International oil and gas management
Energy is a key component of all economic activities in any country. It not only improves the quality of life but is fundamental for sustainable social and economic development in both the developed and developing countries. A secure – adequate, affordable and reliable – supply of energy is thus a necessary precondition for sustainable development. Energy security is therefore a major concern of most governments and thus remains a top agenda. To ensure energy security, it’s mandatory to have a well balanced supply and demand. Fossil fuel (Crude Oil) still remains the main energy source in most countries both in the developed and developing economies. High oil prices and supply disruptions therefore have significant negative impacts on all social and economic activities especially to countries that are net oil importers. Such countries are faced with the challenge of always having enough stock of oil or oil products to avoid any ultimate shocks due to supply disruptions or price changes.
Like many developing countries, the main sources of energy in Kenya and Uganda are biomass and commercial energy sources. Biomass is used mainly in the rural areas and accounts for up to 80% of the overall energy mix in the region. Commercial energy sources on the other hand are used mainly in the urban areas. The figure below shows the energy sources consumption patterns in the region.
Kenya and Uganda are heavily dependent on oil especially in the transport sector and partially for electricity generation and commercial purposes. The lack of a commercially viable substitute fuel remains the main reason behind the over dependence on oil in the transport sector. These two countries are net oil importers faced with the challenge of ensuring there is enough supply of oil products to meet the demand of the various sectors of the economy. This over reliance on imported oil has constantly exposed these two countries to externalities of market power by the powerful suppliers. Kenya and Uganda import crude oil and finished products from the Gulf region through the Indian Ocean to Mombasa Port. There is a fully functional Oil refinery at Kenya’s Mombasa Port where the imported crude is received, refined and later on pumped to the major towns through a petroleum pipeline in the country. Uganda being a land locked country relies to a greater extent on Kenya (some of the imports come through Dar es Salaam in Tanzania) for its oil import which is first refined at the Kenya Petroleum Refineries before being pumped through the Kenya Oil pipeline to the Eldoret fuel depot. The products are then transported by road or rail from the depot to Uganda. This process has proved quite inefficient causing supply disruptions that finally impact all the socio – economic sectors in Uganda negatively. This inefficiency made the two governments draw a game plan to ensure efficient transportation of petroleum products to Uganda. These developments facilitated the signing of a Memorandum of Understanding between the Government of Kenya and Uganda that led to the establishment of a Joint Coordinating Commission (JCC) in 1995. The JCC was charged with the responsibility of coordinating a feasibility study for constructing an oil pipeline from the Eldoret Depot in Kenya, an extension of the already existing Kenya pipeline, to a terminal to be constructed in Kampala, Uganda. In 1998 a feasibility study funded by the European Investment Bank (EIB) was conducted by JCC’s consultants, Penspen Limited of UK. The report by the consultants presented in May 1999 concluded that the project was feasible and viable. JCC was later on given the mandate in 2000 to implement the project. However due to time lapse between the feasibility study and the decision to go ahead with the project implementation, taking the dynamic nature of the oil and gas industry in these two countries, a second feasibility study was conducted funded by the two governments. The report from the consultant, like in the first study, concluded that the project was still viable and could be taken to the next phase. JCC therefore made a decision to proceed with the project implementation on Public Private Partnership with the two governments having a share of 24.5% each and 51% for the private investor
An invitation to Tender was floated inviting interested bidders internationally to bid for the execution of the project on BOOT basis for a period of 20 years. Tamoil East Africa Ltd (TEAL) won the bid in 2006 to finance and construct an 8 inch pipeline at a cost of US$78.2 million. An agreement, The Heads of Agreement, between the two governments and TEAL was then signed in January 2007 to enable the investor to start the development phase of the project.
