Service station dealers in dilemma after massive oil price change

When a massive oil price drop was announced by the Energy Regulatory Commission (ERC) mid this month, many service station dealers screamed foul while others did not immediately effect the price change.

When prices drop and dealers are holding stocks purchased at the previous higher price, they incur an inventory loss.

When they anticipate a price drop, the temptation is to go slow in ordering products just prior to the price change, or as happened in a number of reported cases recently, delay affecting the new lower prices until they have liquidated the old higher cost stocks.

Conversely, when dealers anticipate prices to go up, some of them will be tempted to stock up or go slow on sales just before the 14th day of the month.

This is the time when a number of stations close down early, pumps are mysteriously said to be broken down, and credit card machines are out of network. The daring ones will lie about running out of stocks.

The law of averages should dictate that the pluses and minuses on price movements will eventually balance out, but this is true only when increases and decreases are varying evenly and in small and manageable percentages. The last price drop was as much as Sh10 per litre on a price of more than Sh110 per litre.

Why has the ERC not effectively addressed this dealer behaviour? The regulator will need a test case in court to prove that it has effective enforcement mechanisms in place. My opinion is that the law may not be tight enough to obtain a conviction, and I am sure the dealers already suspect this.

READ: Fuel marketers ignore ERC on new price caps

There is shared responsibility on service station licensing with the counties (that is the District Commissioners, for the time being) and this may be a source of vagueness on prosecutorial responsibility. However, ERC bears the ultimate accountability in enforcing petroleum price regulation.

The petroleum price control requirement was a last minute insertion into the Energy Act 2006 and there was probably not enough time to think through the enforcement mechanisms. However, the law can be enhanced to strengthen enforcement while ensuring fairness to service station dealers.

Perhaps, it will help to understand the economics of running and financing a service station before we pass quick judgment on dealers.

Dealers are independently-licensed businesses and legally, they are individually responsible for legal compliance. Currently, about 70 per cent of service stations are owned by the major oil companies (branded stations) and they have supply agreements with their counterpart oil companies.

The other 30 per cent are independently owned by individuals and they purchase their supplies from the cheapest oil importer.

The oil companies, also referred to as importers or wholesalers, are allowed Sh6.62 per litre gross margin in the ERC price formula, while service station dealers are permitted a Sh3 per litre gross margin.

During the early 1980s, the dealer margin was set by the Ministry of Energy at Sh2.50 per litre; and this is when the retail prices were in the region of Sh30 per litre (about eight per cent dealer margin).