Document of The World Bank FOR OFFICIAL USE ONLY Report No. 3483 THE WORLD BANK PROJECT PERFORMANCE AUDIT REPORT KENYA MOMBASA - NAIROBI OIL PRODUCTS PIPELINE PROJECT (LOAN 1133-KE) June 8, 1981 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized
This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.
VI. Institutional Developments .............................. 18VII. Economic Re-evaluation .................................. 19VIII. Role of the Bank ........................................ 19
IX. Conclusions ............................................. 20
I This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.
The following is a performance audit on an oil products pipelineproject in Kenya for which a Loan (1133-KE, US$20.0 million) was made in June,1975. For all practical purposes the project was completed in February,
1978 when the pipeline went, as scheduled, into commercial operation. OnFebruary 1, 1979, the original closing date of the loan, a small balance ofabout one-quarter of a million dollars remained in the loan account, and isbeing used to purchase fire fighting and other ancilliary equipment expectedto be delivered in early 1981; the closing date of the loan has been extended
accordingly. The Borrower provided the basic data for the Project CompletionReport (PCR) which was prepared by the Eastern Africa Ports, Railways, Avia-tion and Pipelines Division. This project was briefly discussed with countryauthorities during a mission undertaken by OED staff to audit other projects
in Kenya.
OED has reviewed the Appraisal and President's Reports, the Minutesof the Executive Directors Meeting at which the project was considered, Bankrecords and the PCR, and has found that the PCR adequately covers experiencesof implementing the project, as well as its ex-post justification. OED hasfound some of the findings of the PCR questionable and the Audit comments onthose as well as a few other points of interest, and highlights the role ofthe Bank in the implementation of the project.
The draft Audit was sent to the Borrower for their comments, theirviews are referenced in the text and attached in full in the Annex.
The purpose of the loan was to assist the Government-owned KenyaPipeline Company (KPC) build a pipeline to solve the increasing problems thecountry was experiencing in the moving of oil products from the refinery inMombasa to Nairobi and upcountry destinations. This objective was effectivelyachieved. However, the expected rate of return of the project was affected bycost overruns (36%) and a significant decline in traffic volumes againstproject estimates (about 33%). The economic rate of return of the project isnow estimated to be 19% compared with 31% expected at appraisal.
The question of pricing the services of KPC is a point of particularinterest. Rather than charging marginal costs, the Company's tariffs coverall costs, debt service, taxes and in addition, a large dividend to theGovernment. KPC's exclusive right to carry all pipeable oil products betweenMombasa and Nairobi, and the Government's policy of setting tariffs thatensure the company's financial self-sufficiency raise the question of whetherthe pipeline is operating as efficiently as possible. While the Governmenthas declared a policy of financial self-sufficiency for the pipeline, nosimilar position seems to be held for oil traffic on the railways. Opening ofthe pipeline has compounded the financial problems of the railway through thediversion of oil traffic and failure to raise the railways' charges on suchtraffic, for movements particularly beyond Nairobi.
To assist the railways, and to avoid further damaging the road net-work, the Audit argues that a proposed rail loading facility at the pipeline'sNairobi terminal should be constructed and that the type of truck allowed tohaul oil should be closely controlled.
The Bank's assistance in helping the Borrower find co-financing forthe construction of the pipeline is commended but a closer assessment of theforeign exchange effects of the terms of the co-financing should have been
1. In the early 1970s, Kenya began experiencing problems with the
capacity and cost of transporting oil products from the refinery in Mombasa
to Nairobi and upcountry destinations. Also affected were Uganda and other
neighboring countries to which part of the oil refined at Mombasa was ex-
ported. Prior to that time, the products were shipped by rail. By 1972,
however, the railway had lost about half the traffic to road transport,
despite higher trucking tariffs. The immediate purpose of the project was thus
to ease the heavy transport costs and thus ensure that adequate supplies of
oil reached Nairobi and upcountry locations efficiently and economically.
2. The construction of the pipeline appeared to be an obvious solution.
However, it was intensively compared against the alternatives of (a) maintain-
ing the then existing 50:50 share of traffic between rail and road, under
improved operating conditions, and (b) shipping all the products by rail,
as had been the case a few years earlier. Vis-a-vis both alternatives the
pipeline was found to be a superior economic solution, based on assumptions
and estimates about the costs of the project, the operating costs of the
system and the traffic throughput. It was estimated for example that it would
cost about double to move the products by rail than by the pipeline. The
project was justified on the strength of this argument. Implicitly it was
accepted that the railway could not have coped with the volume of traffic
anticipated. In retrospect this assessment was probably correct: given the
severe operational problems experienced by the railway because of the breakup
of the East African Community and its Railways Corporation, it would have been
difficult, if not impossible for the railway to cope with the traffic volumes
forecast at the time. However, the traffic volumes forecast did not material-
ize, so the question of whether the railway could have coped with the actual
volumes must remain moot.
3. The key variable affecting the viability of the project was the
traffic forecast. In fact, throughput on the pipeline was about 50% below
expectations in the first year of operation (1978) and about 30% below
in the second. In 1980 traffic is expected to be about 33% below forecast,
and the pipeline's capacity, which at appraisal was expected to be reached by
about 1990, will now not be reached, if present trends continue, until well
beyond the year 2000. Two elements contributed to actual traffic falling
below forecasts. Firstly, the 1975 appraisal estimates for the 1974 consump-
tion did not reflect the immediate impact of the 1973 oil price increase.