A number of developmental phase activities had to be completed before commencing the construction activities. These included the preparation of all the legal agreements affecting the Project, the pipeline Route Survey to determine the right of way, the Environmental Impact Assessment Study in compliance with the environmental laws in the two counties, updates of the Market Study and revised product demand forecast leading to optimum sizing of the pipeline and finally carrying out the Front End Engineering Design (FEED). The successful completion of the above phase was the main determinant of the project costs upon which the developer was expected to make a final investment decision to proceed with the construction phase of the project.
TEAL had finished all the tasks at the development phase by 2008 when large Oil discoveries were made in Uganda in commercial quantities. This therefore meant the initial 8 inch pipeline design, having considered only one way flow from Kenya to Uganda, could only serve Uganda in the initial years before production begins and would be rendered inactive thereafter as the there will be need to transport oil from Uganda to the Neighboring countries and to the other international. With these new developments, JCC therefore considered a redesign of the pipeline to accommodate reverse pumping from either direction. This would satisfy Uganda’s petroleum needs in the short run, importing fuel through Kenya, and finally in exporting its refined oil products to the other markets through the Kenyan Port of Mombasa.
A new financial analysis of the project based on the redesigned pipeline diameter was therefore necessary to capture the new CAPEX and projected throughput as this would have an impact on the project cash flow when product will be pumped from Uganda side. TEAL through its consultant, Matt MacDonald UK, finished the new design earlier this year and came up with the new project cost as shown in Table 1 in Annex 1( the table also shows the cost breakdown of the initial design). TEAL also carried out additional economic analysis to come up with a new tariff based on the new developments. TEAL was therefore faced with the challenge of carrying out a more detailed financial and project analysis to justify the viability of the project to its shareholders and to present the same to JCC for review and approval.
It is at this stage that I joined the company as an intern to assist the project team on various tasks but more specifically on the financial analysis of the project based on the new project developments and to analyze the effect of scope creep on the project’s viability. This report aims at elaborating more on the tasks undertaken during the internship period. However the main task undertaken was working with the financial consultant of the company in carrying out the financial analysis of the project and finally discussing with the project team the impact of the changes in scope (scope creep) on project cost. A report of the analysis was presented to the project team with a summary of the model assumptions and results. The final investment decision was to be taken based on the findings and the results presented in the report. This report gives a brief description of the project from inception to the status during the internship period in its first and second chapters. The third chapter focuses on the financial analysis carried in fulfillment of the allocated task. A brief of other tasks undertaken during the internship is given in the fourth chapter. The final chapter focuses on the conclusions and recommendations of the whole exercise highlighting the benefits of the internship both to the intern and the company. The conclusions details the key challenges of scope creep in effective project management. The report will be based on the information collected from the Project Information Memorandum (document available in TEAL’s project office), earlier study reports in the project office, skills gained from different modules taken up during my training at CEPMLP and various text books.
1. Overview of the Project
The need for adequate and reliable supply of oil products to Uganda at affordable cost was the key driver of the Kenya – Uganda Pipeline project. However this was also in line with the policies of the Kenyan government ensuring the country also benefits from the project. The key issues of the project are briefly mentioned in the following subsections. These include the main project drivers, the justification for the choice of having a public / private partnership, the economic policies in the two countries and the benefits of the project to the two countries.
1.1 Project Drivers
A reliability, efficiency and cost effective means of transportation of oil products to Uganda was the main project driver as already mentioned. In addition to that, there was a need to have a safe and an environmentally acceptable means of transportation of the products in line with the environmental laws in both countries. Various transportation options discussed in the following chapters were considered and the pipeline emerged as the most cost effective option that satisfies the requirements above for both the current and future oil demand.
