Ideas & Debate

Critical pricing decisions needed as oil prices rise significantly

oil
george wachira_img

Summary

  • Kenya’s oil supply chain has functioned smoothly for many years because of an open tender import system (OTS) that is guaranteed by a transparent and predictable monthly cost recovery pricing formula.
  • The world is quickly recovering from Covid impacts, with petroleum demands rising fast.
  • Geopolitical happenings around the world, especially the Russia/Ukraine standoff, are also scaring prices upwards.

Global oil prices are now above $90 per barrel, the highest since 2014 when prices plummeted from above $100 to about $25.

Before I explain what is moving global oil markets, I will discuss oil pricing process in Kenya which I judge to be moving towards unsustainability, with increasing likelihood of supply chain upsets if not promptly and correctly addressed.

Kenya’s oil supply chain has functioned smoothly for many years because of an open tender import system (OTS) that is guaranteed by a transparent and predictable monthly cost recovery pricing formula.

These two regulatory instruments are stewarded by the Energy and Petroleum Regulatory Authority (EPRA), and they reassure offshore oil suppliers, financiers, marketers, and consumers of uninterrupted supply of oil products.

In 2020, when global oil prices were low, the government made a policy decision to introduce consumer price stabilisation (wrongly referred to as subsidisation ) and immediately introduced a Sh5.00 per litre levy to fund the policy. However, the government did not establish a legal, regulatory, and institutional framework to implement the policy.

It is the absence of this framework that is the root cause of oil pricing uncertainties we face today. Further, the inadvertent use of the term “subsidization” gave the wrong impression of price “freebies” from the Treasury to fuel consumers.

Subsidisation of fuel products anywhere in the world is a fiscal anathema that governments practicing it are struggling to get out of.

I understand that the Treasury owes oil marketers about Sh16 billion as at the end of January 2022 in unrecovered margins.

The supplementary budget announced last week had Sh24 billion denoted as petroleum subsidy, which after paying off the outstanding balances to marketers, is unlikely to sustain “subsidies” beyond three months. More so because oil import costs are escalating each day.

What are the government options going forward? The first option is to revert to the familiar monthly price formula, with consumers paying prices as defined by supply chain costs. This should include withdrawal of the Sh5.00 petroleum development levy which was meant to fund price stabilisation.

If the government makes a political/economic policy decision to relieve inflationary pressure on consumers, then the VAT (or excise duties) can be reduced or increased as global oil prices rise or fall.

Secondly, if the government is convinced about keeping price stabilisation, then this should be done properly. Establish an independent Petroleum Stabilisation Fund manager with clear regulations on quantum of levies and how consumer prices shall be varied with fluctuating import supply costs.

An ideal stabilisation fund does not eat into Treasury funds, for indeed it is self-funded by consumers.

When global prices fall below a pre-determined break-even level, consumers pay into the fund. When prices rise above the level , the Fund releases cash to consumers through reduce pump prices.

However, this system is useful only when global prices are in volatile up/down variations. Today prices are essentially in a one-direction move upwards making the Fund less helpful unless it has accumulated surplus amounts of cash when oil import costs were low.

Thirdly consider establishment of Petroleum Strategic Stocks as an alternative method for stabilising oil prices against global volatility.

Procure and stock strategic stocks when global prices are low, and release into the market when prices are going up. This is what Rwanda has done with a PPP petroleum strategic storage project funded by a strategic stocks levy.

Yes, the government has to make difficult pricing decisions in the next few weeks as global prices head towards US$100. The government may have to give up a fraction of petroleum taxes ( VAT or excise duties) to make petroleum affordable to the economy.

Eating into marketers' working capital and margins to keep consumer prices low is not sustainable and will only disturb smooth importation and distribution of petroleum products.

Back to global oil prices. The world is quickly recovering from Covid impacts, with petroleum demands rising fast. There are genuine fears that the supply of oil will be inadequate to match growing demands as spare production capacity is slow to respond.

Further, geopolitical happenings around the world, especially the Russia/Ukraine standoff, are also scaring prices upwards.