A look at Zambia’s petroleum sector

The petroleum industry is a key driver to the Zambian economy and high prices of petroleum prices always have a negative impact on economic activity. The high prices of petroleum products in Zambia cannot be discussed in isolation without taking a broader view of the problems obtaining in the petroleum industry.

This article aims to address the current status of the Zambian petroleum sector and the need to ensure uninterrupted supply and flow of petroleum products in the country against the background of decreasing oil prices on the international market, from a high of US$115/tonne to US$50/tonne in early 2015. There is further need for Government to urgently attend to challenges affecting the petroleum sector and to ensure that petroleum products are sold at economical prices given the sensitive impact on the Zambian economy especially on key sectors such as mining, manufacturing and agriculture.

The importation of petroleum products in Zambia are made available from two sources that have a distinct cost base.  The first and traditional source of petroleum products involves the importation of crude oil (feedstock) through use of the TAZAMA pipeline and INDENI Refinery.  The second source involves direct importation of finished products by rail and road using both the northern and southern corridors.  

The basic business activities involved in the petroleum sector are:

  • Procurement and financing of feedstock;
  • Transportation from Dar-es-Salaam by pipeline to Ndola;
  • Refining of feedstock by INDENI Refinery; and
  • Storage and distribution of refined products to oil marketing companies (OMCs) at Ndola fuel terminal.

The frequent supply interruptions of petroleum products are through the traditional source forces Government and OMCs to import refined products, mainly from South Africa and Tanzania.  Consequently, major stakeholders in the petroleum sector are adversely affected; these are, primarily, TAZAMA Pipeline, INDENI Refinery and ultimately higher prices to the Zambian consumer.  TAZAMA and INDENI Refinery are 100% dependent on a well functioning flow of feedstock that should ensure reasonable capacity utilisation in order to operate efficiently.  Any inconsistent supply of feedstock would result in high cost of operating these facilities below minimum capacity levels. These costs are ultimately passed on to the consumers through high prices. Further, unavailability of feedstock creates fuel supply challenges which lead to shortages and creation of “black markets” as illegal fuel traders cash in on shortages as was the case recently.

Given the significance and impact of the petroleum sector in Zambia, this article attempts to illustrate the extent of current challenges in light of the falling fuel prices on the international market and provide possible practical solutions that would result in a sustainable and secure supply of petroleum products.  At the same time, this should result in predictable and affordable prices to the final consumers.

 

Table 1

 

The chart above shows that the bulk consumption of fuel on the Zambian market is in the transport sector which accounts for 53% followed by mining with 27%. Commerce and industry takes 10%, households account for 6% and goods and services at 4%. This consumption pattern is key for the purpose of setting appropriate policy to ensure that the productive sectors of the economy such as mining, agriculture and manufacturing remain at the focal point of sustaining economic growth. It is important that Government considers formulating a suitable strategy that will restore the integrity and confidence of the petroleum sector which should ultimately guarantee the security of supply and stable prices of petroleum products.

Competitive advantage

Zambia’s competitive advantage in this sector is in the least cost logistical arrangement that petroleum products are delivered into Zambia through the infrastructure network of TAZAMA Pipelines and INDENI Refinery with total delivery costs which are not comparable to other options of delivery such as rail or road given the geographical location of Zambia.   

Since the inception of the Pipeline and Refinery, adequate petroleum products have been consistently supplied to the country at cost effective rates with far much less environmental problems.      

This competitive advantage has even made Zambia export some petroleum products to the Democratic Republic of Congo and Malawi.  

Current challenges

In order to properly determine the nature of current challenges in the petroleum sector, it will be important to relate these challenges to the business activities involved in the sector.    These business activities are:

  • Procurement and related financing of feedstock;
  • Transportation from Dar-es-Salaam by pipeline to Ndola;
  • Processing of feedstock by INDENI Refinery; and
  • Storage and distribution of refined products to oil marketing companies (OMCs).

Procurement and related financing

The aim and objective should be to put in place an efficient procurement system of good quality feedstock.  The current ad hoc (stop-gap measures) procurement of feedstock continues to be one of the major causes of the current problems in the Zambian petroleum sector.

It seems there has been, since 1991, a trend of moving away from the traditional way of purchasing feedstock from genuine oil producers in preference to oil traders.  By nature, traders focus on short-term profits which tend to inflate purchase prices and associated costs.  There is also a possibility of overlooking the quality aspects of the feedstock being procured.  In comparison, procurements from genuine oil producers tend to be of a long-term nature at fairly stable prices with well structured financing.  

Consequently, the related financing of purchases from traders tends to be inflexible with short-term payment terms and high finance charges.  Eventually, these costs are borne by the Zambian consumer through high prices of petroleum products.  There is thus an urgent need to strike purchase deals with producers who are able to offer flexible financing terms. 

