Fighting Trade Mispricing and Capitalizing on Oil and Gas in Kenya, Uganda, and Tanzania

May 19th, 2014

Many experts have called Kenya, Uganda, and Tanzania the “next frontier” of gas and oil production. In fact, these reserves have the potential to turn these nations’ economies from “mixed” to “success” stories. One large impediment to this possibility, however, is trade misinvoicing, which occurs on a massive scale. It’s so serious a problem that it threatens their governments’ ability to capitalize on the potential gains associated with the discovery of oil and gas.

The discovery of oil in Kenya and Uganda, and gas in Tanzania, has thrust each of these nations into the world’s energy spotlight. In 2006, Uganda found massive amounts of commercially-viable quantities of oil in the Albertine Graben, located along Lake Albert and the border with the Democratic Republic of Congo. In fact, some believe the Albertine Graben may hold more than 6 billion barrels of oil. Talks over development plans and refining options, and Uganda’s recent re-take of the Ngasa oil discovery, have delayed production in Uganda, however.

Six years later, Kenya sent the world and the markets a buzz when the government announced Canada’s Africa Oil Corp discovered oil in the northern region of Turkana. Kenya, in conjunction with neighboring Ethiopia and South Sudan, intends to begin construction on a transport corridor and oil pipeline into the port of Lamu in 2014. And neighboring Tanzania had already discovered additional reserves of oil, as well as natural gas.

In their own ways, each of these nations is an example of a “mixed” economic and political success story in Africa. According to Freedom House, they are all “partly free,” but also fare much better in governance terms than most of their northern neighbors. Their economies are similarly mixed. Tanzania is one of the world’s poorest economies in terms of per capita income; however, it has achieved high overall growth rates. Inflation and currency depreciation peaked in Kenya in 2012, but have since stabilized. Meanwhile, Uganda’s exports took a significant hit following the global economic downturn, but GDP growth has since largely recovered.

Poor infrastructure development has hampered economic growth in all three of these nations. In Tanzania, frail rail and port infrastructure impede the nation’s important trade links with inland countries. Although Kenya’s current administration has prioritized infrastructure development, its low investment in this area threatens its long-term position as the largest East African economy. Meanwhile, unreliable power, high energy costs, and inadequate transportation infrastructure inhibit economic development and investor confidence in Uganda.

High budget deficits are also one of the primary impediments to improving infrastructure development in these nations. In 2013, Kenya’s budget deficit stood at 4.1% of GDP (ranking the nation 149 in the world); Tanzania’s deficit was 5.6% of GDP (ranked 174 worldwide); and Uganda ranked 113 with a deficit of 2.7% of GDP.

If these nations capitalize on their potential future oil revenues and wealth, it could provide a valuable means to reduce these deficits. This will only occur, however, if they can stem the tide of illicit financial outflows associated with trade mispricing.

According to Global Financial Integrity’s recent report “Hiding in Plain Sight,” each of these countries suffers from high tax revenue losses from trade mispricing. As GFI explains:

Misinvoicing schemes can remain relatively simple yet foolproof and essentially risk-free. For instance, an importer of fuel oil in Uganda could requisition a shipment of $10,000 worth of fuel oil from his overseas distributor and remit payment for $20,000 to the distributor with an understanding that the distributor would then transfer $10,000 into a foreign account controlled by the Ugandan importer. The invoice for the fuel oil submitted to customs would reflect that the fuel was imported at a value of $20,000, which is $10,000 more than the actual value of the oil. Customs officers are less likely to challenge this transaction since the over-invoicing means that more import duties were paid.

Illicit outflows from trade misinvoicing cost the Kenyan government an average of $435 million between 2002 and 2011, about 8.3% of the nation’s government revenue. Meanwhile, these figures stand at $243 million (12.7% of revenues) in Uganda, and $248 million (7.4% of revenue) in Tanzania. These staggering quantities provide a clear impediment for these nations to capitalize on their oil revenue, make necessary investments in infrastructure to improve their economic outcomes.

To address these problems, Kenya, Tanzania, and Uganda should pursue a variety of policies to combat trade misinvoicing. These actions include boosting customs enforcement, scrutinizing trade transactions with tax havens, creating centralized, public registries for information on beneficial ownership, and active participation in the worldwide movement toward automatic exchange of information. These recommendations, while relatively ambitious, would go a long way toward allowing Kenya, Uganda, and Tanzania to capitalize on their resources riches and become strong success stories in the region.

Written by Ann Hollingshead

Follow @FinTrCo