KENYA EXTRACTIVES POLICY DIALOGUES: TECHNICAL PAPER NO. 1

Transcription

1 KENYA EXTRACTIVES POLICY DIALOGUES: TECHNICAL PAPER NO. 1 REVENUE SHARING AND MANAGEMENT IN KENYA S PETROLEUM SECTOR 4 TH 5 TH April, 2018 The Extractives Policy Working Group ( iii P a g e

2 2018 Extractives Baraza Strathmore University Madaraka Estate, Ole Sangale Road P.O. Box , Nairobi, Kenya Tel: +254 (0) /604 Some rights reserved This Paper is a knowledge product of the Extractives Policy Working Group (EPWG) hosted by the Extractives Baraza. This Paper has been authored by Dr. Melba K. Wasunna, Kate W. Mavuti and James Ombaki with contributions from the Commission on Revenue Allocation (CRA) and expert, Dr. Don Hubert, Resources for Development Consulting, Canada. This paper was validated by the Technical Committee on Revenue Sharing and Management in Kenya s Petroleum Sector in a meeting held at the Strathmore University and lays the basis for discussion during the 1 st series of the Kenya Policy Dialogues held on 4 th 5 th April The paper also incorporates ways forward discussed by stakeholders during the Forum. For more information, info@extractives-baraza.com or visit iv P a g e

3 Contents I. PREAMBLE...vi II. ABSTRACT...vii CHAPTER ONE: INTRODUCTION AND OVERVIEW Introduction Scope Brief Background of Kenya s Petroleum Revenue Sharing Conversations and Current Status... 3 CHAPTER TWO: LEGAL BASIS FOR REVENUE SHARING The Constitution of Kenya The Petroleum (Exploration and Production) Act, The Petroleum (Exploration, Development and Production) Bill Natural Resources (Benefit Sharing) Bill CHAPTER THREE: PETROLEUM REVENUE SHARING OPTIONS Kenya s Petroleum Fiscal System and Petroleum Revenue Generation Collection and Depositories of Petroleum Revenues Sharing of Petroleum Revenues CHAPTER FOUR :PETROLEUM REVENUE MANAGEMENT The Pre-Resource Curse and Its Implications Models of Distribution of Resource Revenues to Subnational Jurisdictions Commission on Revenue Allocation (CRA) and Revenue Allocation Formula Sovereign Wealth Funds Oil to Cash Initiatives: Local Communities CHAPTER FIVE: PRIORITY ISSUES FOR KENYA S CONSIDERATION AND CONSENSUS BUILDING WAY FORWARD ANNEX A: Kenya Extractives Policy Dialogues: Revenue Sharing and Management in Kenya s Petroleum Sector BIBLIOGRAPHY..30 v P a g e

4 I. PREAMBLE The success of Kenya s petroleum sector rests on a robust policy and legal framework which incorporates consultative submissions from all key stakeholders in the sector. It is on this basis that the Extractives Policy Working Group (EPWG) was established in February The EPWG, chaired by the Kenya Institute of Public Policy, Research and Analysis (KIPPRA) and co-hosted by the Extractives Baraza, Strathmore University ( and the Kenya Civil Society Platform on Oil and Gas (KCSPOG) convenes stakeholders for meaningful dialogue and consensus on issues pertinent to Kenya s extractives sector. The main objective of the EPWG is to shape and influence policy in the extractives sector through an organized and recognized organ that consolidates diverse stakeholder views as well as incentivize consensus and clarity on key policy issues in the sector that need to be addressed and strengthened to ultimately achieve good governance. Based on the foregoing, the EPWG identified Revenue Sharing and Management as one of the key policy issues that need deeper interrogation and understanding in light of the current advancements in the petroleum sector. This topic, the first of the three-part series, is addressed through this Technical Paper and the two-day Scenarios Building and High Level Panel Discussion Forum whose goal is to interrogate different scenarios critical to robust revenue sharing and management with possible alternatives for Kenya in light of the Petroleum (Exploration and Production) Bill, This paper therefore lays the groundwork by outlining pertinent issues regarding the equitable sharing of potential petroleum revenues taking into account the legal framework, the priorities and objectives advanced by the government, domestic and international perception as well as international best practices. This is done in preparation for the stakeholder training and dialogue during the Scenarios Building and High Level Panel Discussion Forum led by expert, Dr. Don Hubert, Resources for Development Consulting, Canada. This Technical Paper was validated at a meeting co-convened by the Extractives Baraza and held on 28 th February, 2018 at the Strathmore University Law School by the Revenue Sharing and Management Technical Committee chaired by the Commission on Revenue Allocation (CRA) and comprising of the following key stakeholders; The National Treasury, institute of Economic Affairs, Kenya Revenue Authority, Kenya National Bureau of Statistics, Ministry of Mining and Petroleum, Infonet Group, Econews Africa, Ogle Sheikh Shriff Advocates and Klynveld Peat Marwick Goerdeler (KPMG). vi P a g e

