Big Oil Companies Exiting Oil Retailing Business in Kenya

Reduced profit margins, increased competition and official price caps are forcing big oil marketing firms out of Africa as they shift focus to the more lucrative exploration and production activities.

Anglo-Dutch giant Shell early this year concluded a $1 billion divestiture deal from its 21 markets in Africa, becoming the latest oil marketer to exit Kenya, following in the footsteps of five international majors that have left the country in the past decade over dwindling margins.

It is the latest in a string of departures by global oil brands from the African petroleum market in recent years.

They include Caltex (Chevron), Beyond Petroleum plc (BP), Mobil, Agip and Esso. Shell is exiting from all African operating markets – except Egypt and South Africa, as well as ceasing some exploration activities. Similarly, Chevron left Kenya and Uganda but retained a presence in Tanzania. BP just left Tanzania after initially staying on while Total has just scaled down its presence in Zambia.

Although Shell will retain a 20 per cent stake in the fuel business and 50 per cent stake in lubricants in a joint venture with private equity firm Helios and international oil trader Vitol, there is little appetite for downstream oil marketing among international companies.

Resources for acquisition

Still, Kenya’s petroleum market remains dominated by foreign capital because local firms are unable to raise resources for acquisition. Departures have often only strengthened the position of international oil firms already in the market, even as the state-owned National Oil Corporation of Kenya stakes a claim to a larger market share.

In the past seven years, National Oil has acquired 62 stations across the country, expanding its market share to over five per cent.

“We are not leaving. We are a Kenyan company, so we cannot leave,” says National Oil chief executive officer Sumayya Athumani. Although she claims the domestic market is big enough to attract sufficient economic activity, she acknowledges that for her firm to play in the big league, it has to also invest upstream – in exploration and distribution activities – where all the big players are heading.

Kenya has as many as 50 licensed oil marketing companies, but just six of them control 86 per cent of the market. These are Total, KenolKobil, Shell, OiLibya, Gapco, and National Oil. Of the two largest international firms still with a foothold in the Kenyan market, KenolKobil and Total Kenya, only the latter has continued to expand its downstream marketing presence. Total, which increased its retail network after merging with Chevron’s Kenyan operation in 2009, ceded some of its stations to National Oil to reduce its dominance in the market.

KenolKobil has been pursuing an expansionist strategy beyond the controlled business unit. New price ceilings set in an effort to protect consumers have shaved the profits of oil dealers significantly. Marketers are concerned that the formula for setting price caps does not cover all operating costs, infrastructure costs and the negative effects of system inefficiencies.

The refining cost provided for 20 per cent is not sufficient. Routine refinery production inefficiencies and imports handling demurrage costs pile pressure on the price of fuel, with subsequent effects on the economy. Industry leaders believe that the price controls will make the oil business unviable and unprofitable.

“The formula does not reflect the operational conditions as they currently are. It costs Sh15 to transport one litre per kilometre using the big haulage companies. It is not clear how that was arrived at. Transport and delivery has been pegged at Sh7.50 per litre,” said Mr Jimmy Mugerwa, the Shell country manager.

“It is not clear how the wholesale margin and retail margin were calculated,” he added.

In correspondence to the Energy Regulation Commission, OiLibya managing director Rida Elamir complains that the formula does not recognise nor provide for investment in storage depots.

“The basis of this margin is unknown. The application of arbitrary margins will have ramifications on the industry,” he said. OiLibya, Kenya Shell, KenolKobil and Total, with a more than 75 per cent stranglehold on the Kenyan fuel market, have all warned that controlling fuel prices could see the exit of multinational firms, with investors likely citing the regulations to negatively assess the business climate in the country.

Although the Kenyan economy has consistently expanded in the past eight years, with a corresponding demand for petroleum, little has been done to increase storage and distribution capacity. KenolKobil and Shell, which are listed on the Nairobi Stock Exchange, have over the years blamed the inefficient petroleum infrastructure in the country for hampering their profitability and growth.

The net profitability of the two listed firms – Total Kenya and KenolKobil – changed little in the first quarter compared to last year due to reduced volumes and rising competition.

Their net profit stood at Sh206.7 million in the three months to March, compared to Sh206.3 million for the same period last year. Revenues grew by five per cent to Sh21.9 billion in the period – lifted by high petrol prices as volumes dropped 19 per cent to 220 tonnes due to reduced diesel consumption by electricity power generators and motorists.

National Oil, though not listed, announced pre-tax profit of Sh116 million for the six months through December 2010, up from a loss of Sh13.7 million a year earlier. Besides acquiring more retail stations, National Oil has entered other market segments, including the sale of liquefied petroleum gas. Last September, National Oil acquired an LPG (liquefied petroleum gas) filling plant along Nanyuki Road in Nairobi and five stations, two of them in Nairobi, the main market and some of Kenya’s busy highways.