1.2 Economic Policies of Kenya and Uganda in relation to the Project
Both the GoK and GoU look forward to the successful completion of the pipeline project albeit their different economic policy drivers. Uganda’s main policy behind the project is to ensure adequate, reliable and affordable supply of energy to the various sectors within its economy. On the other hand Kenya’s main driver is the need to create more wealth and employment to its people. The economic policies of the two countries are highlighted below;
Uganda Economic Policies
The overall policy of the Ministry of Energy and Mineral Development Uganda is to “To ensure an adequate, reliable and affordable supply of quality petroleum products for all sectors of the economy at internationally competitive and fair prices within appropriate health, safety and environmental standards”. The responsibilities of the MEMD Uganda include;
- Establishing the available energy resources within the country;
- Carrying out energy demand forecasting for the various sectors of the economy;
- To contribute to poverty eradication by increasing access to modern, affordable and reliable energy services to its people;
- Improving energy governance and administration;
- Stimulating economic development;
- Managing energy-related environmental impacts.
Kenya Economic Policies
Kenya has already established its petroleum pipeline network within the country managed by the Kenya Pipeline Corporation. Kenya economic policy supporting the project as mentioned above unlike in Uganda was based on the country’s Economic Recovery Strategy for Wealth and Employment Creation (ERSWEC) launched in 2003. According to the laid down strategy, the state is expected to facilitate private sector growth and investment. The pipeline project will create a number of jobs from the construction phase through to operation. The KPC has also laid an additional pipeline to ensure there is sufficient product for export to Uganda and the neighboring countries. This expansion leads to an increment in the Countries revenue hence satisfying the policy of wealth creation. On the other hand, one of the key objectives of the Kenya Ministry of Energy is to ensure petroleum products transported within the country and for export purposes is done in the most efficient way with minimal losses while maintaining the country’s environmental and safety standard, a criteria satisfied by the project.
1.3 Public/Private Partnership
Public Private Partnership (PPP) is where a public service is provided through a partnership of the public sector with one or more private companies. The private sector in most cases assumes financial, technical and operational obligations. However accountability remains with the public sector for the provision of that public service. PPP therefore enables most governments to improve on the delivery of public services and proper management of public facilities by sharing the financial obligations with other private investors. The private investor on the other hand gains from the partnership by earning a return on capital employed. The procurement of public services is greatly improved on PPP ventures. However, long term political commitment is mandatory for the success of PPP. Most infrastructure projects are capital intensive but the involvement of the private sector has enabled most countries world over to implement such projects. Figure 1.1 below shows the number and value of private participation in infrastructure projects by region between 1996 and 2006. From the figure it can be seen that other regions of the world have put up many infrastructure projects with private participation well ahead of Africa.
Some of the projects implemented under public private partnership in the region include the Songa Processing plant in Tanzania, Maputo port in Zimbabwe and Skida Desalination Plant in Algeria. Energy sector projects are usually capital intensive and the returns take a relatively longer time to be realised. Most developing countries face financial challenges and can only rely on donors or investors for the funding and implementation of projects of this nature. This is the main reason behind the choice of Public/ Private Partnership for the Kenya Uganda Petroleum Products Pipeline Project implementation. The JCC came up with a mechanism to partner with a private investor for the implementation of the pipeline project. The investor’s responsibility is to finance and operate the project on BOOT basis. The private investor on completion of the project will be expected to manage and operate the pipeline for a period of 20 years before finally transferring ownership and operations of the facility to the two governments. The two governments agreed to have a 49% equity shared equally between them leaving the investor with a 51% share. This was aimed at facilitating the private investor’s growth for faster economic development in line with the economic policies in the two countries. TEAL therefore partnered with the two governments having come up with the most competitive bid for the financing, construction and operation of the proposed pipeline project. The financial plan of the project is discussed in chapter three of this report. The cost of using the facility will be borne by the users and not the tax payers.