5 II. ABSTRACT What Constitutes a Good Deal? In Search of an Equitable and Sustainable Revenue Sharing Model for Kenya s Petroleum Sector As Kenya gears up to move from the exploration and appraisal phase into the development and production phases, the conversation on petroleum revenue sharing and management has become key within the industry, government and general public. Sprouting issues include questions regarding how petroleum revenues are generated, shall be collected, allocated and eventually shared among relevant stakeholders with particular attention to where petroleum revenues ought to be deposited, the administration of these depositories (transparency and accountability) and the intended allocation of petroleum revenues and its rational: the matter of the proposed 75:20:5 split among National Government, County Government and local communities respectively. An analytical look into established revenue sharing models used in oil producing countries while taking into account already existing models of natural resource revenue sharing models in Kenya prescribed by the Commission n Revenue Allocation (CRA) and the specific economic and social circumstances in Kenya indicate that a hybrid model consisting of both derivation and indicator systems, may be the best approach for sharing of expected petroleum revenues. The need for transparency and good governance in the management of these revenues is essential for the appreciation of optimum benefits from the eventual production of Kenya s petroleum. The constitutional principle of equitable sharing must carry the day. The matter of how Kenya can ensure sustainability of these petroleum revenues and avoid the pre-resource curse as well as pre-mature borrowing and spending, must find meaningful discourse and consensus stakeholders. vii P a g e

6 CHAPTER ONE INTRODUCTION AND OVERVIEW 1.1. Introduction Kenya, having discovered roughly 560 million contingent barrels 1 of oil that are likely recoverable according to recent estimates by Tullow PLC, faces many challenges as well as opportunities in its petroleum revenue sharing, management and institutional design. For instance, the Final Investment Decision (FID) is yet to be undertaken, oil and gas prices may shift dramatically within the next few years and decades, and development and operational costs of oil production are unclear. However, the Government of Kenya now finds itself in the position of considering the most appropriate policy and fiscal options, with an eye to being ready once project details become better defined. Generally, petroleum revenues are generated through various legal and contractual arrangements many of which are stipulated in country specific legislation and fiscal regimes. The general practice among many resource rich countries is to rely on the international oil companies (IOCs) which have the financial means and technical expertise to exploit the petroleum resource. In turn, the country uses specific fiscal tools and systems to collect revenues from such activities. Literature categorizes petroleum fiscal systems into three broad areas namely: i. royalty and tax (the company takes ownership of the petroleum as it reaches the surface with the government securing its revenue through royalty payments and the assessment of various taxes); ii. production sharing agreements (PSCs) (the company takes ownership of petroleum only at the delivery point with the government being allocated a share of after-cost petroleum production) and iii. service contracts (the contractor never acquires the title to the resource and is simply paid a fixed or variable fee for oil production services). Over time, the distinction between these types of systems has been blurred and hybrid models (for example, adding royalties and income tax to a production-sharing system) are now more common. 2 In fact, today s best practice denotes that ultimately it is the combination of fiscal terms within the system, rather than the system itself, which determine whether the government has negotiated a good deal. Petroleum revenues are therefore ordinarily derived from such fiscal tools as royalties, taxes (resource rent taxes, corporate income taxes, withholding taxes, import duties, bonuses i.e For example, in Uganda, Tanzania and Mozambique. 1 P a g e

7 signature bonuses and production bonuses) and state equity or state participation whereby the state participates directly in the petroleum project by taking up an equity stake. Kenya does not use the royalty system to generate revenues, they are generated from the country s share of petroleum production allocated to the government after costs have been paid to the contractor and a windfall tax imposed when oil prices exceed a specified threshold. 3 The basis of the production sharing is that of actual barrels of oil remaining after the contractor recovers costs (cost oil) and upon division of the remainder of the production (profit oil) between the contractor and the government. The main source of government revenue under Kenya s current production sharing contracts comes from the government s share of profit oil Scope This technical paper is limited to discussions about the fiscal terms on petroleum revenues especially those concerning sharing and management of revenues from Kenya s petroleum sector. It also highlights different revenue sharing scenarios from select resource-rich countries, namely Australia, Bolivia, Canada, Chad, Ghana, Nigeria, USA Alaska, and Norway among others. In this paper, the term revenue sharing encompasses how the state shares its petroleum revenues among its levels of government and with the local community and the rationale used for such allocation. Revenue Management on the other hand refers to the systems put in place to ensure equitable, transparent and fair running and administration of revenue allocation and expenditure. This paper seeks to invoke thoughts and analysis and inspire impactful dialogue among stakeholders regarding the equitable sharing and sound management of petroleum revenues taking into consideration the legal framework, the priorities and objectives advanced by the government, domestic and international perception as well as international best practices. This paper is structured into five main sections namely: Chapter One this chapter introduces the reader to the meaning of Petroleum revenue sharing and management, provide a brief background of the conversations around this topic in Kenya. Chapter Two This chapter deals with the legal framework and fiscal regime governing petroleum revenues sharing and management in Kenya. Chapter Three Having identified the governing legal framework, this chapter takes the reader through different aspects of petroleum revenue sharing in Kenya including the controversial 75:20:5 split. Chapter Four this chapter outlines the key issues for discussion around petroleum revenue management in Kenya the challenges faced and areas needing dialogue and consensus; 3 See Model Production Sharing Contract P a g e