Consumption, instead of rising as expected, simply stagnated in 1974 in
response to the sharp rise in prices of late 1973 and early 1974. Secondly,
significant volumes of exports to Uganda did not materialize as a consequence
of unforeseeable political events in that country. While the appraisal
report's estimated rate of growth of Kenyan oil consumption for the period
1975 to 1979 was accurately reflected in actual growth, forecasts throughout
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were too high because the forecast for the base year was overestimated.Most of the products now being moved by the pipeline are for Kenyan internalconsumption but, instead of projecting, as at appraisal, a 5.5% growth beyond1979, the Bank is now estimating a consumption growth of not more than 3% for
the next decade (1980 to 1990).
4. The ex-post viability of the project has also been affected by the
cost overruns experienced during construction, by worldwide inflation and by
the realignment of currency values. The statement in the Completion Report
that the project was completed with a "relatively modest" cost overrun of 30%is somewhat misleading. If comparable items are taken into account and the
cost of the pipe excluded, the overrun would amount to 88% over appraisal
estimates. An important saving was made on the pipe, which was later used
to help finance the rather heavy overruns experienced on other items, partic-ularly the civil works and telecommunications (see PCR Annex 1). That such a
saving would be possible was known at the time the project was presented to
the Bank-s Board because bids for significantly lower amounts than the engi-
neer's estimate had already been received about five months earlier. A
corresponding adjustment should have been made to the estimates but was not;thus, these savings acted in effect as a significant additional contingency
allowance for the project. Inflation, the need to relocate some sections of
the pipeline, and the realignment of the US dollar vs. the Japanese yenaccount for much of the overrun in the civil works. The overrun in telecom-
munications is explained by changes in the operational scheme finally used in
the running of the pipeline as against that envisaged earlier. The overrun in
vehicles and equipment is largely unexplained.
5. As a result of higher costs and lower traffic than anticipated, the
difference between the costs of moving oil on the pipeline and moving it by
rail is now not of the same order of magnitude as estimated at appraisal. The
balance, however, seems to be still in favor of the pipeline as shown by the
ex-post economic rate of return of the project (19%).
6. KPC has a monopoly in the transport of white products between
Mombasa and Nairobi because the oil companies are contractually bound to use
KPC exclusively for such movements. This monopoly position might have shel-
tered KPC from pressures to maintain its competitiveness and to keep its costs
under strict control!/. Also, the Government has indicated (and the Loan
Agreement so provides) that KPC should be financially self-sufficient and
yield a return on the Government's investment in it.
7. Because KPC's capital costs were largely financed with short-termborrowing, mostly at commercial rather than concessionary interest rates, the
immediate debt burden of the pipeline is rather heavy and the cash require-
ments correspondingly large. In addition, because the Government has claimed
an annual dividend of KSh 80 million (about US$10 million), KPC-s tariff is
now about twice the rail rate and 12% more than the truck rate for white oil
productsl/. This pricing policy, in which tariffs cover all current finan-cial costs and taxes and provide an important transfer to the public treasury
1/ For KPC's view, see attached Annex.
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may lead to distorted pricing relationships between pipeable and nonpipeableproducts (white oils vs. black oils) to reflect the higher transport costs ofusing the pipeline. It is too soon yet to analyze the price effects of thepipeline and this Audit merely cautions in this direction because in as muchas white and black oils may be technological substitutes for one another thesedistortions could aggravate energy misuse in an oil-short country like Kenya.
8. Construction of the pipeline clearly adversely affected the rail-ways. This was recognized and accepted at appraisal. However, although somemeasures were suggested in the Appraisal Report to help the railways alleviatethe impact of the loss of traffic, there was no attempt made, on the part ofthe Bank, to ensure that such measures were effectively implemented. Forexample, the construction of a rail loading facility at the Nairobi terminalof the pipeline was designed to ensure that the railways had a fair opportun-ity to participate in the carrying of white products beyond Nairobi. Underassurances that such a facility would be built with local financing, it wasleft out of the Bank project. However, an adequate facility was never builtand is a principal cause of trucks now carrying a significant part of thetraffic despite rail rates being significantly below truck rates!/.
9. The railway tariff, which is also controlled by the Government, is50% below the truck rate. Unlike KPC, the railways are not allowed to pricetheir services to ensure self sufficiency. As oil is still an importantcomponent of rail traffic (black products to Nairobi and all products beyond),a tariff increase would not only reflect a more consistent Government policyin the transport sector, but significantly improve the financial performanceof the railways. The Audit suggests that consideration be given to twoactions which would help dampen the impact on the railway: (a) constructionof the rail loading facility at the Nairobi terminaL!/, and (b) realignmentof railway tariffs.
10. At appraisal it was estimated that an important part of the benefitsof the pipeline would come from reduced damage to the highway network. Theintensity of oil traffic and the overloading of trucks on the Mombasa-Nairobihighway was stated as one of the main causes for its bad condition. A similarsituation now occurs on the highway west of Nairobi. Oil traffic that for-merly had moved beyond Nairobi by rail is now being carried by KPC to Nairobiand, in the absence of a proper rail loading facility, by truck beyond.
1/ KPC examined and dropped the rail loading facility project (see Annex,Piperail project) on the grounds that its costs were too high to generatea profit. KPC instead favors extending the pipeline beyond Nairobi.However, Bank staff have reviewed the pipeline extension project and havefound it uneconomic. Although the rail loading facility may not befinancially profitable to KPC the project would appear to be economicallysound and the Government should assist its implementation.
