Risk and reward are crucial to capital flow

• With careful and deliberate planning, implementation and commitment, oil and gas can become Kenya’s ticket to the big league. As you can tell, I assume that Kenya will move out of the club of a net oil importer to a net oil exporter by 2030.
• According to the Constitution of Kenya, all minerals and mineral oils shall be vested in and be held by the national government in trust for the people of Kenya and shall be administered on their behalf by the National Land Commission.
• So why would an E&P company risk its capital where the government owns the oil and gas? Risk and reward are fundamental to capital flow and therefore E&P can either take on all the risk or spread the risk and rewards by inviting partners.

While talking to a friend on my tribulations with the persistent Nairobi traffic jams, he informed me that traffic jams in Lagos are worse and attributed it to the impact of oil and gas.

We digressed and noted that Luanda in Angola is one of the most expensive cities to live in. In the heat of our discussions we wondered whether Lamu would end up with the double trouble of being Kenya’s most expensive city and with the worst traffic.

With careful and deliberate planning, implementation and commitment, oil and gas can become Kenya’s ticket to the big league. As you can tell, I assume that Kenya will move out of the club of a net oil importer to a net oil exporter by 2030.

The taxation arrangements that characterise oil and gas is the government’s most significant factor for managing oil and gas.

If one looks at the typical analysis of the cash flows of an Exploration and Production (E&P) company, you will notice that in the exploration and development phases, funds are spent without any revenue being earned.

It is generally known that there is a one-in-ten chance of declaring a commercial discovery. The risks that an E&P company needs to identify and manage are significant and few have the financial muscle to take on such an investment.

Governments in Africa do not usually have the financial muscle, technical skill and experience to undertake E&P activities. The government therefore aims at attracting investors to risk their capital in E&P activities.

In return, the government promises the investor a share in the oil and gas revenue. Underlying this statement is that the oil and gas discovered belongs to the government.

According to the Constitution of Kenya, all minerals and mineral oils shall be vested in and be held by the national government in trust for the people of Kenya and shall be administered on their behalf by the National Land Commission.

So why would an E&P company risk its capital where the government owns the oil and gas? Risk and reward are fundamental to capital flow and therefore E&P can either take on all the risk or spread the risk and rewards by inviting partners.

It is on this basis that the relationship between the Government and an E&P company in Kenya is negotiated and on that basis a an agreement called a Production Sharing Contract (PSC) is signed by the parties.

Mr Wanyoike is a Senior Manager at PwC Kenya Tax.