8 Chapter Five This chapter outlines priority issues of petroleum revenue sharing and management deliberated by stakeholders during the Scenarios Building and High Level Panel Discussion Forum: Attached to this Technical Paper is the programme of events for the Scenarios Building and High Level Panel Discussion Forum entitled The Kenya Extractives Policy Dialogues: Revenue Sharing and Management in Kenya s Petroleum Sector Brief Background of Kenya s Petroleum Revenue Sharing Conversations and Current Status The debate around sharing of petroleum revenues was propelled into the limelight by the Petroleum (Exploration, Development and Production) Bill This has now been republished as the Petroleum (Exploration, Development and Production) Bill Kenya, now having a devolved system of Government with 47 counties, finds herself in a position whereby the issue of resource revenue sharing has struck a cord and eliciting in-depth discussions among economic stakeholders in particular, in the extractives sector. The petroleum revenue sharing and management discussion is further propelled by projected revenues. As stated above, Kenya s production is estimated at 560 million barrels. 4 Notably less than Uganda and Ghana, it has nevertheless been projected that with exports expected to begin in 2021, there will be an injection of approximately USD 1.2 billion a year at peak production going by the current market prices. 5 This is about 10 per cent of the annual revenue comparable to tea, the country s largest export. The revenues stemming from these resources are proposed to be shared among national government and sub-national levels, i.e. county governments and the local communities. Ongoing dialogue to this effect has seen the Executive arm of the Government in its Presidential Memo 6 ask the Members of Parliament to re-consider the Petroleum (Exploration, Development and Production) Bill 2015, particularly the provisions on revenue sharing and amend the sharing ratio from 70:20:10 between national government, county government and local communities respectively, to a 75:20:5 ratio, thereby reducing the share to local communities by half. This is now the state of affairs under the Petroleum (Exploration, Development and Production) Bill 2017 which has been presented to Parliament for its first reading Kenyan Oil Revenues Dispute Threatens to Delay Production Business Daily (Nairobi, Kenya, 26 February 2018) < accessed 13 March The Presidential Memorandum on the Petroleum (Exploration, Development and Production) Bill, 2015 (National Assembly Bills, No. 44 of 2015). 3 P a g e

9 CHAPTER TWO LEGAL BASIS FOR REVENUE SHARING 2.1. The Constitution of Kenya 2010 The discourse on petroleum revenue sharing draws its legitimacy from the Constitution of Kenya 2010, Article 62(3) of which vests ownership, on behalf of its citizens, of the natural resources within the country in the National Government. Article 62 (1) (f) of the Constitution defines public land to include minerals and mineral oil. Article 66 (2) asserts that Parliament shall enact legislation ensuring that investments in property benefit local communities and their economies. The core principles under the Constitution are reducible to four: equity in distribution of resources, public participation throughout the process, openness, and accountability. 7 The equity principle is made explicit under Article 69 (1), which requires the State to ensure sustainable exploitation, utilization, management and conservation of the environment and natural resources, and to ensure that the accruing benefits are shared equitably, ensuring the resources are utilized for the benefit of the people of Kenya. Article 201 also states that the burdens and benefits of the use of resources and public borrowing shall be shared equitably between present and future generations. The Constitution clearly provides the basis and mandate for the government to ensure equitable and sustainable allocation and distribution of natural resource revenue The Petroleum (Exploration and Production) Act, 1986 The Petroleum (Exploration and Production) Act 8 (the Petroleum Act ) and the annexed regulations currently govern exploration and production in Kenya s petroleum sector. As is the case in many developing countries, Kenya has selected to operate a production sharing system where a private oil company is responsible for oil exploration and production and the government receives a proportion of oil produced after costs have been paid. The specific fiscal terms are set out in a production sharing contract (PSC). Kenya s model PSCs were published in 1986, 1999 and These template documents provide standardized language for the majority of the contract. Kenya s current petroleum fiscal regime is through its 2008 Model Production Sharing Contract. 7 Article 201(a) of the Constitution, Petroleum (Exploration and Production) Act of 1986 (Chapter 308, Revised Edition 2012) 4 P a g e

