges Facing the Oil and Gas Industry in Kenya

The recent developments in oil industry have put Kenya on an international platform with

various foreign companies showing interest in oil exploration. The question that many experts

need to ask themselves is whether Kenya is ready or not for extraction of oil and whether it can

address the challenges that will manifest. Will the discovery of oil be a blessing or a curse?

Addressing the eight challenges facing oil and gas industry in Kenya, Sikwati argues that the oil

and gas discovery in Kenya should be celebrated as a catalyst to transform Kenya into an

investment destination and a source of additional revenue to the country. 8 He emphasizes that if

Kenya stays the course to fully implement its new constitutional order, she is likely to escape the

‘resource curse’.

Oil discoveries have been a mixed blessing for many African countries and the Middle East

providing great wealth but also bringing the curse of corruption. Political elite control over oil

revenue presents as one of the stumbling blocks to sustainable growth in Africa and the Middle

East.9 The first challenge for an African country with lucrative natural resources is how to

8
James Shikwati, ‘Oil and Gas: Kenya’s Eight Challenges’ (Modern Ghana News 24 July 2013).
9
Wilson Africa Centre, ‘Oil in Africa: Blessing or Curse’ (2011).
maintain and address its legitimacy.10 The recent discovery of oil in Kenya came at the right time

to contribute to the economic development of the country. It has transformative potential to

reduce poverty, expand health and education services in Turkana, currently among Kenya’s

poorest counties. However if improperly utilized oil and gas revenue may turn up to be a curse

other than a blessing. The gas and oil industry faces the following challenges:

a) Inadequate Capacity

The discovery of oil and gas in Kenya came at a time when the country was not prepared for

extraction. This includes state capacity, human capacity and sector knowledge. State capacity is

the capacity of states to effectively legislate and monitor the sector activities and performance

and to collect taxes. Human capacity refers to the number of graduates that come out of

universities with appropriate skills to man the national oil companies and ministries. Sector

knowledge is knowledge that comes with experience in licensing design, contract negotiation,

regulations for health, safety and environment, exploration programmers and development plans.

Local business capacity refers to whether there are companies and capital available nationally to

create supply chains.11

The upstream, midstream and downstream segments in oil and gas sector raise their own

technicalities and require different skills sets. To benefit fully from the sector there is need for

capacity building. The Kenyan government’s preparedness is in deficit. There is lack of enough

skilled manpower for example engineers, geologists and other personnel required to man the oil

and gas exploration and extraction business. Similarly, as the upstream sector is new in Kenya,

parliament has yet to master the expertise to understand the complex and technical matters

10
James Shikwati, ‘Oil and Gas: Kenya’s Eight Challenges’ (Modern Ghana News 24 July 2013).
11
Varelie Marcel & Patrick Heller,’ Governance Challenges for emerging oil and gas producers’ (November 2012)
pg. 2 – 3.
involved in the sector, including scrutinizing Petroleum Agreements. This capacity challenge

limits parliament’s current oversight power and gives the Cabinet Secretary and agencies of the

state opportunity to determine the licensing process. There is need for the Kenyan government to

build capacity required to prudently manage the flow of revenues, address the environmental and

social issues regarding community resettlement and compensation. These issues are broader in

scope and require collaborative efforts in building structured institutions12.

b) Weak Institutional Framework

The oil and gas sector requires a strong institutional and regulatory framework to implement the

legal framework. A weak institutional framework leaves gaps that may perpetuate corruption.

The role of the Ministry of Energy and Petroleum Cabinet Secretary in granting petroleum

agreements creates room for rent seeking behavior and corruption through abuse of discretion.

This might lead to conflict and in most instances, cabinet secretaries do not excuse themselves in

case of conflict of interest. This undermines state interest in favour of individual interest as the

terms of the negotiated petroleum agreements can be used to seek personal favours from oil

companies. There is need for checks and balances on the power of the cabinet secretary.

The institutional framework in place also lack capacity to run its affairs. The National Oil

Corporation of Kenya provides policy support to the government by making recommendations to

the Ministry of Energy and Petroleum. It has limited capacity to harness the full potential of the

hydrocarbon basins in the country. Thus, in order to fulfill its functions as the commercial arm of

the government in the oil and gas sector, its internal capacities require upgrading.

