Kenya’s tea sector presents considerable opportunities for financial investment. But those banks eager to get involved will need to get comfortable with the uncertainty of the country’s regulatory regime and the limitations that the sector imposes. Shannon Manders reports.
Banks financing commodities in Africa have historically been reluctant to extend funds for tea transactions due to the underlying risk.
The sector’s lack of a stable, consistent market for selling and buying tea has hampered its ability to secure financing for inputs and trade.
Tea prices are influenced by weather conditions, the cost of fertilisers, economic conditions in export markets and foreign exchange rates.
“In reality, banks are not keen to take on the risk; the tea sector needs an overhaul. But there is defi nitely room for banks to get involved – once they feel more comfortable with the risk,” says a source familiar with the market.
The lack of a tea futures market means that market players largely use their own supply chains to self-fi nance tea purchases. But that could be set to change. A recently introduced tea levy, which increases costs for tea importers, has provided producers with the incentive to try and market their tea directly to buyers in foreign markets.
And although a futures exchange is doubtful in the near future, greater demand from both small and large players may increase the possibility of such an initiative being developed. Futures exchange
“In the long term, a futures market is likely to be established, especially if more erratic weather disrupts the regularity of tea production and makes periodic shortages on the global market more common,” says Edward George, head of soft commodities research at Ecobank.
Adverse weather in the region in 2011 led to less Kenyan tea being produced than the year before.
A lot more banks would be more comfortable with tea financing if a futures market was established, as it would allow price discovery, agrees John Vowell, director, structured trade and commodity finance, FBN Bank (UK). But the difficulty would come in defining the quality for delivery when there are so many grades of tea.
“I’m sure a futures contract will be very restrictive in that it would just be an indication,” says Vowell. “It would represent a standardised grade which would not cover a lot of the tea traded – and maybe that’s what stops a futures market developing. Traders could use a futures contract as a reference to physically trade the various grades of tea at either a premium or discount to the futures contract.”
However, George maintains that until there is demand from the larger players who dominate the business, any scheme is likely to be “wishful thinking rather than a serious effort”.
Although the tea market is highly fragmented on the production side, it begins to consolidate as one moves further to the consumer end of the supply chain, creating opportunities for banks.
“Structured trade/commodity fi nance is suitable for medium to large processors with direct access to buyers and end markets,” a financier in the field tells GTR.
“Before 2004, Kenya had the Kenya Tea Development Authority (KDTA), which acted as a buyer and processor from the myriad of farmers and growers. So large syndicated facilities could be structured based on state support, offtake and warrants over stocks,” he explains. The Kenya tea market was “liberalised” in 2004, and the marketing of tea is now independently carried out by tea traders.
Roughly 70% of the country’s tea is sold through the Mombasa tea auction. Financing today tends to be bilateral trade for FOB/CIF shipments – although there are banks that are willing to offer fi nancing to tea producers – particularly to the main manufacturing companies, even without a futures market.
“Ecobank is defi nitely interested in getting involved and coming up with structured trade fi nance solutions,” says George. Stepping up to the plate, FBN Bank (UK) in August last year provided agribusiness Export Trading Group (ETG) with a US$10mn five-year tea pre-export financing facility. ETG has a large tea estate in Northern Mozambique, and most of its tea goes to Mombasa via Nacala.
The transaction marked the fi rst time this plantation was financed by a bank, and not by the ETG Group.
“We spend a lot of time looking at historical tea prices, going back five years,” says Vowell.
“We look at auction prices and pull an opinion number. It’s simply math, really; it’s not hard.” In 2010, Barclays signed a US$25mn supplier finance programme with Unilever to support the company’s tea purchases from Kenya and South Africa. According to Maria Malinowska, director of supply chain fi nance sales at Barclays Corporate, the deal was landmark in that it allowed Unilever to combine its need to modernise supplier payment processes with its wish to access best quality tea from its traditional suppliers. Other banks have tried – and failed – to successfully close deals in the sector.
“We tried our hand at it a couple of years ago, but the fact that price discovery is done on the auction fl oor on a weekly basis left our credit committee slightly uneasy about the prospect,” says the head of Africa commodity finance at one of the continent’s biggest banks.
Export levy doubt
It is not only pricing uncertainty that has left banks wary of the sector; Kenya’s regulatory regime has historically been unpredictable.
The country’s tea industry was plunged into crisis in January this year when the Kenyan ministry of agriculture introduced a new levy on tea exports. The Tea Board of Kenya has said that proceeds from the levy will be used to finance research and infrastructure development in the tea industry.
But tea traders are concerned that the levy – capped at 1% of the total custom value of exported tea – will make Kenyan exports more costly, and will ultimately affect their competitiveness in key markets. The levy is imposed only on Kenyan tea sales and not on other East African countries who sell at the Mombasa auction.
According to Ecobank’s George, the problem lies in the way that the levy was introduced. Stakeholders in the industry have complained that they were not consulted during the process, nor involved in the decision to increase the levy.
“Even though the ministry of agriculture might have been justifi ed in imposing the tax, you get the sense among the traders that they don’t know where the next tax is coming from. It refl ects Kenya’s problem of regulatory uncertainty,” says George.
“If, for example, you’re investing in a plantation, and you don’t know whether the tax regime you’ve been given is going to stay the same, or if new taxes are going to come out of the blue, it can really undermine your faith in investing,” he adds.
This lack of confi dence is the reason why Kenya’s coffee production has halved in the last 20 years, he believes. These and other East African Community tariffs may further push producers to increase the direct sales of tea – and could even lead to a declining role for the aged Mombasa tea auction system.
The future of the auction system is further threatened by advances in technology, which will soon allow producers to inform buyers of the quality of their harvest in real time, and to agree on a price, without sending the product to auction. GTR
Kenya has long dominated Africa’s tea sector. The country’s main tea export markets are the UK, Pakistan and Egypt, but it is also a leading tea re-export hub, with re-exports making up 25% of total tea exports in 2011, said Edward George, head of soft commodities research at Ecobank, at Exporta’s East Africa trade and commodity finance conference in late May. Although less tea was produced last year, earnings soared to a record KSh109bn (US$1.3bn) last year, up from KSh97bn in 2010, due to high prices and a weaker Kenyan shilling against the dollar. The shilling fell by 5.4% in value last year and is down 0.5% this year.
This year’s performance looks uncertain due to harsh weather conditions; a regional drought has already resulted in a 15% year on- year drop in Q1 2012. Other factors blocking the expansion of tea production include the scarcity of land, dwindling water resources (none of Kenya’s tea plantations are irrigated) and urban construction – all of which fuel disputes over land rights.
“I think they’re going to struggle to get over 400,000 tonnes, which is what they managed in 2010. This year is not such a good harvest,” George tells GTR. It is expected that the fall in Kenya’s production in 2012 will be offset by strong gains in Uganda and Malawi, both of which vie for position as the region’s second largest producer.
However, experts are certain that Kenya will remain the leading tea exporter, and that regional production will rebound by 10% in 2013 to 600,000 tonnes due to good weather prospects.