10 2.3. The Petroleum (Exploration, Development and Production) Bill 2017 The country has embarked on a journey to reform its 1986 petroleum law, and is now in the final stretch of the Petroleum (Exploration, Development and Production) Bill, 2017 (the 2017 Petroleum Bill ) and Model PSC, and with it sparking a critical developmental debate. We have identified two major changes proposed by the 2017 Petroleum Bill: how petroleum revenues will be generated (fiscal regime) and how they will be shared. Proposed changes to the Petroleum Fiscal Regime The 2017 Petroleum Bill and Model PSC seek to revise Kenya s petroleum fiscal terms including sources of government revenues and fiscal rules. It should however be noted that the fiscal terms outlined in already negotiated PSCs (pursuant to the 2008 Model PSC) such as those for Blocks 10BB and 13T Turkana Oil, shall not be affected by these changes. The changes shall affect how petroleum revenues are generated from future PSCs negotiated after the enactment of the Bill. Figure 1: Comparison between the Current (2008 Model PSC) fiscal terms and proposed (2017 Model PSC terms 2008 Model PSC Proposed 2017 Model PSC DROP & Windfall Tax - Art. 27(3) Production sharing based on the daily rate of production (DROP) combined with a Windfall Tax imposed when oil prices pass a certain threshold Deemed Corporate Income Tax - Art. 27(5) CIT paid out of the government s share: was included in the government s crude oil share hence deemed to be paid. Cost Recovery - Accounting Procedures (Appendix B) Sec Company could recover interest on its loans for capital as petroleum costs at commercial rates R-Factor - Art. 37 Production sharing based on measure of profitability of the value of the R-Factor. Actual Paid Corporate Income Tax - Art. 39(3) CIT actually paid by the company: government s share of crude oil is exclusive of CIT and must actually be paid by the company Cost recovery and Uplift - Art. 36 (3) Cost recoverability of interest on loans recovered through an amount of 15% of the development costs (uplift) within the first 5 years (company recovers 115% of costs within the first 5 years) 5 P a g e

11 Proposed Changes to Petroleum Revenue Sharing The 2017 Petroleum Bill provides that the proceeds raised from the exploitation of petroleum resources shall be shared out according to a 75:20:5 ratio to National Government, County government and local communities respectively. 9 A provision on the actual method of petroleum revenue sharing is notably missing in the Petroleum (Exploration and Production) Act, The 2017 Petroleum Bill provides: 85. (1) The national government s share of the profits sharing derived from upstream petroleum operations shall be portioned between the national government, the county government and the local community. (2) The county government s share shall be equivalent to twenty percent of the national government s share: Provided that the amount allocated in accordance with this is subsection shall not exceed the amount allocated to the county government by Parliament in the financial year under consideration. (3) The local community s share shall be equivalent to five percent of the Government s share and shall be payable to a trust fund managed by a board of trustees established by the county government in consultation with the local community: Provided that the amount allocated in accordance with this subsection shall not exceed one-quarter of the amount allocated to the county government by Parliament in the financial year under consideration. (4) The respective county government shall legislate on the establishment of the board of trustees and the prudent utilization of the funds received under this section for the benefit of present and future generations. The following is a summary of Kenya s current petroleum fiscal system as further discussed herein. It is to be noted that this system is prone to change significantly upon enactment of the 2017 Petroleum Bill: 9 Section 85 of the Petroleum (Exploration, Development and Production) Bill, P a g e

12 Figure 2: Obtained from Don Hubert, Mapping Risks to Future Government Petroleum Revenues in Kenya (Oxfam International, March 2016) 2.4. Natural Resources (Benefit Sharing) Bill 2014 One cannot discuss revenue sharing in the Petroleum sector without making reference to the Natural Resources (Benefit Sharing) Bill The Benefit Sharing Bill was passed by the Senate with amendments and referred to the National Assembly. It was intended to provide a framework for the establishment and enforcement of a system of benefit sharing between resource exploiters, the national and county governments and the local communities. 11 The Benefit Sharing Bill defines benefits as any gains, proceeds or profit of natural resources. 12 Further, the Benefit Sharing Bill has particular provisions on revenue sharing and revenue management specifically regarding the revenue sharing ratio and the use of retained funds. 13 All the royalties and fees collected by the Kenya Revenue Authority under the Bill will be paid into Natural Resources Royalties and Fees Fund, 20 percent of which will go to the Sovereign Wealth Fund while 80 percent will be shared between the national government, county governments and local community. However, the Bill broadly applies to all natural resources, including forests, water, wildlife and fishery. 14 Should the Petroleum Bill 2017 be passed, the revenue sharing split envisaged under the Benefit Sharing Bill will not apply to petroleum. These pieces of legislation together with others touching on core issues of natural resource revenue sharing and management the Community Land Act and the Sovereign Wealth Fund Bill, 10 Senate Bill No. 34 of Section 5 of the Natural Resources (Benefit Sharing) Bill Section 2 of the Natural Resources (Benefit Sharing) Bill Section 26 and 38 of the Natural Resources (Benefit Sharing) Bill Clause 3 of the Natural Resources (Benefit Sharing) Bill P a g e