Therefore an efficient procurement system can only be put in place if the Zambian Government endeavours to initiate direct dialogue with major oil producers in the Middle East region, as this is the closest oil region to Tanzania and Zambia.   The major advantage being very short voyage time from source to Tanzania and hence reduced shipping and insurance costs. In addition, bilateral discussions with Middle East oil producing countries may further help Zambia attain realistic and economical CIF procurement prices. 

Achievement of this strategy will no doubt solve subsequent problems encountered in the entire supply chain. 

Transportation system (pumping)

As stated above, transportation involves the movement of feedstock from Dar-es-Salaam port to INDENI Refinery via the TAZAMA Pipeline network.  The petroleum sector assets available for this process consist of:

  • The Single Point Mooring and other offloading facilities at the Tanzanian Harbour;
  • A sea-line between the harbour and storage tank farm in Tanzania;
  • The Feedstock storage tanks and associated pipeline networks at the tank farm in Tanzania; and
  • The TAZAMA pipeline from Dar-es-Salaam to Ndola which feed into the storage tanks at INDENI Refinery.   

The main aim and objective with regard to this mode of transportation should be to ensure efficient pumping of feedstock and to minimise pipeline losses.  This task is undertaken by TAZAMA Pipelines Limited which is jointly owned by the Zambian (67%) and Tanzanian (33%) Governments with a Taxation Treaty in place.

The Company is heavily dependent on a well functioning flow of feedstock that would ensure reasonable capacity utilisation in order to operate efficiently bearing in mind the need to meet the fixed costs of operating the plant.  The continued inconsistent supply of feedstock has resulted in high costs of operating this facility below minimum capacity levels resulting in high fixed operating costs. 

Essentially, the performance of this company can be improved once there is a consistent flow of feedstock.  

Processing (refining)

The main aim and objective with regard to processing would be to have in place an efficient and economical processing system.  INDENI Refinery is a basic simple Hydroskeemming unit and processes commingled feedstock of a specified composition.   

The introduction of an efficient and effective procurement system would result in a well functioning Refinery.  It is important to note that each time there are disturbances in the operational flow of petroleum products, both INDENI Refinery and TAZAMA have to shut down operations.  This results in very high costs of maintaining these facilities because there is no corresponding revenue to absorb unavoidable fixed costs.

It is therefore imperative that all petroleum sector assets remain under Government control in order to minimise such risks, although it will be important that these vital and significant facilities are run on a commercial basis, with adequate monitoring mechanisms in place.   

Foreign currency exchange risk 

Besides the above operational related problems, another major problem in the Zambian petroleum sector is that of inherent exposure to foreign currency exchange risk.  By and large, the costs of procurement, transportation and refining are incurred and payable in foreign currency.   However, the refined products are sold in Kwacha and, in most cases, realised Kwacha proceeds per shipment are not sufficient to cover the foreign currency denominated costs.  This inherent risk tends to trigger constant price increases of petroleum products, as players in the sector try to hedge against the foreign currency risk.

Government taxes

There is need for Government to consider reviewing rates for taxes and levies, applied on petroleum products in order to allow for further possible price reduction.  Any reduction in these rates would:

  • Increase earned margins and thereby accelerating any major capital rehabilitation required on, say, TAZAMA, INDENI Refinery and Ndola Fuel Terminal; and
  • Reduce prices to consumers thereby increasing the sales volume which may lead to increased tax revenues to Government. 

The way forward

There is no doubt that the original structure of the petroleum sector achieved its desired goals.  What is now required is for Government to reposition this sector in order to ensure that there is a consistent flow of petroleum products into the country to ensure stable and predictable prices to the consumer. 

The major function of this sector is to procure, transport, refine and supply refined petroleum products to the country at a reasonable cost.  

Consequently, there is a need for Government to consider the following;

  • Putting in place an efficient procurement system of good quality feedstock from reputable oil producers, preferably from the Middle East oil producing countries. 
  • Involving the OMC’s (as a consortium) to procure and finance both feedstock and finished products, they would take all the risks associated with procurement including providing the necessary financing
  • Ensuring efficient pumping, processing of feedstock and management of bulk sales of products to OMCs;
  • Reviewing current Government taxes with a view of reducing the price of petroleum products in the country;
  • Reviewing the need for Government to continue owning petroleum sector assets for strategic and sovereign considerations; and 
  • It might also be useful as part of the commercialisation effort to consider concessioning the Pipeline to a private operator given the current challenges of the state of the infrastructure. Government has approved the policy of Public Private Partnerships (PPP) for infrastructure in Zambia. It would be possible to structure a suitable PPP for the Pipeline and the resulting structure would have to be well thought out to avoid earlier pitfalls experienced with the concessioning of Zambia Railways.
  • The liberalisation of foreign exchange transactions has brought about competitiveness in foreign exchange dealings which the petroleum sector cannot easily match up to; it will be imperative that the issue of oil financing facility options is reviewed.  

*This was a discussion paper presented by energy expert Andrew Kamanga

 

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