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Fuel prices in Kenya: Myths and realities

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Customer attendant serving a client at Rubis Petroleum Station along Koinange Street in Nairobi on Sunday, November 14, 2021. PHOTO | DENNIS ONSONGO | NMG

Summary

  • The debate on the cost of fuel overlooks critical factors that determine the final pricing, especially due to the silence by experts resulting in half-truths.
  • Myth one is that oil firms are responsible for price increases and make a lot of money when prices go up.
  • It is incomprehensible that many stakeholders both in industry and in government continue to take price stabilisation as a solution.

Politics aside, nothing causes more animated discussion among Kenyans than high fuel prices. The recent increases in pump prices to more than Sh130 per litre for petrol has led to widespread consternation.

Parliament, the media, and other commentators are all proffering their views as to the cause of the high prices, their impact on the cost of living and a myriad of possible solutions.

Industry experts have been largely absent from this debate. This is nothing new, in contrast to other sectors such as banking or manufacturing both of whom have vigorous and effective industry lobbies, the petroleum industry has historically shied away from public debate on industry matters.

The unfortunate outcome is that many of the relevant facts that would inform public debate are remain unheard and several myths have taken hold. This article seeks to correct some of these misunderstandings and propose workable solutions to managing high pump prices and the trade-offs required. Let us first look at the myths:

1. Myth one is that oil firms are responsible for price increases and make a lot of money when prices go up.

This is factually incorrect. Month-to-month price adjustments are done by the regulator Energy and Petroleum Regulatory Authority (Epra) through a pre-determined formula that simply adjusts prices based on changes in the landed price of products in Mombasa and the prevailing exchange rate to the dollar. This formula is publicly available and any Kenyan wishing to access it can do so and do the calculations for themselves.

The Epra fixes the gross margins for petroleum companies at only Sh8 per litre regardless of the pump price. For a pump price of Sh120, this represents a margin of six percent.

After deduction of distribution and operating costs petroleum companies have a net margin of between Sh1.50 and Sh2 per litre or a net margin of about 1.6 percent.

One would struggle to find other businesses operating with such thin margins in the country.

The reality is that petroleum companies make less money when prices go up, simply because the sales volume often decline and the investment required to keep the same amount of stock goes up.

To illustrate this, consider a petrol station operator selling 75,000 litres per month. He or she needs Sh7.5 million for one week’s stock cover if the price is Sh100 per litre.

The value of one week’s cover goes up to Sh9 million if the price is Sh120 per litre while the margin remains fixed, and the volume may even decline.

2. That the process of importation of oil products is opaque and could allow petroleum companies to make some of their profits offshore before the product gets into the country.

The reality is that the Open Tendering System operating in Kenya is exactly what it states on the label, an open tendering system. Every one of the about 30 cargoes of petroleum products shipped into Kenya every year is openly and competitively tendered for, allowing Kenyans to enjoy one of the lowest landed prices of petroleum products in Africa.

Needless to say, such an open and transparent system has its detractors, most of whom would like it changed for reasons that have everything to do with their selfish interest and not those of Wanjiku. Fortunately for Kenyans, their selfish lobbying has so far not borne any fruit.

3. This myth, which is linked to those above, is that oil marketers in Kenya have parent companies in the upstream petroleum sector that benefit from high prices, and they should therefore accept lower margins in the country.

Except for TotalEnergies, none of the petroleum companies’ operations in Kenya is a subsidiary of an oil major.

All others are independent distribution and marketing companies that buy oil products at world market prices and make a profit only from their business conducted in Kenya.

In any event, investors would expect a local business to be profitable in its own right, and not be cross-subsidised by investments elsewhere.

It is worth noting that many of the oil majors that had subsidiaries in Kenya including Shell, BP and Exxon Mobil all disinvested partly as a result of the insufficient return on their investments. The one exception, TotalEnergies Kenya is quoted on the Nairobi Securities Exchange and has local shareholders who no doubt expect an adequate return on their investment.

The current debate is correctly centred on the impact of taxes and levies which, depending on the product, constitute between Sh50 and Sh60 of the pump prices.

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The Kenya Petroleum Refineries Limited in Changamwe. FILE PHOTO | NMG

The problem was made worse by tax increases on petroleum products effected during the Covid-19 period to take advantage of lower global oil prices and help close government revenue gaps that were not subsequently removed after global oil prices rose again.