A year earlier in mid 2009, Nock had acquired some 33 stations from Somken – an independent oil firm. Nock’s retail outlets now stand at 70 countrywide, and are expected to reach 132 in the next three years in an attempt to control at least 15 per cent of the retail market.

Even with its increased footprint, Nock’s presence is nowhere near that of the international oil majors. In order to be profitable and influence market prices, Nock needs to more than triple its market share to 15 per cent.

“We are aggressively expanding downstream to enable us to respond to anyone who would want to hold the Kenyan consumer to ransom,” says Ms Athmani.

Although there is official recognition that the petroleum infrastructure is not adequate, investments have been insufficient, late and haphazard. Even after the Kenya Pipeline Company completed a major upgrading project to improve product flow between Mombasa and Nairobi, this did not ease problems as petroleum is still hauled by truck.

The pipeline and refining systems have repeatedly failed to deliver products to the market efficiently and at a fair cost. Inefficiencies in the refinery, which has been slated for an overhaul and an upgrade, cause oil firms to receive lower grade products necessitating private imports which are more expensive. The pipeline flow is yet to deliver its full potential despite an upgrade in November 2008.

With margins in the industry shrinking faster than in other industries due to high competition among marketers, the government’s tightening control of oil import, storage and distribution processes with the price caps introduced in December and inefficiencies in the supply chain, fears are rife that the marketing firms could be strangulated.

Oil terminals

Because of limited berthing space of tankers at the Kipevu and Shimanzi oil terminals in Mombasa, ships wait for as long as a month to discharge their products, thus introducing demurrage charges into the cost of fuel when it reaches the consumer.

Consumer clamour, fuelled by a belief that oil marketers were exhibiting cartel-like behaviour in pricing, forced the Government to reintroduce price caps nearly 16 years after liberalising the economy. The Energy (Petroleum Pricing) Regulations 2010 cap the margin for oil wholesalers at Sh6 per litre of petrol and Sh3 for retailers. Oil firms say the price caps, which are announced every month, do not recognise investment in depots.

The Kenyan pricing model differs significantly from that in South Africa, on which it is modelled. In South Africa, the prices change on the first Wednesday of every month as advised by the Central Energy Fund, to which the Department of Minerals and Energy (DME) and the marketers contribute a levy to offset temporary changes in international fuel costs.

The Government negotiates with the oil companies what is called the “basic fuel price”, described as the realistic cost of importing a litre of fuel from international refineries and meeting the country’s cost of distribution.

Under the South African model, marketers are guaranteed a return on investment in the range of 15 per cent. Industry experts are raising issue with the ERC’s dual role in the pricing as both a regulator and auditor.

“For the price formula to be credible it should be managed by an independent audit firm as is the case in South Africa. This way we remove political and government input and become transparent and independent,” said Mr George Wachira, a petroleum industry expert.

Oil firms have been faulted for making few industry investments in the past decade, but they argue that there are no incentives to put money in the handling infrastructure.

The five oil majors that have exited the market over the past decade feel that they do have sufficient headroom to meet the high infrastructure costs incurred in moving the oil products upcountry.

Anti-competitive behaviour

The Government’s decision to allocate National Oil a 30 per cent import quota for all the country’s refined petroleum products in an attempt to secure supplies has also not gone down well with oil marketers.

Although the quota has since been reduced to 15 per cent because of lack of storage facilities, sector players insist that it will encourage anti-competitive behaviour since the Government has multiple roles – in the downstream market, industry regulation, and the importation of refined products.

National Oil has vigorously defended this allocation, saying it is necessary to give it clout to negotiate directly for regular supplies and cheaper prices with oil producers rather than shop on the spot market.

The absence of sufficient and unrestricted products loading capacity in the key Nairobi market limits competition, turning it into a seller’s market with those who control capacity to load locking out their competitors. Of Kenya’s over 50 licensed oil marketers, only six own capacity to load products in Nairobi. This greatly reduces the scope for competition.

Over the years, the capital costs for upgrading the refinery have continued to escalate, thus making it unviable. It costs about Sh3 more per litre to supply products through refining compared with direct products imports.

The refinery runs on old technology and cannot compete with imported white productions from modern refineries. It also faces frequent power outages and water supply shortages, leading to shutdowns – with adverse impact on machines, which take long to restart.

About 45 per cent of Kenya’s petroleum demands are met through crude oil refining at the Mombasa refinery, with the balance coming from direct imports.

Shell has been one of the biggest and most respected brands for close to a century, with its specialised lubricants commanding a niche in the industrial, commercial, and transport sectors. Its departure is the first time, partial or phased pullout of a petroleum multinational firm from the Kenyan market is happening.

Buyouts over the past decade have been characterised by the purchaser being allowed to retain the seller’s brand for the transitional year. Shell is also reducing its presence in midstream refining businesses, and downstream marketing where margins have dropped.