Ideas & Debate

Policy intentions of the petroleum stabilisation fund

fuel

george wachira_img

Summary

  • The apparent policy intention by the government is to stabilise consumer prices against unpredictable swings in global oil markets and prices.
  • Price stabilisation has been used around the world, but this is a dying practice as countries opt to align consumer prices with actual market costs.
  • A number of countries abused price stabilisation funds when they used them for unintended national “emergencies”.

I have been asked by many to explain what the additional Sh5 per litre petroleum development levy enacted in mid-2020 is all about. Words like “subsidization”, “stabilization” and “development” have variously been used to explain the levy, making it even more confusing. I will here try to analyse the policy, legal and regulatory implications of the levy.

The pump prices announced by EPRA (Energy and Petroleum Regulatory Authority) on February 14,2021 were based on $55 per barrel average January 2021 crude oil price. When the government commenced collecting an additional Sh5 development levy effective July 2020, the indications were that this would go into a “petroleum development levy fund” which would compensate consumers when crude prices went above $50. The “datum” crude price in July last year was around $40.

In February 2021, crude oil prices have oscillated between $55 and $65, implying that EPRA will announce higher pump prices on March 14,2021, unless of course consumers are compensated from the fund for costs above $50.

The apparent policy intention by the government is to stabilise consumer prices against unpredictable swings in global oil markets and prices. Price stabilisation has been used around the world, but this is a dying practice as countries opt to align consumer prices with actual market costs. A number of countries abused price stabilisation funds when they used them for unintended national “emergencies”.

The Petroleum Act 2019 does not explicitly provide for price stabilisation. The legal and regulatory framework would need to be enhanced to permit setting up a “petroleum price stabilization fund”, while detailing modalities for its operation and authorisations.

Indeed, Petroleum Act 2019 allows the establishment of Consolidated Petroleum Fund, but this is specifically for the purposes of funding strategic petroleum reserves, which implies that this fund cannot be used, as it is, to operationalise a price stabilisation fund.

The mentioned Petroleum Development Levy Fund does not exist in the 2019 Act. However, a development levy of Sh0.40 per litre has always been charged since 1980s. The initial purpose of this levy was to develop retail distribution infrastructure in marginalised regions where marketers were not willing to invest. This was however never done, and the Sh0.40 levy became another routine “tax” which I suspect became part of petroleum ministry’s budget.

Adding Sh5 to the existing Sh0.40 to make a new Sh5.40 development levy to fund, among others, price stabilisation looks legally untidy. Price Stabilisation and Petroleum Development are quite different policy considerations and cannot possibly be administered in the same Fund, especially when accountability of public funds is a critical guiding principle.

There was also an implied policy intention to have petrol costs subsidise diesel prices. This process is called “cross-subsidization” of one product by another. The policy justification for product cross-subsidization is obviously different from that of price stabilisation. Although diesel is a key economic driver (transport, agriculture etc), there are several potential unintended consequences that advise against petrol subsidising diesel.

We do not wish to experience “Vitz” petrol car owners subsiding the luxury of the “diesel V8” owners. Artificially making diesel cheap will result in reshaping of the vehicle population with increased diesel vehicles. KRA which collects more tax per litre from petrol product will be the first to cry foul of cross-subsidisation.

Further, artificial diesel price disparities in the region will induce cross-border smuggling of the cheaper diesel. All the above are potential happenings which have indeed occurred in the past when diesel was significantly underpriced at the expense of petrol.

Here are my sincere recommendations about price stabilisation and cross-subsidisation. If the government decides that price stabilisation is indeed necessary, then the Petroleum Act 2019 should be enhanced to include a Price Stabilization Fund with supporting regulations detailing how it will be operated. This should be separate from anything labeled development levy.

The stabilisation procedures should be anchored in an enhanced Pricing Formula, to ensure that the integrity of supply chain costs and margins is ring-fenced and not distorted by price stabilisation. While the cabinet secretary for petroleum will oversee policies, implementation of price stabilisation should be by EPRA.

Finally, I am of a strong opinion that cross-subsidization of prices between petrol and diesel should altogether be omitted from price stabilisation.