Unfortunately, the solutions being proposed are completely off the mark and in fact risk making the problem worse.

The concept of a price stabilisation fund or a so-called “subsidy” is a very bad idea and will not work.

First, it is incorrect to talk of a subsidy when the product is already taxed. That aside, price stabilisation funds work on the basis that funds are collected when global oil prices are low and deployed to cushion pump prices when prices rise.

At the height of the Covid-19 pandemic when oil prices fell below $40 per barrel the government set an anchor point price of $55 a barrel. This effectively meant that the pump prices would reflect the price of $50 even when the actual price was $40.

The difference of $15 per barrel would be kept in a price stabilisation fund. When the barrel price rose above $50, the price would remain unchanged and oil marketers would be compensated by the fund for selling at below the real cost. That is the theory.

The practice though, is that the billions collected into such a fund invariably end up being used by the exchequer for unrelated expenditure, pilfered by the fund managers or both.

This concept has been tried in many other African countries before has always ended in tears!

In Kenya, it has turned out that the exchequer dipped its hands into these funds even before the ink dried. Even if the fund were to be fully safeguarded, it is still impossible to determine an accurate anchor point.

If, for example, with an anchor point of $55 per barrel, prices stayed at $40 for six months then the funds collected are enough to cushion consumers for another six months if, as the case today, the price rises to seventy dollars per barrel.

After this period the fund will then be fully exhausted, and prices would immediately rise to reflect the true cost exposing consumers to an enormous price shock. The price stabilisation mechanism would thereafter be effectively dead until prices fall below $55 again.

It is incomprehensible that many stakeholders both in industry and in government continue to take price stabilisation as a solution. They should wake up and smell the coffee!

An even more disastrous outcome awaits Kenyans if we allow current efforts by Parliament and other political bodies to meddle in the price adjustment or the tender process for the importation of petroleum products.

Their interventions will, without doubt, be determined more by short term political calculus or by vested interests than by creating a workable system that balances the interest of all stakeholders.

However well-meaning, Parliament should “stay in their lane” and avoid emulating another important arm of government that seems to think it is their mandate to make decisions on every aspect of our lives and may soon be telling Kenyans, which side of the bed to wake up from.

Three possible options to address the high pump prices are: First is to remove the additional taxes that came into effect last year. This would reduce prices by about Sh8 per litre. Pump prices would, however, continue to rise and fall each month depending on input costs.

A second option would be to cap pump prices by applying a variable tax formula in which a part of the taxation on petroleum products can be reduced when prices go above a predetermined ceiling.Let us assume that the ceiling was set at Sh100 a litre and Sh120 per litre for diesel and petrol respectively. If applied today, then the taxes on both products would be reduced by about Sh10 per litre to keep prices within the cap.

In doing this it is important to articulate levies such as road maintenance levy that must remain untouched. This option avoids the pitfalls associated with collecting money into a stabilisation fund with all the risks entailed.

The Treasury mandarins will not like the uncertainty this brings to their revenue forecasts, but Covid-19 has shown that it is possible to deal with much larger revenue collection gaps without the country coming to standstill.

Kenyans must off course bear in mind that there is no free lunch, and the revenue gap must be filled, most likely in form of other taxes or a reduction in spending.

A third option is to do nothing and leave taxes as they are while allowing pump prices to fluctuate monthly based on input costs. Before readers throw stones at me, this is not as ridiculous as it sounds.

A price of Sh130 for petrol may look exorbitant until you remember that prices reached Sh123 in 2013 before going down again.

Consumers in many other countries, including some of our neighbours, pay higher pump prices without any calamities befalling them. It is also interesting to observe that prices of fresh food from the farm goes up and down by much bigger percentages than petroleum products based on season and rainfall patterns without provoking anything more than mild comments.

Maybe the difference is that most Kenyans have an implicit understanding of the dynamics of food production. With the electoral season upon us, this option may, however, prove to be politically unpalatable.

All said I would recommend option one as best the way to go.

A sober evaluation of these and other options will, however, only happen if petroleum industry players wake from their slumber and learn to articulate industry issues more clearly and more loudly to Kenyans.

Having worked for a combined total of more than 30 years in both the manufacturing and the downstream petroleum industries in Kenya and across Africa gives me sufficient perspective to say that the industry is sleeping on the job and allowing parties without sufficient industry knowledge to steer the ship into turbulent waters.

Mureithi is a former executive vice president at Vivo energy in charge of the East and Southern African region