The Energy Regulatory Commission (ERC) is established under the Energy Act 2006. It

approves operational permits and enforces compliance and has wide ranging powers to issue,

renew, modify,

12
Kenya Civil Society Platform on Oil and Gas, ‘Setting the Agenda for the Development of Kenya’s Oil and Gas
Resources: the Perspectives of Civil Society (Nairobi, July 2014) pg. 19
suspend or revoke licenses and permits for all undertakings and activities in the energy sector.

The Cabinet Secretary has regulatory powers in the upstream sector and this duplication of roles

curtails the ERC’s ability to act as a check and balance on the ministry. Further, ERC’s

independence is compromised because the Cabinet Secretary appoints all commissioners

including one from the ministry itself.

c) Weak Revenue Management

A weak revenue collecting system leaves loopholes. If managed properly oil revenues spur

growth. Where oil revenues are not managed properly it may lead to conflicts and cause

economic challenges of inflationary pressure, weak export industries and cyclical government

expenditure. The first question is which model of revenue management should Kenya adopt and

how shall Kenya address any loopholes in order to minimize revenue losses. The different

revenue models in the petroleum industry attempt to answer two political economy questions:

how much to spend and save; and how much to spend and invest? The model which Kenya will

adopt will depend on a number of factors such as the availability of the oil and gas resources,

fiscal sustainability, uncertainty of prices amongst others. It’s a political decision. There are three

types of models: hand-to-mouth rule, the bird-in-hand rule and the permanent-income rule.13

In its report the Kenya Civil Society Platform On Oil and Gas describes the three models as:

The hand-to-mouth rule requires that the government spends all revenues generated and is used mostly by

countries where the size of revenues is insignificant, or where development challenges are enormous… The

bird-in-hand rule requires that petroleum revenues are put in a Petroleum Fund and invested in financial

instruments whilst the government spends only the returns on the investments. The permanent-income rule

allows the spending of discounted net revenues annually computed over the lifespan of an investment

project.

13
Ibid.
 This ensures that a permanent proportion of the size of the petroleum wealth is spent every year into

eternity, whilst the balance invested through a Sovereign Wealth Fund continuous to grow beyond the life

of the project.

Section 136 (1) of the Energy Bill provides for the establishment of the Petroleum Sovereign

Fund which shall be at least 5% of the government shared proceeds. Another challenge is where

the government shall prioritize its investments of the oil revenue. Oil revenues can be invested

either in agriculture development, industrial or human capital. In the Petroleum Exploration,

Development and Production Bill, the government has expressly articulated its priority in

infrastructure development.

Another issue that arises in oil revenue management is the sharing of such revenue between the

national government and the county government. The current revenue sharing system between

the national government and the county government is based on a special formula which aims at

equitable distribution of funds taking into account criteria such as poverty levels and population.

The county government have in the recent past complained that the revenue allocated to them is

not enough hence demanding that the government increases revenue allocation to the county.

There is lack of procedure on how county government shall spend oil revenue ceded to them.

Kenya Civil Society Platform On Oil and Gas argues that the fact that oil exploration is in areas

that is prone to ethnic competition and rivalry, improper oil revenue management in such areas

may escalate conflicts. The central government shall therefore be sensitive to the needs of the

county while adopting its revenue sharing system.

Another challenge is revenue losses. Revenue losses is either through tax evasion or revenue

collection and assessment. Kenya has to put in place mechanisms to ensure that it maximizes on

revenue collection.

d) Lack of Transparency and Accountability in the Sector

Transparency requires that people are informed of what is going on in the oil and gas industry in

an open manner. The government should also be accountable. Corruption in Kenya is at its

highest rate with public officials embezzling public funds. Lack of transparency and

accountability in the sector undermines the potential economic growth that oil revenue would

spur. Without transparency and accountability citizens cannot ensure that oil revenues contribute

to economic sustainability.

The concept of transparency and accountability runs throughout the CoK. Article 35 of the

Constitution of Kenya 2010 provides for right of access to information for the exercise of

fundamental freedom. However Kenya’s Production Sharing Agreements have a nondisclosure

agreements as provided under the Petroleum Act which bars any party in a petroleum contract

from disclosing any information, material or not. Article 71 of the constitution also provides for

parliamentary ratification of any transaction which involves exploitation of Kenya’s natural

resources. Article 10 of the CoK also recognizes transparency and accountability as national

values and principles of good governance which every state organ should uphold.