1.4 Benefits of the Project
Alternative options of transporting petroleum products to Uganda have been considered in the next chapter. These range from transportation by road tankers, rail wagons, marine ships or ferries and finally pipeline transport. A number of benefits of the pipeline project that were the key drivers have been outlined below;
- Secure and environmentally acceptable means of transportation of Petroleum products to the Uganda market;
- Provision of secure and easy access to supply of petroleum products to the other neighboring countries to Uganda;
- Reduction of road maintenance costs and reduction in the number of road accidents i.e. decongesting the roads;
- With a reliable supply of petroleum products, the oil marketers in Uganda will be able to maintain low stocks and reduce their costs resulting in low cost passed on to the consumers;
- The overall reduction in transportation cost will also lead to a reduction in the final market prices of the oil products;
- The pipeline will lead to a reduction in illegal product movement across the Kenya-Uganda border and ultimately prevent product adulteration which is common when products are transported by road tankers and finally,
- The pipeline will lead to a reduction on HIV prevalence among truck driver a situation that has become a national pandemic in the two countries.
2. Market analysis
A number of market studies have been done in line with the Kenya Uganda Petroleum Products Pipeline Project. The most recent study was done in 2007 by TEAL through their consultant, Nexant Limited. The main objective of the study was to carryout petroleum products demand analysis and forecasting. The study was a development of the earlier studies carried out in 1999 and 2001. With an optimistic commencement of works by end of this year (2008) , the consultant focused on the prevailing Market data and carried out a demand forecasting up until 2028 (End of BOOT period). There has been a considerable growth rate in the demand of white products in Uganda and the Neighboring countries.
2.1 Oil Transportation System in Kenya and Uganda
As earlier mentioned, Kenya has an already functional oil products pipeline to the major cities operated by KPC. In addition to the pipeline, the country relies on rail and road transportation for distribution of the products to the remaining towns. Uganda on the other hand relies mainly on road transportation from Kenya and distribution within the country.
2.2 Market Opportunities for the Pipeline
The main driver of the project was to ensure efficient distribution of petroleum products to Uganda. However there are a number of neighboring countries, relying on road transportation of their petroleum products supply through Uganda that would also benefit from the pipeline. These include Rwanda, Burundi, North Western Tanzania and Eastern Congo. The delays caused by long distance hauling add to the final fuel costs. The pipeline will therefore serve a bigger market beyond Uganda. With the new discoveries, depending on the quantities of crude discovered in Uganda, the pipeline will be used later on in transporting white Oil products from Uganda refineries to the Kenya Port of Mombasa for distribution to the wider international market.
2.3 Competitors to the Pipeline
Despite the benefits of the pipeline outlined, it is still subjected to stiff competition largely based on the final tariff charged to the shippers. This will ultimately affect the final cost of fuel passed on to the consumers. If the tariff charged for utilizing the pipeline is relatively high in comparison to the cost of using road or rail modes of transport (that are largely being used currently), then the oil marketers may not use up the facility instead they will maintain the current alternatives. The three main competitors, road, rail and marine transport are discussed below.
Uganda is currently relying heavily on road transportation, using oil tankers, for its oil imports through Kenya. There are two alternative routes to Uganda, through the Malaba border from Eldoret depot or Busia border from the Kisumu Depot. The shortest route to Uganda is however through the Eldoret Depot. In addition to the relatively shorter distance is its larger capacity, relative to the Kisumu Depot, to handle the extra transit oil products to Uganda.
There have been massive delays in product delivery caused by road transportation of petroleum product. However there are a number of factors that have contributed to this delay the main factor being customs clearance for transit oil at the Kenya/ Uganda border where the trucks are expected to move in regulated convoys to avoid tax fraud. The other disadvantages of road transportation are the safety and environmental problems associated with spillage of products and road accidents. The high unit labor costs make road transport more expensive as compared to rail or pipeline over long distances. Despite the shortcomings of road transportation, it is still considered as the fastest way of transportation in relation to the other existing means in the absence of a pipeline. On the other hand it also provides employment to different groups at different levels, the drivers, mechanics etc. as compared to the other modes.