13 further discussed hereunder, seek to better govern and provide clarity on related and emergent issues. CHAPTER THREE PETROLEUM REVENUE SHARING OPTIONS One of the most important aspects of petroleum fiscal regime design is to ensure a balance between attracting inward investment and generating a fair share of government revenue. Sharing of non-renewable natural resource revenues contributes towards a country s economic growth and sustainability as well as mitigates conflict and generate incentives for sub-national governments to exploit other natural resources to generate revenue. However, poorly designed mechanisms can exacerbate regional inequalities and cause the resource curse Kenya s Petroleum Fiscal System and Petroleum Revenue Generation Kenya has a production sharing system as evidenced in its petroleum laws discussed above and specifically outlined in its 2008 Model PSC. Most revenues would derive from the government s share of oil production once the company recovers its costs. Current negotiated PSCs have indicated that out of the total production, a company may recover its costs from between 60% - 80% of the production, cost oil with the remaining 40% profit oil, shared between the company and the government according to a predetermined formula. 15 This percentage of cost oil is influenced by the fact that the company finances the exploration taking up all the financial risk and therefore, must first recover its initial investment. The government on the other hand does not finance the exploration operations but rather provides access to the resource. In addition to enabling the company to recover its initial investment, the cost recovery limit also guarantees a certain amount of profit oil for the government. The company s recoverable costs normally include petroleum costs i.e. costs of running petroleum operations and capital expenditure in respect of each development area. 16 Therefore, the Government s share of production from oil in Turkana and other basins shall be the gross revenue from crude oil sales less the company s exploration, development and operating costs. This is what shall then be shared among the three stakeholder levels i.e. National Government, County Government and local communities. The 2008 Model PSC stipulates that sharing of the profit from oil between the government and the company is calculated against the total oil produced (less cost oil) on a sliding scale of the daily rate of production (DROP) with an additional windfall tax levied when oil prices are 15 A 60% cost recovery limit applies to Blocks 9, 10A, 11A, and 12B. 16 Article 27 (2) of the 2008 Model PSC 8 P a g e

14 greater than USD 50 per barrel. 17 Figure 2 above illustrates this concept. The R-factor approach proposed by the 2017 Petroleum Bill is designed to be more economically efficient by being more sensitive to productivity i.e. it allocates a higher proportion of the profit oil to the government as production becomes more profitable: the core definition of the R-factor is that it is essentially the ratio of cumulative revenue to cumulative costs. However, the R-Factor does have its challenges: it is vulnerable to cost inflation that could result in worse revenue outcomes for the government. Another aspect is the government s right to hold an equity stake in oil and gas operations. The Government holds this equity through the National Oil Corporation of Kenya (NOCK). This is what is referred to as state participation. The advantages of such an approach are capacity building: the state becomes a domestic expert in commercial aspects of oil and gas, and improved monitoring. Having a seat at the table as a shareholder provides the state with an opportunity to monitor activities, and direct financial benefits in the form of dividends or a share of the production itself. In Kenya, negotiated PSCs indicate that the state can elect to acquire an interest from a minimum share of 10% to as high as 22%. For instance, the PSC for Block 1 indicates an 18% interest. 18 The proposed provisions of the 2017 Petroleum Bill are generally aimed at increasing both international investment into petroleum exploration as well as, increasing petroleum revenues for the government. However, while the R-factor makes the fiscal regime more profit-sensitive, other aspects like the paid CIT make Kenya a less attractive fiscal regime. The rationale is that proof of commercial quantities of oil allows the government to ask for more Collection and Depositories of Petroleum Revenues This paper has outlined that petroleum revenues in Kenya shall come from: production sharing and state participation or the state s equity share in the petroleum operations. As a nonrenewable natural resource, provisions regarding the management of petroleum revenues must be clear and unambiguous to avoid loss of potential revenues. As stated in this paper, the Constitution vests all minerals and mineral oils in the National Government on behalf of its citizens. 19 It would go therefore that collection of Petroleum revenues would be the mandate of the National Government. The 2017 Petroleum Bill provides that petroleum revenues are to be collected by the national government. Further, section 80 (2) of the 2017 Petroleum Bill provides that the contractor shall pay to the National Government all taxes, relevant fees and levies. It goes on to say that taxes and profit petroleum (profit oil and in turn, proceeds from the sale thereof) from upstream petroleum operations shall be collected in accordance with relevant tax laws i.e. the Ninth Schedule of the Kenya Income Tax Act which Model PSC. 18 Article 28 of 2008 Model PSC, PSC Block 1 to Lion Petroleum. 19 Article 62(3) of the Constitution of Kenya, P a g e

15 provides specific tax regulations to be applied to petroleum operations. These provisions show that the current and proposed collector of petroleum revenues is the National Government. The issue that then arises is whether to classify petroleum revenues as general natural resource revenues and have them deposited in a centralized fund has emerged. The Constitution states that: 20 There is established the Consolidated Fund into which shall be paid all money raised or received by or on behalf of the national government, except money that-- (a) is reasonably excluded from the Fund by an Act of Parliament and payable into another public fund established for a specific purpose; or (b) may, under an Act of Parliament, be retained by the State organ that received it for the purpose of defraying the expenses of the State organ. A centralized resource revenue model in which petroleum revenues are included in the general budget of the central/federal government, can potentially reduce inter-regional disparities because of its ability to establish horizontal equalization mechanisms and absorb revenue fluctuations through diverse tax bases. 21 This mechanism has been used in Algeria, Botswana, Libya, Norway, and Trinidad and Tobago, among others. Botswana, for instance, uses a solid approach to budgeting based on a viable National Development Plan (NDP) that is meant to stabilise and prioritise government spending and whereby resource revenues are not earmarked to specific recipients, but rather accrue to citizens more generally, as determined by the central budgeting process. In Trinidad and Tobago, revenues from oil and gas extraction are allocated to the national budget, the Heritage and Stabilization Fund established under the Heritage and Stabilisation Fund Act 2007 to cushion the economy in case of a sustained shortfall caused by collapse of petroleum prices, 22 Ministry of 20 Article 206 (1) of the Constitution of Kenya, ibid Ministry of Finance, Trinidad and Tobago Heritage and Stabilisation Fund Annual Report (Ministry of Finance, 2016); Ministry of Finance, Government of Trinidad and Tobago, Board of Directors Heritage and Stabilisation Fund (Ministry of Finance) < accessed 23 February 2018; Trinidad and Tobago EITI < accessed 23 February P a g e