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Measures should be instituted to protect the road beyond Nairobi from unduedamage. One means of achieving that objective would be to have the oil carriedon the railway. In addition, the Government should ensure that whatever oilis loaded on trucks is moved on adequate vehicles. All too often road tankersare single rear axle trucks fitted with oversized tanks, thus prone to beoverloaded and to damage the road. The limited success in controllingtruck overloading by means of enforcing axle weight regulations makes thealternative of controlling the vehicle rather than the load worth pursuing.
11. The innovative approach followed by the Bank in assisting Kenya tofind co-financing for the project should be commended. Official co-financingwas sought from major materials and equipment manufacturing countries, the useof which was tied to one of its own nationals winning international competi-tive tenders for the materials, equipment or the civil works required for theproject. However, it is unclear that the effects of the particular financingobtained for the project, mostly short term loans at commercial rates, weresufficiently considered in the light of the oil-price crisis of 1973-1974.The effect of this type of borrowing on the foreign exchange resources of thecountry, at a time of rapidly increasing oil and other import prices, shouldhave been more closely assessed. As it turned out, by 1978 the balance ofpayments situation of the country had dramatically deteriorated, reflectingamong other factors the effect of rising debt payments due to short-termborrowing.
12. An important element in the timely implementation of the project(there were practically no time overruns) seems to have been the incorporationof Kenya Pipeline Company under the Companies Act and not as a GovernmentCorporation, which allowed the appointment of a strong management able tooperate comparatively free of civil service restrictions.
13. An interesting side effect of the project was the training of anall-Kenyan staff to operate and manage the pipeline. The comparatively lowturnover of Bank staff involved with the project allowed the establishment ofa close working relationship that was instrumental in facilitating the timelysolution of difficult problems.
14. Finally, while it took little less than two and one-half years tocomplete the project and fully disburse 99% of the loan, it will have taken asmuch time to disburse the 1% of the loan that remained undisbursed at theoriginal closing date. In this case, it has been the purchase of a small firetruck that has delayed closing the loan account. The worth of keeping openloans for small miscellaneous items may be seriously questioned.
Lessons to be Learned
15. Experience from this project suggests that the likely effects of aproject should be researched thoroughly both in a macro-economic and sectoralcontext before the project is undertaken. For instance, it would have beenbeneficial to have assessed the wider foreign exchange impact of the projectearly in the cycle. Similarly, greater benefits would be obtained had therebeen more definite agreements on pricing of the pipeline's services and not
giving the company full reign to use its monopolistic positionL/. In this
sense this experieice E.lso suggests that the project's price impact should be
monitored perhaps for a long time after the project's physical completion.
16. The abser.ce tE a covenant in the loan agreement to ensure construc-
tion of the rail loading facility at Nairobi is a shortcoming that points to
the need to have :important elements related to a project's impact, but not
directly controlled through it, covered by suitable agreements. In this case
the completion of the terminal was an important element of transport coordina-
tion which should have been reflected in a specific covenant.
17. Finally, the delays in disbursing the one percent of the loan that
remained at the original closing date suggest that serious consideration
should be given, both by the Borrower and the Bank, to cancel small outstand-
ing balances much sooner than is actually the case.
1/ KPC has indicated (see attached Annex) that because its tariffs must be
approved by the Government it does not have "full reign to use itsmonopolistic position". The Audit maintains that Government control of
tariffs charged by a Government owned company does not ensure removal
of monopolistic pricing pressures and practices. In fact, financial
arrangements agreed with the Bank and stated in the Loan Agreement ensure
that at least some of the monopolistic market position of KPC will
effectively be used.
ANNEX
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12TH ,FLOOR.NATIONAL BANK BUILDING,HARAMBEE AVENUE,
f~~~\AAflAK!~~~~~~~~/ ~P.O. BOX 73442,KENYA rPEUNE COMPANY LIMITED TELEPHONE 335666f7,TELEX 22112,NAIROBI, KENYA
OUR REF F/L/1521 DATE 14th April 1981
Mr. Shiv S. Kapur,Director,Operations Evaluation Department,The World Bank,1818 H Street,N.W., Washington D.C. 20433,U. S. A.
I thank you for your letter dated 16th March 1981 enclosing the PerformanceAudit Report (PAR) and the Project Completion Report. While agreeingin principle with most findings of the PAR, I should like to make thefollowing comments:
(a) Princing of KPC Services:
During the appraisal stages of this project, the Kenya Governmentmade it clear to all concerned that it expected KPC, like otherparastatal bodies, to become financially viable and to generaterevenue for general development purposes. While the KPC tariffpolicy is primarily geared towards achieving this, it also aims atensuring that both the direct and indirect costs of transporting,storing and handling white petroleum products between Nairobiand Mombasa are kept as low as possible. I do not think the abovetwo objectives can be attained by charging marginal costs assuggested in the Performance Audit Report.
It should also be noted that KPC tariff include an element of storageunlike the rail or road tariffs. It is, therefore, incorrect to statethat KPC tariff is now twice the rail rate and 12% more than thetrack rate.
Directors: G. Muchiri (Chairman), (Managing), H Mule, D. Mwiraria, G.W GichukiW.- N. Mbote
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(b) KPC Monopoly on Pipeable Oil Products
It is well known that the purpose of constructing the Nairobi -Mombasa pipeline was to transport and store pipeable oilproducts. Having commissioned the pipeline, it would becontradictory if pipeable oil was allowed to be transportedby other means.