Uganda has two options of transporting oil products by rail. This can be through the Kenyan railway system managed by Rift Valley Railways Company or the Tanzanian railway system. There are three alternative routes by rail to Uganda, two from the Kenyan Side (direct routes from Mombasa and from Kisumu) and one from Dar-es-Salaam in Tanzania. The routes through Kisumu and Dar-es-Salaam involve lake ferries through Lake Victoria. The preferred route by rail is through the Mombasa route, this is about 100km longer than the Kisumu route, as it takes relatively shorter transit duration than the other routes. The railway systems use roll – on ferries for moving across the lake.
Railway transportation has the advantage of low marginal costs for incremental freight traffic after the initial capital investment is fully paid up. The major concern on the railway system in the East African region is poor maintenance in addition to the operational problems. The networks are not well developed causing delays. It however has environmental and safety advantages over road transportation.
Lake Victoria connects the three East African Countries. Uganda therefore has the option of using either route through Kenya or Tanzania. The routes are however a subsidiary to the railway systems through the ferries. The infrastructure is not well developed and the systems are not so actively used. The oil jetty in Kisumu on the Kenyan side has not been in use since mid nineties when the existing pipeline was commissioned. Plans are however underway in looking at the possibility of constructing a loading Jetty in Kisumu but no work or studies have been carried out so far to this effect. Mwanza port in Tanzania is partially in use, the oil exports currently utilize the existing ferries discussed above.
Movement via inland waters is a low cost option due to low maintenance costs. The cost of putting up terminal facilities is relatively low compared to other modes of transport. The main disadvantage of marine transport is the inflexibility due to delivery times and environmental concerns due to oil spillage that can negatively affect the fishing industry.
2.4 Risk analysis of the market and other project risks
Risk management involves using past occurrences to forecast future events. By extrapolating from the past occurrences, risk analyst can forecast the probability that a particular risk might occur or not. A good understanding of the project phases is important in risk analysis and finally managing the identified risks. The Capital intensive nature of energy ventures calls for a detailed risk analysis before making the final investment decision. Risk analysis starts with risk identification followed by an assessment of the probability of occurrence of the risk and finally an evaluation of the cost estimates of each risk identified. Quantifying the risks enables the Project management team to make decisions on what measures to take to avoid the risks or mitigate and manage them. Adequate analysis of various risks was carried out at the development phase of the project. Changes cannot be fully avoided in such big projects. A good understanding of risk management principals can therefore help the project team in managing the ever recurring changes. The benefits of risk analysis and risk management are summarized below; 
- A good clarification of project issues right from project inception to completion,
- A good support of decision making based on a detailed analysis,
- Continuous monitoring of project definition and specification,
- A good understanding of project risks hence finding various options of management at a relatively lower cost,
- The historical data can be used in future risk management procedures.
There are a number of risks associated with the Kenya Uganda Petroleum Products Pipeline Project. These have been briefly discussed below based on the market studies that were carried out by the company consultants.
Market Risk Analysis
Market risks are risks that results from changes in the market environment. There are a number of external and internal forces at work that all firms need to address in order to remain competitive in any business environment. According to Michael Porter, there are five competitive forces in any market environment. It is rare to find more than one petroleum products pipeline in the developing countries because of the capital expenditure involved. Most pipelines in the developing countries therefore enjoy natural monopoly and are hardly threatened by new entrants. From the discussion in the last section, the pipeline will offer the lowest oil products transportation tariff in comparison to the other modes of transportation in addition to the other benefits. It will therefore have a competitive advantage over the other competing modes of transportation. The customers (oil marketer) will therefore be forced “naturally” to use the pipeline in transporting their products to Uganda. The only threat left would therefore be oil products substitutes. Oil products are currently used mainly for electricity generation and in the transport sector, the largest consumer being the transport industry. The lack of a commercially viable substitute in the transportation sector leaves oil products as the only option. No market risks are therefore envisaged in the 20 year period that TEAL will operate the pipeline and the following years until the region develops any commercially viable substitute. There are however other project risks associated with the pipeline discussed in the following chapters.