16 This provision is deemed to apply to petroleum revenues which position has been further bolstered by statements Energy and Energy Affairs; and the Petroleum Fuel Subsidy through which petroleum revenues are shared directly with citizens. 23 from the Department of Petroleum that, resultant funds are expected to go directly to the exchequer meaning that the Treasury will receive these funds through the Central Bank. 24 This matter has been made more controversial particularly by the 2017 Petroleum Bill further provisions that the National Government s share of petroleum revenues, before the imposition of taxes, shall be deposited into a dedicated petroleum fund, and managed in accordance with the Public Finance Management Act, 2012 and any other relevant law. 25 The enactment of the 2017 Petroleum Bill, as the proposed legislation to deal with all matters petroleum, will see petroleum revenues exempted from the Constitutional mandate to have the same deposited in the Consolidated Fund same as general revenues pursuant to Article 206 (a), outlined above Sharing of Petroleum Revenues It must be said that petroleum revenues, among other factors such as volume and individual agreed upon PSCs, are largely dictated by market prices. Kenya s projected Petroleum revenues are based on estimated volumes and calculated against the current market value. This state of commercial affairs can change either favorably: oil prices go up or catastrophically drop as seen in June 2014 when oil prices dropped by more than half plunging many economies into serious turmoil and which contributed to the global recession. The connection between oil price volatility and economic growth cannot therefore be gainsaid. Therefore, as Kenya readies itself to join the league of oil producers, there needs to be a vigorous campaign carried out to sensitize the public and stakeholders on the actual revenues projected to be gained and when these revenues will be realized. The public knowledge of how much oil is expected to be produced, how much revenue is expected and how long after production to expect these revenues lends to this effort. As we have seen, the actual petroleum revenue sharing ratio provided under section 85 of the 2017 Petroleum Bill, as outlined above, is a 75:20:5 split. The issue arising is what does this 23 Introduced in 1974 through the enactment of the Petroleum Production Levy and Subsidy Act (Act 314 of 1974), the Fuel Subsidy absorbs part of the total costs of petroleum fuels as a means of protecting consumers from high fuel prices and sharing of the petroleum wealth. The Subsidy is managed by the Ministry of Finance while the Stabilisation Fund is managed by a Board of Directors and supervised by the Ministry of Finance. 24 Allan Olingo, Kenya s oil revenue to go directly to Treasury (The East African, 15 April 2017) < 6lju7qz/index.html> accessed 13 March Section 84 (2) of the Petroleum (Exploration, Development and Production) Act, P a g e

17 actually mean? Having identified the sources of petroleum, it is these resources that are subjected to the proposed 70:25:5 split. Dialogue as to the appropriateness and rationale for the split has been frequent among stakeholders. To reiterate, one of the major reasons for the 2015 Petroleum Bill being rejected by the Executive and brought back to the house for amendment and re-publishing was the issue of the actual proportions to the county and local communities with a bid to reduce such proportions. Of note is the provision in the 2015 Petroleum Bill, (section 85 (2)) that the County Government s twenty per cent share shall not exceed twice the amount allocated to the County Government by the national Assembly in the financial year. The 2017 Petroleum Bill has however amended this provision to read that this amount shall not exceed the amount allocated to the County Government from Parliament. It cannot go unnoticed that the amount of petroleum revenues allocated to County Government, though the percentage is still the same at twenty percent, has been essentially reduced to not exceeding its usual budgetary allocation, as opposed to the previous provision that County petroleum revenues shall not exceed twice the usual budgetary allocation. The reduction of petroleum revenues to the local communities seen with the reduction from 10% in the 2015 Petroleum Bill to 5% in the 2017 Petroleum Bill, and that of the County Government as seen above begs questions as to the rational and equitability of such amendments. This, however, is not to say that these amendments are in order, or otherwise, but simply spurs critical and analytical dialogue among stakeholders on the same. The following table outlines in brief some of the factors influencing sharing of natural resource revenues among four pinnacle countries: Ghana, South Africa, Canada and Australia. It is important to draw comparisons from these countries to establish designs best suited for the Kenyan context in similar factors. Figure 3: Case analysis of factors influencing revenue sharing Country Non-Renewable Natural Revenue Stream Tax Assignments Revenue Depositories Sub-National Levels of Distribution Royalties and Taxes PSCs (Contract Terms and Signature Bonuses) State Participation (Equity Share) Corporate Income Tax Royalties Property /Land Tax Centralized General Fund (General Revenues) Specialized Fund Allocation to Sub-National Government Share with Local Community Ghana N N N South N N S 12 P a g e