So far KPC's operations have been efficient and competitive. Themonopoly being enjoyed by KPC cannot be said to have beensheltering it from pressures to maintain its competitiveness or tokeep its costs low. All possible measures are being taken tokeep KPC as efficient and competitive as possible.
The KPC tariff has got to be approved by the government. Thecompany has not therefore, been given "full reign to use themonopolistic position it has in the market" as alleged by the PAR.
(c) Piperail Project
The Kenya Pipeline Company Ltd. and the Kenya Railways were atone stage seriously interested in the Piperail Project. However,after careful appraisal taking into account the project's economicviability and the future of the pipeline and the railway the projectwas considered inappropriate and was dropped. The PARrecommendation that the issue be re-opened is not thereforeacceptable.
Instead, serious consideration should be given to extending thepipeline to Western Kenya. If this was feasible, it would makeoil more available in this region and stop the undue damage onthe roads beyond Nairobi.
1.01 Petroleum products meet almost one half of Kenya's total annual
energy requirements, with the modern sectors in manufacturing and transport
particularly dependent on them, while the unorganized rural sector relies
principally on firewood, charcoal and bagasse. With no domestic resources,
the country mostly depends on crude oil imports to meet the demand for oil
products. The principal source of product supply is the refinery at Mombasa
owned by the East African Oil Refinery Ltd. (EAOR), a joint venture of the
Government of Kenya and the oil marketing companies. Some products, which the
refinery cannot produce in adequate quantities, are imported, while surplus
fuel oil is exported. The refinery also meets part of the requirements of
Uganda and Rwanda, with the balance of those countries' needs being imported
through Mombasa.
1.02 The main centers of consumption of EAOR petroleum products are
upcountry, with Mombasa and the coastal areas accounting for only about 10% of
the output; 90% of the products have to be transported to Nairobi and beyond.
Of this, about two-thirds comprises the lighter white products and the other
one-third the heavier black products.
1.03 Until about 1967, almost all petroleum products moved upcountry
from Mombasa by railway. Between 1967 and 1969, the Mombasa-Nairobi road
was upgraded to paved standard, and the Government also began issuing
licenses for tanker-trucks to operate on this route. Owing to the growing
inability of the railway to handle all the traffic being offered, by 1973 the
road/rail share of oil product traffic on this route had settled at around
50/50, despite the lower rail tariff (K Sh 90 vs. K Sh 120 per ton by truck
in 1972). As a result, and with growing petroleum traffic, the highway had
been carrying a far larger number of heavy trucks than it was designed for,
resulting in its rapid deterioration. The subsequent problems within the East
African Community (EAC) compounded the railway's capacity and operational
problems, making it difficult to recapture the oil traffic lost to trucks.
1.04 With the steady and steep rise in trucking costs since 1973 due to
the petroleum price increases, the transport of oil products between Mombasa
and Nairobi became a matter of serious concern to the Government of Kenya,
reinforcing a proposal to construct a pipeline for the movement of white oil
products.
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II. PROJECT PREPARATION AND APPRAISAL
2.01 A feasibility study on the construction of a pipeline betweenMombasa and Nairobi to carry white oil products was completed in 1970 byconsultants. An indication that the Government was planning to approach theBank for financing the project was given in January 1972. This was followedby a formal letter from the Government in February 1972 seeking the Bank'sagreement to the construction of the pipeline, as, under the GuaranteeAgreement, relating to Loan 674-EA to the East African Railways Corporation(EARC), owned jointly by Kenya, Tanzania and Uganda through the East AfricanCommunity (EAC):
"Kenya shall not construct, or permit to be constructed,any oil pipeline which may compete with the oil transportoperation of the (Railway) until a feasibility study forsuch oil pipeline shall have been completed, and Kenya andthe Bank shall have been satisfied that such oil pipelinewould be economically justified."
After reviewing the consultants' study and other pertinent information, theBank informed the Government in 1973 that it would not object to the construc-tion of the pipeline.
2.02 Thereafter, on the Bank's suggestion that proposals be invited froma short list of firms for detailed engineering and further work, the KenyaGovernment invited proposals from seven firms in July 1973 and finally selectedone to undertake the work, including updating of the economic and financialfeasibility.
2.03 Due to delays in finalizing and signing the contract, the con-sultants actually began work only in late 1973. They completed an updatedfeasibility study based on revised construction costs for review by theGovernment, by the Government-owned Kenya Pipeline Company (KPC) (which hadbeen set up in the meantime), and by the Bank, early in May 1974. Based onthe above report and supplementary notes prepared by the consultants inresponse to questions raised during review of the report, appraisal of theproject was undertaken in June 1974.
2.04 The project was expected to comprise a 14-in., 452-km long pipelinefrom Mombasa to Nairobi, with a 2-km lateral line to Nairobi airport; 4 pump-ing stations with staff living quarters; 2 maintenance depots; productreceiving, storage and transfer depots; staff training; telecontrol andtelemetry system and other miscellaneous ancillaries. As completed, the mainpipeline is 449 km long, with a 4-km lateral connection to Nairobi airport.