Lack of transparency is envisioned in both the contract system and revenue system. Lack of

transparency in procurement of contracts due to a corruption is a challenge in the oil and gas

industry. This requires that the process for licensing oil blocks must be open and competitive,

contract and disclosure must be mandatory and the products of contracts (oil production data,

sale prices, revenues and costs) must not be held confidential. Therefore if the government is

unwilling to disclose payments it receives from the oil companies or specific details of

Production Sharing Contracts, there can be no parliamentary scrutiny over these transactions by

parliament. This is unconstitutional.

Revenue transparency enables the government to be accountable to the citizens in accordance to

the social contract that exists between them. It also builds trust for the government, ensuring its

legitimacy to manage the resources of the people as the trustee. On the demand side, it empowers

citizens to track their resources, the performance of their government and the value such

revenues add to the economy or community.

e) Low Bargaining Power with Foreign Countries

Foreign companies always have a high bargaining power. Some of the reasons for this is that

they have the capital unlike the government of Kenya which lacks the capital to even enable it

initiate exploration activities. Due to low bargaining power foreign companies have an upper

hand. In essence its Kenya who needs the foreign countries more than they need her. Bargaining

and negotiation between host states and oil companies determine the division of rents. In most

case for example in Kenya, the oil companies have much bargaining power than the host country.

Adequate and correct information on oil and gas is vital. Lack of it leads to a low bargaining

power in contract and concession negotiations, resulting in suboptimal capture of rents from oil

resources. National strategies for natural resources extraction must involve plans and funding for

capacity development and generation of reliable and timely information.14 Most African

countries lack data on demand and supply by end use, price, cost, inventory movement,

investment and trade flows, on a timely and consistent basis. Information should not only be

available but must be accurate and distributed in a timely manner when needed.

3.0 RECOMMEDATIONS

Based on the following challenges the government of Kenya should address the following

challenges in the following manner:

14
African Development Bank and the African Union, ‘Oil and Gas in Africa’ (uk, July 2009) pg. 181
 1. Build Capacity

Capacity is very essential in the extraction and exploration of oil and gas in Kenya. There is need

to introduce oil and gas courses in the education system to educate people on the same. This shall

ignite interest in the sector. The oil and gas companies should also be encouraged to train

Kenyans and offer scholarships to Kenyan in other countries with established system. Norway,

Malaysia and Middle East countries like Doha can provide training to the Kenyan expertise. So

far Tullow Oil is offering scholarships and training to Kenyan to increase human capital and

knowledge capital. The Ministry of Education should encourage and incorporate the same in the

educational curriculum.

2. Strengthen the Institutional Framework

There is need to strengthen the institutional and regulatory framework governing oil and gas

sector in Kenya. A weak institutional framework leaves loopholes for corruption and bad

governance. The cabinet power should be limited and Parliament should be given the powers to

check on the powers of the Ministry. The oil and gas industry is a vital sector in the economy of

Kenya. There should be clear separation of roles between policy making, regulation and

commercial operation. There should be established an Independent Authority to regulate

petroleum activities including conducting due diligence on application of licensing rights. The

Director General of the Authority should be appointed by the President subject to approval of

parliament. Parliament’s oversight role should be strengthened through capacity building.

Parliament must submit the Petroleum Agreements to public hearing to invite public comments

before their approval.

3. Strengthen the Revenue Management System

Oil revenue can only catalyze economic growth if well utilized. The revenue management

system should be strengthened to avoid revenue losses through tax evasions and avoidance. The
government should develop a comprehensive spending, investment and savings policy and

legislate it. Spending of petroleum revenues should be guided by Long Term National

Development Plan to prevent ad hoc spending. Spending priorities must reflect national

consensus. The county government should also play a role in revenue management by ensuring

that oil and gas revenue allocated to them should be put to good use. Oil and gas revenue should

be invested in projects that will help the common mwananchi. It can be invested in agriculture,

industrial, infrastructure etc.

4. Improve Transparency and Accountability in the Sector

Transparency in the oil and gas industry is very key if we are able to realize its benefits. Good

governance in the sector cannot be underestimated. Every process must be transparent and open

to the citizens. Adequate, accurate and timely information must be available when needed. The

government must adopt an open and competitive bidding process in oil and gas concessions.

Revenue sharing and management must be accountable. should be a legal framework for

transparency across all oil and gas value chain. This includes contract transparency, revenue

transparency and expenditure transparency.

4.0 Conclusions

The oil and gas sector in Kenya faces various challenges such as inadequate capacity, weak

institutional framework, revenue management, weak bargaining power, lack of transparency and

accountability. However these challenges can be strengthened through reinforcement. The oil

and gas sector should not be seen as a resource curse but it can be turned into a blessing.