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THE KENYAN PETROLEUM INDUSTRY:DISTRIBUTION...IS IT A PIPELINE DREAM?

EXECUTIVE SUMMARY
We initiate coverage of the Kenyan Petroleum Industry and the two Kenyan listed Oil Marketing Companies; KenolKobil Plc (NSE: KENO) and Total Kenya Plc (NSE: TOTL). Our coverage lays emphasis on the three divisions of the petroleum industry; upstream, midstream and downstream activities from a global viewpoint, down to the Kenyan petroleum industry. Below, we highlight opportunities and challenges in the industry:

Opportunities in Kenya’s Petroleum Industry:

1. Investment in exploration in other basins identified with potential oil-Similar to exploration by Tullow Oil, other private firms, Local and International can apply to the government for allocation of blocks for oil exploration and potential production in the unallocated basins in Lamu deep off-shore. Kenya has a total of about 63 petroleum exploration blocks with 37 in Lamu Basin, 7 in Anza basin, 5 in Mandera basin and 14 in the Tertiary Rift basin.
2. Through PPPs, private firms can invest in midstream activities- Due to the capital intensity of the infrastructure required, there’s an opportunity for private firms (both international and local) to partner with the government to invest in midstream infrastructure. Currently, The Lamu-Lokichar crude oil pipeline is a joint investment by the Kenyan government and a consortium of oil companies; Tullow Oil Kenya B.V, Africa Oil Turkana Ltd and Total Oil. Additionally, the construction aspect of the projects presents an opportunity for private investors who may participate in tenders floated to construct the different infrastructure. The Lamu-Lokichar pipeline will be constructed by a British firm, Wood Group Plc which was awarded the tender for that project.

 
Challenges in Kenya’s Petroleum Industry

1. Insufficient and inefficient infrastructural systems- The sector continues to grapple with inefficiencies in infrastructure which has maintained the fuel costs at high prices.
2. Volatile international crude prices and foreign exchange rates- This has led to unpredictable consumer prices especially in the local pump prices. In spite of our expectations that crude prices will come off to levels of USD 65 per barrel, there still exists uncertainties on crude price movement due to geo-political issues surrounding major oil producers in the world i.e. US sanctions on Iran, oil supply disruption in Libya and Venezuela.
3. Adulteration of Fuel- This remains a key challenge for the industry despite efforts by Energy Regulatory Commission (ERC) to quash the illicit trade. Notably, ERC has increased crackdown of adulteration of fuel, hiking excise duty for Kerosene to match that of Diese,l reducing the price difference. However, the tax difference stands at USD 0.18 which is still high to entice the illicit traders.
4. Conflicts between local communities and the government- We note that, following oil discovery in Lokichar, the local community raised various issues with the government. This included making demands of involvement in usage of their share of oil revenues. The issue led to stalling of the Early Oil Pilot Scheme (EOPS) programme where Tullow threatened to stop operations in Kenya. We note that this may be an emerging issue in the future with explorations in other areas.

Valuation summary:
Based on the above opportunities and risks, we are overweight on the upstream and midstream sectors of the Kenyan Petroleum industry while underweight on the downstream sector. On the backdrop of this information, we value KenolKobil Plc (NSE: KENO) as a HOLD based on a target price of KES 16.33, a 0.5% upside potential on the current market price of KES 16.25 and a SELL recommendation on Total Kenya Ltd (NSE: TOTL) based on a target price of KES 19.75, a 25.5% downside potential on the current price of KES 26.50