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III. PROJECT IMPLEMENTATION
3.01 A Bank loan of US$20.0 million was approved by the Board on June 10,1975, with signature of the legal documents on June 27, 1975. The loan becameeffective in December 1975. The delay in effectiveness was mainly caused bythe need to place before the Kenya Parliament, when in session, the GuaranteeAgreement between the Government and the Bank before it could become effective.This, however, did not delay implementation of the project, which was veryclose to the agreed appraisal implementation schedule. The scope of theproject underwent no significant change in the course of implementation.
3.02 Project design and procurement proceeded on schedule, but construc-tion start-up was delayed by about eight months. The main cause was that pipeprices were extremely high at the time, and the borrower, on the Bank'sadvice, waited until prices began to decline. Subsequently, there were pro-tracted negotiations with a Japanese trading firm and the Japanese Ministryof International Trade and Industry, to arrange financing of the civil workscontract (including pipe-laying), pump station and telecontrol equipment.Construction was, however, completed on schedule in October 1977, and trialruns started on November 1, 1977. The pipeline went into commercialoperation in February 1978, very nearly on schedule.
3.03 A breakdown of estimated and actual costs is shown in Annex 1. Thetotal capitalized cost of the project now carried in KPC-s books is K140.979million. This compares with K1E29.611 million estimated at the time ofappraisal and constitutes an overrun of about 38%. Excluding expendituressuch as pre-operations expenses not anticipated in the appraisal estimate, theoverrun is about 30% in terms of Kenya shillings and 23% in terms of U.S.dollars. Part of the overrun can be attributed to the sharp rise in theexchange rate of the Japanese yen during the project period. There were alsosome relatively minor changes in the project, mainly additional aviation fueland gasoline storage facilities at Nairobi airport and KPC's Nairobi terminal.However, the main cause of the overrun was the underestimate of the construc-tion costs. The estimate seemed reasonable at the time, but the sharp increasein labor and material costs triggered by the OPEC oil price increases was notsufficiently allowed for. An exception to this was line pipe. During 1974pipe prices had risen to an all-time high because of acute shortages, but bythe time the order was placed, following international competitive bidding,they had fallen to one-half of what had been projected.
3.04 Disbursements from the Bank loan followed appraisal forecasts quiteclosely, as can be seen from the following data:
However, a small balance of US$258,000 remained unutilized at the time of theoriginal closing date of February 1, 1979, which has been extended untilDecember 31, 1980, to allow KPC to complete the procurement of some fire-fighting and ancillary equipment. These items are expected to be delivered inthe fall of 1980.
Performance of Consultants
3.05 KPC2s consultants for the project have performed their professionalduties in a satisfactory manner. The organization is relatively small anddoes not have all the in-house expertise for all facets of design andengineering for a sophisticated pipeline system such as the Kenya Pipeline,but it had arranged adequate back-up support from other firms. The arrange-ments worked well, resulting in a smoothly operating pipeline system mannedby trained local personnel.
Performance of Contractors and Suppliers
3.06 The project was divided into the following four components:
(a) Line Pipe(b) Storage Tanks(c) Mainline Pumps(d) Main construction contract
3.07 Except for the initial delay due to the extremely high price ofsteel pipe at the time, and subsequently to protracted negotiations with theJapanese on financing of the civil works contract, pumping stations andtelecontrol equipment, the project proceeded smoothly to completion. Allcivil works, outside of the actual pipeline construction and mechanical,electrical and instrumentation installations, were sub-contracted to localcontractors. Obtaining spare parts from Japanese suppliers has been time-consuming because of the financial arrangements to be completed before shipmentsare made. Some Japanese suppliers have also been remiss in providing adequateequipment manuals and drawings.
3.08 Equipment performance has been very good. One of the main pumpsunderwent the 5,000-hour inspection in late 1979 and showed no signs ofwear-and-tear. There are some sealing defects with the floating roof tanks,which are being rectified. The two turbine meter provers, at Mombasa andNairobi, have to be replaced because the inner epoxy has come loose; a newprover is being installed in Mombasa and the one removed in the process willbe reconditioned and installed in Nairobi.
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Performance of Borrower
3.09 KPCGs top management has been outstanding from the beginning of
project implementation to its commercial operation. They deserve a great deal
of credit for the successful completion of the project. Most important, in
our view, is that this enterprise is operating essentially with local manage-
ment and a staff completely new to the complexities of sophisticated pipeline
operations. The Government of Kenya is quite legitimately very proud of KPC's
achievements.
IV. OPERATING PERFORMANCE
4.01 The operating capacity of the pipeline is as follows:
Pump Stations Opera5ing Range
Operating (m /hr.)
1 and 3 180-2301, 5 and 7 260-290
1, 3, 5 and 7 350-400
4.02 The pipeline design capacity was specified to be 1.5 to 3.0 million
metric tons of petroleum Rroducts per year, which corresponds to the operating
ranges given above (one m is equal to approximately 0.8 ton of products based
on their average densities). To date pipeline traffic has been substantially
below original forecasts, mostly because of the situation in Uganda and the
slackening of demand caused by the sharp increase in oil prices. Throughput
has been as follows:
Monthly
Actuals Total Average
(m3) (m3)
1978 (February to December) 955,017 86,820
1979 1,370,959 114,247
Appraisal Forecasts
1978 1,870,000 155,700
1979 1,970,000 164,200
Forecasts up to 1997, shown in Annex 2, reflect the changed situation arising
from recent oil price increases and assume a slow and modest recovery of the
economy.