18 Africa Canada S S S Australia N S S *N National Government S Sub-national Government (where applicable, includes local communities) 13 P a g e

19 CHAPTER FOUR PETROLEUM REVENUE MANAGEMENT The World Bank report of Kenya s Economic Memorandum advises that the policy decisions that need to be made include a decision of the proportion of the revenue that should be saved or spent, mode of allocating additional spending that is financed by oil revenues and coming up with institutional mechanisms that ensure prudence in implementing the first two policy decisions. Countries with nonrenewable resource wealth face both an opportunity and a challenge. When used well, these resources can create greater prosperity for current and future generations; used poorly, or squandered, they can cause economic instability, social conflict, and lasting environmental damage. Natural Resource Charter, Introduction 4.1. The Pre-Resource Curse and Its Implications Petroleum discoveries can constitute either a positive a positive shock to economic activity or detrimental long-term effects. The trend is that resource-rich countries, against expectations, tend to experience slower economic growth and more social problems than other non-resource rich countries. A large increase, or expected increase, in non-renewable natural resource revenues may at times cause governments to shift labour and capital from other sectors into the resource sector to try and secure and generate more revenues stunting the growth of the former. This is what is called the Resource Curse, or the Dutch Disease. The resource curse suggests more of the aforementioned long-term detrimental effects that a boom in nonrenewable natural resource revenues can have on a country. 27 The more immediate detrimental effects for a resource rich country is the pre-resource curse. This is a phenomenon where economic growth begins to underperform long before the first drop of oil is produced. The pre-resource curse is primarily driven by elevated expectations which may cause, for instance, premature spending and unsecured borrowing by governments pressured by citizens on the back of overly rosy projections Borko Handjiski and others, Kenya - Country Economic Memorandum: From Economic Growth to Jobs and Shared Prosperity (Washington, DC: World Bank Group 2016) < accessed 13 March Natural Resource Governance Institute, The Resource Curse: The Political and Economic Challenges of Natural Resource Wealth (2015) NRGI Reader 3 < Curse.pdf> accessed 13 March Evidence for a Presource Curse? Oil Discoveries, Elevated Expectation, and Growth Disappointments. James Cust and David Mihalyi, World Bank Policy Research Working Paper, WPS P a g e

20 One of the causes of the pre-resource curse is lack of accuracy in forecasting petroleum revenues which many times is due to a lack in expertise, faulty data or a general over ambition about potential revenues and when the same are to be realized. Many resource-rich countries fail to manage expectations especially with regard to the delay between discovery, exploration and production and consequently, the delay in the actual petroleum revenues. The volatility of market prices may also affect the value of petroleum product and it is vital for resource-rich countries to take this into consideration and put in place mechanism that can shelter the economy from significant petroleum price drops, while building institutional capacity to be able to make maximum use of petroleum price hikes. Further, the lack of capacity or poor and inefficient policies can transform the positive economic growth expected for a resource-rich country into serious adverse effects. On the one hand, and on a more long-term scale, the impacts of the resource curse include the stunting and/or decline of other sectors, increase in national debt, minimalizing the country s absorptive capacity to transform petroleum revenues into tangible investments i.e. the government s ability to use petroleum revenues to make investments to generate non-resource sector growth. The question that rises is then, what steps should a country like Kenya take to avoid or mitigate the pre-resource curse? Further, how can the private sector and other stakeholders assist with these efforts? Some approaches advanced are to manage expectations by openly sharing information and data, establishment of sovereign wealth funds and ensuring good governance in their administration and putting in place policies and frameworks promoting transparency, accountability and sustainability of petroleum revenues. These initiatives are discussed hereunder Models of Distribution of Resource Revenues to Subnational Jurisdictions In many countries, subnational governments receive public funds from the national government where non-renewable natural resource revenues are apportioned no differently than other revenues. However, more and more resource-rich countries are choosing to distribute their non-renewable natural resource revenues governed by a set of rules that are distinct from those governing distribution of general revenues. Countries typically either use the derivation model which allocates a portion of the nonrenewable natural resource revenues, on the basis that it is perceived to be equitable, back to the producing territory; or the indicator model whereby revenue accruing from non-renewable natural resources is placed in a common pool and allocated to subnational governments based on a formula irrespective of where the resources are extracted. The formula may include a series of characteristics (indicators) such as population size, revenue collection effort, poverty 15 P a g e