Other Project Risks
Financial risks are risks associated with changes in the financial value of the portfolio. They are therefore risks that lead to reduction of the investment’s cash flow. Changes in the interest rates, stock market values etc are but some of the major causes of financial risks. The project’s Request for Proposal specified a Debt Equity Ratio of 70:30 financing for the pipeline project. The equity contribution by all the parties is an indication of how much risk they are willing to take on the project. The initial bid by TEAL to finance the project was based on the return on investment from the CAPEX and OPEX assumed at the time of contract award. This has however changed significantly posing great risks to the investor. There have been a number of variations that have come up having significant cost impact on the CAPEX. Some of the variations that were not foreseen during project inception have negatively impacted the project’s CAPEX leading to reductions in the project returns. A new financial model has however been developed (discussed in the next chapter) to look at the viability of the project. The time delay in the commencement of construction works has also had an impact on the project revenues that were initially forecasted to start in 2008. Discussions are however underway between the JCC and TEAL on eliminating or sharing any loses that may accrue to the developer (TEAL) for the successful completion of the project.
Technical risks in engineering projects are exposures to losses that occur mainly due to technological changes or design failures. In order to avoid any negative impact on the project during construction through to the operation phase due to technical failures, it is mandatory to do a thorough analysis of all the design parameters and ensure they are closely monitored and implemented during all the phases of the project. It’s also important that provisions are made for any future technological changes during the design stage. Technical failures can also cause losses of revenue due to lack of operation of the facility constructed. It is therefore mandatory that stringent checks are made during design through to construction and finally during the commissioning of the facility and operation. TEAL have put in place all the necessary checks and ensured the design meet internationally accepted standards. The pipeline design was carried out by qualified consultants to TEAL and reviewed by discipline engineers in the project team. To avoid any design incompatibility with the already existing pipeline on the Kenyan side, TEAL held several design review meetings with the KPC engineers. An agreement was signed between KPC and TEAL (Interconnection Agreement) to avoid any technical failures of the pipeline networks in the future. Detailed manuals have been put in place for future maintenance and operation of the facility to further eliminate any technical risks.
Political risks are risks that occur due to changes in the political arena in a particular country. These are mainly changes in governance, policy, civil unrest etc and can have significant impacts on an investment’s returns. The risk increases where an investment involves two countries like in the case of Kenya Uganda Petroleum Products Pipeline Project because of the differences in governing systems and policies in socio-economic environments. The 2008 post election violence in Kenya had a significant effect on the economic activities in the whole Eastern Africa region. During this period, it was impossible to transport petroleum products to Uganda as the roads were impassable due to civil unrest causing serious impacts on Uganda’s socio – economic activities. Most investors always opt for taking a Political risk insurance to address this risk but the project team opted on forming a commission representing all the involved parties. The JCC was therefore formed to address political risk issues in addition to the other tasks discussed in the report already. One of the responsibilities of JCC was therefore to address any potential difficulties that would result from political and national differences between the two countries. The JCC therefore put into place the Legal frameworks through which tendering for investors were managed. On completion of the construction works, a Joint Venture Company will take over the operations of the pipeline. The directors of the JVC will come from the two governments and TEAL. The ownership of the pipeline system is established through the Shareholders Agreement, and the Legal frameworks created by the Host Governments Agreements and the Intergovernmental Agreement. It is however important to note that the two countries have a history of good relations but this should not be an indication of lack of any disagreements between the two governments in the future. The JVC will therefore be a neutral ground where all the pipeline operational issues will be discussed.
3. Finance Structure of the Pipeline
The principal objective of any firm’s directors is to maximize the shareholders’ value by undertaking investments with positive returns. Shareholders of a firm can earn returns on their capital from taking up investment decisions themselves and investing in other ventures outside the firm but if they ge