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4.03 Pipeline operations have been complicated by the small product batchsizes and the irregular deliveries from the refinery. According to theSuperintendent of EAOR, since the Iranian crisis, the refinery has not beenreceiving the type of crude oil best suited for its operations, and tankersarrive at very erratic intervals. As a result, refinery runs have to befrequently altered to cope with the changing crude oil supplies, in bothquantity and quality. These abnormal operating conditions, which could nothave been foreseen, prevent the refinery from supplying a well planned regularflow of products to the pipeline. However, despite this supply problem, KPC'sdeliveries to the shippers have not been seriously affected.
4.04 The theoretical inierface volume for the pipeline between twobatch5s of products is 142 m . During commissioning, interfaces in excess of400 m were experienced and it was necessary to return a substantial portionof the interface slops to ths refinery. However, KPC has been able to reducethe interface to about 190 m by eliminating unscheduled starts and stops andby maintaining back pressure at Nairobi airport and the Nairobi terminal. Theinterface slop now generated is easily absorbed by injecting it within per-missible contamination limits into the appropriate batch being delivered.Larger batches and higher throughput would further reduce the amount ofinterface slops.
4.05 Discussions with the shippers have been going on for some timeregarding product losses in excess of the originally agreed system lossliability by KPC of 0.2%. Losses have been averaging 0.3% - 0.4% which maybe only an apparent loss because the tolerance allowed for tank volumecalibration is 0.25%. A committee consisting of the parties involved and aproducts measurement specialist is reviewing this problem. The turbinemetering system is not likely to be fully operative and accepted for measur-ing product transfers for sometime since several months of operation will berequired for proper calibration after the defective provers are replaced.
4.06 Pipeline operation is presently remote-controlled from the NairobiControl Center which manually sets the appropriate control points. Attemptsto operate the pipeline in an automatic remote mode have, so far, been unsuc-cessful. Attempts to commission automatic remote operation have been deferredbecause of the supply and small batch problem and other matters. Only somemodifications will have to be made in the timing of pump start-up sequencingand flow control at Nairobi airport and the Nairobi terminal to facilitatethis.
4.07 An inspection of the pipeline and its ancillary facilities showedexcellent housekeeping and care of equipment. Fire-fighting, accident andother emergency instructions are prominently displayed in the appropriateoperating areas. There is adequate security against unauthorized entry andno-smoking rules are strictly enforced. The pipeline right-of-way is wellmaintained, but several river crossings require careful, periodic maintenancedue to the possibility of erosion during heavy rains.
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Users Reactions
4.08 In March 1980, Bank staff held meetings in Nairobi with managers and
other senior officials of the six oil marketing companies who are the users of
the pipeline. All of them, some implicitly and some in so many words, stated
that the pipeline was doing a much better job than the other modes could.
They also felt it was a more efficient mode, with lower in-transit losses,
with potential for reducing such losses even further. They, however, pointed
to three features of KPCGs tariff which, they felt, were not justified:
(i) the high level of the tariff,
(ii) frequent revision of the tariff, often, in their view,
without adequate justification, and
(iii) Government's ruling that KPC tariff revisions would
not automatically be reflected in the retail prices
of oil products.
KPC's response to the above complaints is as follows:
(a) the level of the tariff is determined by the escalation
in project costs, the real cost of alternative modes,
the need to ensure KPC's financial viability, and the
need to contribute to the Government's general develop-
ment outlays in the form of dividends;
(b) revisions are made as needed to meet the above objectives;
and
(c) KPC has no control over Government policy on retail prices.
4.09 Some oil companies also complained that the limited rail loading
facilities at KPC's Nairobi terminal were seriously hampering their upcountry
distribution activities. Without such facilities they would have to increase
their own storage capacity at Nairobi, but this would be rendered unnecessary
should the pipeline be extended further towards the Uganda border, in which
event they would build the additional storage needed at the new terminal point.
(The Government has since authorized KPC to commission a detailed feasibility
study of extending the pipeline.)
V. FINANCIAL PERFORMANCE
Operating Results
5.01 The actual financial results for the first two years of operations
differ from appraisal estimates for the following reasons:
(a) for 1978 the actual throughput was only approximately 50%
of appraisal estimates;
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(b) operating costs were substantially higher than forecast;
(c) the actual tariff was K Sh 138 per 3 compared with the
appraisal estimate of K Sh 90 per m ;
(d) interest expense during the initial years exceeded the
estimates; and
(e) the appraisal assumed that corporate income tax would be
payable from the outset whereas payment of taxes has
been deferred due to the write-off of certain pre-
operational expenses for tax purposes.
5.02 The combined result of the foregoing has been that KPC recorded a
net loss during 1978 of KE2.9 million rather than the appraisal forecast of a
profit of KE2.3 million. During 1979, however, a profit of KE2.9 million was
realized, compared with the appraisal forecast of KL2.2 million. Details are
given in Annex 3.
5.03 The actual balance sheet position of KPC, as compared to the
appraisal, differs primarily for the following reasons:
(a) the project costs were higher than anticipated;
(b) the long-term debt is correspondingly higher; and
(c) the Government subscribed to KPC's share capital
KE7.7 million, KE3.7 million above the KE4.0 million
agreed during negotiations.
5.04 Due to the cost increase and the higher than expected debt service
KPC rescheduled one of the supplier credits to avoid a cash shortfall in
mid-1978. Details of the balance sheet position are given in Annex 4, and the
cash flow in Annex 5.
