Why State is banking on oil, minerals fund to pay debts

Kenya plans to establish a fund to manage proceeds from its nascent petroleum and mining industries.

In a new Bill, the National Treasury has proposed setting up the Sovereign Wealth Fund (SWF) that will be split into three components, with the key one saving earnings from the two sectors for Kenya’s future generations.

The other two components will be used for stabilising the budget in years when there will be “extraordinary shocks” and investments in infrastructure.

In the Bill, Treasury has proposed using funds that will be accumulating in the Stabilisation Component, as well as the occasional windfalls from the sectors, for debt repayment, a pointer to the level of pain that the growing public debt has become for the government.

While the upstream mining and oil industries are yet to emerge as key economic sectors for Kenya, they are said to hold immense potential but have, over the years, failed to live up to the potential and perennially been termed as being on the verge of takeoff. 

The government is nevertheless preparing to manage the petrodollars it expects to earn from the sectors with the publication of the Kenya Sovereign Wealth Fund Bill.

The Bill stipulates how the money will be saved and invested, with a focus on how Kenya’s future generation will benefit from the finite petroleum and mineral resources through what will be known as the Urithi component of the Fund, but also taking away some of the money to repay debt.

 “The purpose of the Fund shall be to – provide the national government with a buffer from fluctuations in resource revenues or extraordinary macro-economic shocks (and) provide finance for strategic investment priorities to foster strong and inclusive growth and development,” reads the Bill in part.   The third component is expected to “build a savings base for future generations when minerals and petroleum reserves are exhausted.” 

The Bill says the key revenue source for the Fund will be the government’s share of profit derived from upstream petroleum operations, petroleum royalties’ payable to the government and mining royalties that mining firms pay to the national government.

Production companies

It will also be funded by other earnings from the sector, including bonuses paid to the government by production companies and sale shares in oil and mining companies in which the government will have a stake.  

The earnings will be deposited into a holding account maintained at the Central Bank of Kenya, then transferred into the three components of the Fund – Stabilisation, Strategic Infrastructure Investment and Urithi.

 The Bill pays a heavy focus on the Urithi Component, seeking to save for future generations to enable them to reap the benefits of the minerals and oil when they are eventually depleted 

 “The object and purpose of the Urithi Component is to build a savings base for future generations by providing an endowment to support Strategic Infrastructure Investment for future generations, when the revenues from minerals and petroleum are depleted, generating an alternative stream of income to support expenditure on capital projects as a result of revenue downturn caused by depletion of minerals and petroleum and distributing wealth across generations,” reads the Bill.

Aside from the money that will be transferred from the Holding Account into the Urithi Component, the Bill also stipulates that half of the investment income earned on the Stabilisation and the Strategic Infrastructure Investment Components would also be deposited into the Urithi Component. 

The Bill also caps the money that will be deposited into the Stabilisation Component at five per cent of Gross Domestic Product (GDP). After hitting the five per cent to GDP target, funds that would have been going to the Stabilisation Component will then be diverted to repay Kenya’s loans to local and foreign lenders. 

The government has been borrowing at an alarming rate, with the stock of public debt hitting Sh11.97 trillion as of August this year. The use of earnings from oil and minerals could erode the impact that earnings from the two exploration and production sectors could have on the Kenyan economy.

“Transfers to the Stabilisation Component shall cease when the component grows to five per cent of the nominal gross domestic product and the share shall be utilised to service national debt,” reads the bill.

 It further adds that once it hits five per cent of GDP, the money that would have been going to  the Stabilisation Component can be “distributed by the CS (Treasury) to the Strategic Infrastructure Investment component or the Urithi Component.” Whenever there are unexpected earnings, such as bonuses, the Bill says this money would largely be used for loan repayments but also distributed to the Stabilisation Component and the Strategic Infrastructure Investment.

“Where there is a windfall in resource revenues, the windfall shall be utilised in order of priority as follows: Debt servicing to reduce national debt, transferred to the Stabilisation Component, transferred to the Strategic Infrastructure Investment component to fund strategic infrastructure investment priorities as may be determined by the Cabinet Secretary,” says the Bill in part.

In setting up a SWF, Kenya is following in the footsteps of other countries that have made investments to take care of future generations who will find the resources, such as oil and minerals, depleted. 

It is, however, in the early days of exploiting its oil and gas resources, with only one oil block having so far been determined to be commercially viable.

Right policies

The fields of Lokichar, where the oil was discovered in 2012 have however faced major delays in moving them to the commercial phase, with the latest setback being the exit of Tullow Oil, the UK firm that discovered the oil but faced major hurdles in commercialising the oil.

In its place, Gulf Oil has taken over and just recently submitted its plan to the government on how it plans to move the project forward. 

The local mining industry also faces its unique set of challenges. While it has been tipped to hold immense potential, its performance has over the years been underwhelming. The sector on average contributes 0.7 per cent to Kenya’s GDP but with the right policies and investments, industry players have in the past said, this can increase to 10 per cent by 2030. 

In the last decade, the sector was dominated by titanium mining in Kwale County, which at some point accounted for 80 per cent of the sector’s earnings.

The mines have, however, reached the end of their life and shut down, which is set to have a heavy toll on activity in the sector.

A 2015 report that consultancy firm McKinsey did for the Kenyan government indicated that the full potential of mining could be in the region of $2.5 billion (Sh350 billion) in terms of direct revenues annually.