21 rates or regional output (e.g. gross regional product) which are used to determine the share allocated to each entity. 29 Kenya proposes to use a hybrid model whereby revenue sharing is based on both place of origin and pre-determined indicators. Elements of the derivation system can be seen in individual pieces of legislation such as the 1986 Petroleum Act, the proposed 2017 Petroleum Bill and the Natural Resource (Benefit Sharing) Bill 2014, while elements of the indicator system are evident in the Constitution whereby a set of criteria is outlined for consideration when distributing resource revenues 30 i.e. the national interest; capacity building for county governments; fiscal capacity and efficiency of county governments; developmental needs of counties; economic disparities within and among counties; the need for affirmative action in respect of disadvantaged areas and groups and considerations and recommendations made by the Commission on Revenue Allocation, among others. Figure 4: Case studies of factors influencing revenue management Country Governance Structure Resource Revenue Sharing Model Sovereign Wealth Fund Unitary Federal Minerals Petroleum Derivation Model Indicator Model Direct Collection by Sub-National Level Ghana South Africa (small reserve) (Proposed) Canada Australia 29 Andrew Bauer and others, Natural Resource Revenue Sharing (Natural Resource Governance Institute and UNDP, 2016) 34 < Accessed 13 February Article 203 and 217 of the Constitution of Kenya P a g e

22 4.3. Commission on Revenue Allocation (CRA) and Revenue Allocation Formula The Commission on Revenue Allocation (CRA) 31 derives its mandate from Articles 216, 204, 205 and Schedule 6 of the Constitution of Kenya. The Commission s mandate is further enabled through the Commission on Revenue Allocation Act, 2011 and the Public Finance Management Act 2012.The Commission is constitutionally mandated to provide objective and impartial recommendations concerning the basis for the equitable sharing of revenue raised by the national government between the national and county governments. 32 The decision on how to allocate revenues among counties therefore begins with a recommendation to Parliament by the CRA. All revenues in Kenya are shared pursuant to the constitutional principal of equitable distribution. The current conversation on sharing of petroleum revenues among counties is whether what method or criteria will be used to share petroleum revenues with both producing and non-producing counties while still adhering to the principle of equitable distribution. Below is a table showing the parameters and the weight of each parameter forming the basis of equitable sharing of revenues to counties: 33 Figure 5 & 6: Comparison of CRA s first and second basis and second revenue sharing formula No. Parameter First Basis Second Basis 1. Population 45% 45% 2. Basic Equal Share 25% 26% 3. Poverty 20% 18% 4. Land Area 8% 8% 5. Fiscal Responsibility 2% 2% 6. Development Factor - 1% TOTAL 100% 100% These parameters are used to generate the revenue sharing formula as follows (second revenue sharing formula): 34 CAi = 0.45PNi ESi PIi LAi FEi DFi Whereby, CA i = Revenue allocated to county = County: 1, Established under Article 215 of the Constitution of Kenya Article 216 of the Constitution of Kenya Commission on Revenue Allocation, Recommendation on the Basis for Equitable Sharing of Revenue Between National and County Governments for the Financial Year 2018/2019 (Nairobi: CRA, 18th December 2017) Ibid. 17 P a g e

23 PNi ESi PIi Lai FEi DFi = Revenue allocated to a county on the basis of Population Factor = Revenue allocated to a county on the basis of Equal Share factor. This is shared equally among the 47 counties = Revenue allocated to a county on the basis of Poverty Factor = Revenue allocated to a county on the basis of Land Area Factor = Revenue allocated to a given county on the basis of Fiscal Effort = Revenue allocated to a given county on the basis of Development Factor 35 It must be noted that the CRA revenue sharing formula is not specific to natural resource revenues but rather addresses normal division of revenue. Further, according to the formula, it is observed that the amount of revenue to be shared with a specific county is pegged on indicators such as population size, land area, and poverty rate, among others. As seen above, there have been two successive basses for allocation of revenues with CRA, with the aid of public participation, currently revising and developing the third basis Sovereign Wealth Funds Prudent management of petroleum revenues not only leads to the generation of wealth from petroleum resources but also translate into sustainable and long lasting impacts. However, without proper policies, frameworks, and oversight, there is potential to destabilize public financial management systems, bring negative economic and social impacts, and increase the risk of corruption. One method of ensuring the sustainability of petroleum revenues is by use of future funds with sovereign wealth funds (SWFs) increasingly becoming more popular in global petroleum industries. A SWF is a state-owned investment fund that is established from resource revenues. The primary objective is to ensure sustainability and continuity of revenue from the exploitation non-renewable natural resources principally due to their finite nature, potentially volatile market prices and the country s consumption needs accruing over time. In essence, a SWF is meant to ensure savings from petroleum revenues and cushion the future when the resource depletes and avoid the resource curse. In Kenya, the concept of a SWF is captured in both the Benefit Sharing Bill 2014 and the Kenya s National Sovereign Wealth Fund Bill 2014 (the National SWF Bill ). Kenya s proposed SWF, modelled against the Norwegian model, is meant to address issues of intergenerational equity. 36 The Benefit Sharing Bill provides that 20% of the revenue collected from natural resource exploitation to be paid into a Sovereign Wealth Fund established by the National 35 Commission on Revenue Allocation, Brief on the Second Basis for Equitable Sharing of Revenue Among the County Governments < accessed on 16 February Hannah Wang ombe, Can sovereign wealth fund help us avoid resource curse? Business Daily (Nairobi, 12 January 2017) < accessed on 12 February P a g e