Financial Re-evaluation
5.05 In order to re-evaluate the financial prospects of KPC, the follow-
ing assumptions have been made:
(a) throughput as shown in Annex 2;
(b) revised tariff schedule of K Sh 208 at KPC's Nairobi terminal
and K Sh 283 at the Nairobi airport;
(c) constant maintenance costs;
(d) corporate income tax of 45% payable in the year following; and
(e) payment of a dividend of K Sh 80 million each year.
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5.06 Based on the foregoing KPC will show profits each year through 1985
substantially higher than the appraisal forecast due entirely to the higher
tariff. Projected comparative operating statements are shown in Annex 6.
5.07 Including the payment of dividends and corporate tax, KPC should showpositive annual cash flows for all years, except 1980 and 1981, which will be
covered by the existing cash reserve. The cash flow statement is set out inAnnex 5 and projected balance sheets are given in Annex 7.
Financial Internal Rate of Return
5.08 The internal financial rate of return for the project as appraisedwas 17%. The project as re-evaluated shows a rate of return of 23%. Althoughthe actual costs to date are substantially higher than estimated, the addi-tional pumping stations will not be required in 1990 due to the lower revisedthroughput forecast. Thus the total capital costs for the projection period to1997 are approximately the same. The revenues, however, are greatly increaseddue to the higher level of tariff. Details are given in Annex 8.
Financial Convenants
5.09 KPC maintained proper books of account and prepared managementreports, including projected cash flow statements, throughout the projectperiod. Annual accounts were prepared on a timely basis and reviewed withBank staff prior to audit. The final audited annual reports were, in someinstances, issued beyond the six-month period stipulated in Section 5.02 of the
Loan Agreement, but this delay should be regarded as only a technical violation.
5.10 Due to the low throughput during 1978 (para. 5.01), revenues, andhence profits and working capital, were low. As a result, covenants relatingto these items were not kept. The return on net fixed assets was 2.1% in 1978and the internally generated cash barely covered interest expense. However,the issued share capital was increased by KfE2.8 million (US$10.0 million) in1978 to assist KPC overcome the cash flow problem.
5.11 Section 5.03 of the Loan Agreement states that the rate of return onnet fixed assets in use should be not less than 15% through 1982 and 20%thereafter. With the exception of 1978 (already noted in para. 5.10), KPCshould exceed these requirements.
5.12 A dividend of K Sh 80 million was declared during 1980, with apayment of K Sh 20 million for the first quarter. Section 5.06(i) of the LoanAgreement states that a dividend may be declared if the net cash generated forthe preceding year is 1.5 times the maximum debt-service service requirementfor any succeeding year. KPC has conformed with this covenant. Section5.06(ii) further requires that the current assets, after payment of thedividend, must be 1.5 times the current liabilities. Projections for 1980indicate that this may not be the case. Based on the projections in Annex 4,it appears that the dividend was two years premature with respect to thiscovenant.
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5.13 In retrospect, the financial covenants were reasonable, although
the Bank was probably unrealistic in regard to the rate of return covenant for
the first year of operations. A grace period of one year, to allow for
problems during the commissioning period, would have been desirable.
VI. INSTITUTIONAL DEVELOPMENTS
6.01 In September 1973 the Government of Kenya set up the Kenya PipelineCompany (KPC), registered under the Companies Act and fully owned by theGovernment, to own and operate the pipeline when it was completed. Soon
thereafter the Government filled the positions of chairman and the top three
managers of KPC - the Managing Director, and the Technical and Financial
Managers -- with competent Kenyans, who also took the lead role in the imple-
mentation of the project. These officials took a leading part in arranging
the cofinancing and in the subsequent loan negotiations with the Bank. Theywere also behind the drive to complete the project on time, dealing with
problems, both in project execution and in subsequent operations, promptly and
efficiently. They deserve a great deal of credit for the successful implemen-
tation of the project.
6.02 As a result, KPC is now a well established and efficiently run
enterprise capable of providing technical assistance, especially in projectplanning and implementation, and in training, to other countries in the region
which may be contemplating oil pipeline projects. KPC currently has about 340
employees, all of whom are Kenyan nationals except for three expatriates - two
engineers from India and one operations expert from the U.K. From December
1979, KPC has successfully taken over the operation of the Nairobi airporthydrant fueling system from the operator who was acting as its agent since the
inauguration of the pipeline.
6.03 The three top managers of KPC underwent an initial program of
training in the UK organized by the consultant. Appointees for the remainingsupervisory posts and for skilled jobs underwent training in Kenya and abroad,under a program developed by the consultants and utilizing facilities in
the UK, India and of technical institutions in Kenya. Semi-skilled and
unskilled staff were recruited as required. Their training included formal
lectures both locally and overseas; training at equipment manufacturers
factories; training/familiarization on other similar pipeline systems; and
on-the-job training during construction of the project. These trainingschemes were integral parts of the project.
6.04 Staff turnover through resignations and terminations has averagedabout 10% a year, confined mostly to the lower levels. Resignations have been
mainly to continue education or to pursue better prospects elsewhere. Recruit-
ment of qualified staff has generally not been a problem. For both existingand new staff, KPC has a continuing training program ranging from on-the-job
training to local and overseas courses.
