Why it’s premature to discontinue monthly oil price regulation formula

There have been murmurs from consumer organisations and even politicians in respect of last month’s petroleum price increases.

They argue that the prices should have continued to come down. Pump prices calculated by the Energy Regulatory Commission (ERC) have been dropping since August last year, but showed a surprise increase mid last month.

From what I have gathered, there appears to be three issues which should not be mixed up. Firstly, were the March prices correctly calculated as per the price formula detailed in the price regulations?

Secondly, should oil prices continue to be controlled? Thirdly, is there a better method for controlling prices?

I have perused the details that led to March price increases, and they look consistent with the price formula provisions. They reflect the global price movements for petroleum products in the period prior to March 15.

What actually happened in March was a sudden crude oil price recovery from a low of $46.4 in February to an average of $56.6 in March.

However, with our Mombasa refinery closed, crude oil no longer features in the ERC price formula. The formula is currently 100 per cent based on imported products.

It is the international prices (Platts) for products that count because our actual imports are paid for on basis of Platts listings.

Like crude oil, the petroleum products prices also hit the bottom in February and then rebound in March. It should, however, be noted that product prices do not always follow the same exact trend as crude oil.

Other factors like global refining capacity, product stocks, and product winter/summer demands fluctuations all impact product prices differently. However, it is the crude price movements that we normally see in the media, not products price trends.

The ERC price formula was intended to be transparent, predictable (in method and timing), and reflective of actual product cost increases in the past month. The formula was meant to be free from “political” discretionary inputs.

The formula objectives were consumer protection, while ensuring reasonable investor profitability to permit continued sector investments.

The application of the formula is very straightforward since the inputs are from accredited global sources. In fact, the formula is so free of discretionary decisions that in a number of countries the price formula calculations are contracted out to independent audit firms. The Kenyan price formula is modelled on the South African formula.

The only government inputs are when gross margins for the marketers and retailers require to be revised to reflect justifiable marketing cost increases.

There have been only three updates of gross margins since 2010, and these were to mainly reflect increased cost of working capital financing.The last margin update was a year ago in February 2014.

Many will ask if at this age of free markets sophistication we really need petroleum price regulation. A free market is essentially defined by the quality of market competition , and absence of restrictive barriers to free trade.

When price regulation was abandoned in 1994, it was on the assumption that the petroleum supply and distribution infrastructure and systems in Kenya were to be liberalised and modernised.

The government and its agencies (KPC and KPRL) essentially remained in control of supply systems which are mostly restricted in capacity and supply flexibility. Imports systems implementation is also alleged not to be fair and equitable. Not an ideal situation for a free market set-up.

When the government sufficiently improves the import supply systems, then I will be the first to vouch for withdrawal of price regulation. As it is today, the price formula protects the consumer from arbitrariness by marketers in passing on costs of supply chain inefficiencies.

There were hints recently that the government intends to modify the price regulation by introducing a price stabilisation fund to even out market price fluctuations.

This is a retrogressive system of price regulation. It denies the consumer the immediate benefits of price decreases. It retains part of price reduction to be refunded to consumers at a later date when prices are going up.

Price stabilisation funds are usually prone to official bureaucracy, contention and often open to abuse and corruption. We should be reducing not increasing opportunities for corruption.

The consumer should be free to adjust oil usage as the global prices fluctuate. This is the way global economies work. Price stabilisation funds are an indirect form of price subsidisation, which in today’s world is archaic.

The ERC needs to widely educate the public on how the price formula works. The Energy ministry also needs to address the petroleum supply chain systems to ascertain that they are not restrictive or unfair. Only then can we correctly discuss withdrawal of price regulation.

Finally, the consumer organisations should invest in capacity for effective research and analysis to enable them correctly interrogate market facts on behalf of consumers. It is important that consumer advocacy is backed with correct facts and data.

Further, insistence that consumer organisations sit on boards of regulatory agencies (like ERC) is inadvisable. This would essentially dilute their representational independence and effectiveness.

Mr Wachira is the director, Petroleum Focus Consultants. E-mail: [email protected].