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VII. ECONOMIC RE-EVALUATION
7.01 The principal economic benefits of the project were expected to be
the following:
(i) railway investments avoided (locomotives, tank cars, addi-
tional storage tanks) and postponed (installation of central-
ized traffic control, doubling the track,
lengthening of passing loops; strengthening of wagon couplings);
(ii) postponement of reconstruction of the Mombasa-Nairobi
highway and eliminating the additional maintenance
expenditure necessitated by the large volume of heavy
tanker-truck traffic; and
(iii) very low operating costs for the pipeline compared with
the railway and with road transport.
These were expected to yield an economic return of 31%.
7.02 In the event, the volume of railway traffic has fallen short of
the levels visualized in 1974 and some of the railway investments designed
to increase line capacity on the Mombasa-Nairobi section will not be needed
for another 10-15 years. Also, the volume of pipeline traffic has been below
expectations, reducing the additional locomotives and rolling stock the rail-
way would have needed to carry the white oil traffic. Future traffic volumes
are also expected to be considerably below the appraisal forecasts (Annex 2),
with an annual projected growth of only 3% (vs. 5%).
7.03 However, owing to the worldwide escalation in prices, especially
oil prices, since late 1973, which has been far more severe than was antici-
pated at appraisal, rail and road operating costs were much higher in 1978,
the year the pipeline went into operation, than in 1974. Simultaneously
the cost of railway rolling stock has also risen.
7.04 An important benefit not taken into consideration at the time of
appraisal is the reduction in losses in transit. The pipeline has brought
these losses down to 0.30% from about 0.50% and will soon reduce them to about
0.15%.
7.05 As a result, despite the 30% escalation in project costs, the
economic return on the project as a whole is expected to be a very satis-
factory 19%.
VIII. ROLE OF THE BANK
8.01 Once the Bank signified its agreement in principle to a project
for the construction of an oil products pipeline between Mombasa and Nairobi,
the Bank's role was constructive and of considerable assistance to KPC in
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mobilizing the required co-financing and in dealing with contract problemsthat arose during project execution. But it took the Bank about a year to
come to the conclusion that a pipeline project would be justified, owing toits rather excessive concern over the pipeline's impact on the East AfricanRailways' finances. Ultimately the Bank's decision was correctly based
solely on whether or not the project had economic merit of its own.
8.02 The Bank's helpful role could best be illustrated by the flexible
position it took on what part of the project it would finance. In the earlystages after appraisal, it was felt that line pipe could easily be obtainedthrough bilateral financing, and the Bank agreed to finance the civil workscontract. As soon as it was found that bilateral financing could involve a
line pipe cost of US$800 or more per ton, the Bank readily agreed to finance
pipe, procured on the basis of international competitive bidding, thus cuttingthe cost by almost one half, a favorable development that was also facilitated
by a slight delay in procurement, on the Bank's advice. As a result, thoughthe civil works contract probably cost somewhat more than it might haveotherwise, there was a substantial saving to KPC.
8.03 The Bank also played a constructive and helpful role by agreeingto the Borrower's request for review of all contract evaluation reportsand approval of all contract awards for the project, including those financed
by other agencies. This helped to keep non-technical considerations out ofbid evaluation and thus paved the way for efficient and timely implementation
of the project. The Bank also assisted KPC in introducing an element of
competitive bidding for contracts financed under bilateral sources by helpingto line up the possibility of more than one source of financing for most
contracts.
IX. CONCLUSIONS
9.01 Although future volumes of pipeline traffic are highly dependent onworld crude oil prices, this project must be considered a remarkable success
for several reasons. First, it is one of the few Bank-financed projects in
Kenya, and in fact anywhere, that was carried out according to the originalimplementation schedule. Second, despite the worldwide escalation in costssince the October 1973 initial increase in petroleum prices, the pipelineconstruction was completed with only a modest cost overrun. Third, itsoperations with an entirely Kenyan staff, without prior experience in thissophisticated field, have so far been smooth and have won the approvalof the international oil companies operating in Kenya. Fourth, even in itsthird year of operation, it has declared a substantial dividend to its soleshareholder, the Government of Kenya, testifying to its financial soundnessand competent management.
9.02 The only disappointing feature of the operation of the pipeline is
that traffic has fallen considerably short of appraisal forecasts and every-thing indicates that the shortfall will widen in the future. This, of course,is beyond the control of the oil companies operating in Kenya, KPC and even
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the Government of Kenya. Although the appraisal forecasts were considerablylower than those in the consultant's feasibility study, actual traffic in 1997is now expected to be only one half of the appraisal estimate. According tothe appraisal report, the pipeline was expected to be close to its maximumcapacity by 1997, whereas with the rate of traffic growth now expected, it canmeet Kenya s white oil product transport needs in the Mombasa-Nairobi corridorfor a further 20 years.
9.03 Before deciding on the pipeline size at 14", the consultants made asummary evaluation of sizes ranging from 10. to 20" and a detailed evaluationof 14" and 16" based on their traffic forecasts. Their conclusion was acceptedby the appraisal mission for somewhat lower traffic forecasts, since the extracost of 14" pipe over 12" pipe was estimated to be relatively small (underUS$1.0 million) and worth the extra built-in capacity and flexibility of a 14"pipeline vis-a-vis a 12" pipeline. It is possible the mission would havetaken a different view had the extent and worldwide impact of higher petroleumprices on oil products consumption been foreseen correctly at that time.
9.04 As anticipated in the appraisal report, the pipeline has had apositive effect on the ecology of Kenya, as it is a buried pipeline, and hasreplaced pollution-causing surface transport. This has been of particularimportance to the Tsavo Game Park.
