Theft at pump: Why Kenyans should be paying Sh80 for a litre of petrol

Kenya’s energy regulator could be handing hefty profits to oil marketers at the expense of consumers.

When it instituted price capping for retail prices of petroleum products in late 2010, the Energy Regulatory Commission (ERC) said the key rationale was to protect investors and consumers. It would increase and lower prices in line with what happened at the international markets.

This was unlike the situation before, where oil marketers were quick to increase retail prices when crude prices went up but are slow doing the same when international prices came down. ERC was hailed for its bid to break the alleged cartels among oil industry players in Kenya.

The high expectations of a just pricing regime for the oil industry and consumer appear to have been quashed and ERC now seems to have taken on the ways of the oil industry. The regulator is now being criticised for seeming to have abandoned the spirit of the price capping regulations and failed to pass on the benefits of lower global oil prices to the consumers.

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Analysts say this has benefited just the industry while hurting consumers. Oil has now halved in value since June, with analysts saying this tumble in global crude oil prices to below $60 (Sh5,430) per barrel, a litre of super petrol in Nairobi should be going for about Sh80, instead of Sh102.01 set by the Energy Regulatory Commission (ERC) last Sunday.

Early in the week, crude was quoted at Sh5,300, ($59) per barrel, equivalent to 159 litres, the lowest levels since May 2009 while the prices announced by the energy regulator Sunday are only comparable to March 2011 pricing - when a barrel of crude sold for Sh9600 ($114). This sharp drop is attributed to shrinking Chinese manufacturing output, economic turmoil in Russia and ample crude supplies, mostly due to increased production of crude by the US.

Put simply, global oil supplies are exceeding demand and driving down prices. Another factor is the struggling economies in Asia and Europe leading to a decrease in oil consumption. The faltering fortunes in China’s economy has seen the country significantly cut back on its energy demand.

Saudi Arabia also cut the price of its own crude to the US earlier this month, which has further propelled the sell-off. Kenya buys its oil from Middle Eastern countries including Saudi Arabia, where the choice of market depends on the specific importer who won the bid to procure on behalf of the market.

The Organisation of Petroleum Exporting Countries (Opec) said they projected that the crude prices could fall below $40 (Sh3,620). Opec, the cartel responsible for one-third of global oil production, said it would keep its self-imposed output ceiling at 30 million barrels per day. The sent already-low oil prices down even further as Opec maintained quotas will do nothing to lower overall oil output.

However, ERC says Kenyans should not expect any significant drop in fuel prices till February. Director of Petroleum at the ERC Linus Gitonga says current crude prices will only translate to a reprieve in the February review.

“It is not until February when the current crude prices will reflect at the pump,” Eng Gitonga told The Standard on Sunday. The petroleum selling in the market now was procured in September and October, he explained, to justify the marginal drop announced by the agency on Sunday. ERC cut super petrol by Sh4.79 per litre, Sh3.67 less for diesel and Sh4.94 for kerosene.

Consumers however, expected a bigger reduction in pump prices, in view of the events that have seen crude prices fall by almost half in just six months. Gitonga explained that the next pricing review scheduled for January 14 will only reflect a marginal drop since the cargo will have been procured at the November prices.

“We allow up to 45 days from the time of purchase to delivery, so the review will be based on pricing as at November,” he said.

It is true Kenya imports refined products and the pump price is more in relation to refined products rather than crude oil. However, Mohamed Wehliye, Senior Vice President —Financial Risk Management, Riyad Bank, Saudi Arabia says there is an almost perfect positive correlation between prices of crude oil and refined products.

Retail price

One can easily prove this by looking at the Free On Board price of Murban crude vis a vis refined products. But the current Sh102 price for a litre of super in Nairobi that will be in place until January 14, 2015, does not reflect current crude oil prices. “You see, the price of crude (the product) has the most significant impact on the average price of fuel, contributing to more than 60 percent of the retail price,” Wehliye says.

This means, a one per cent change in the price of the benchmark should lead to the pump price adjusting by at least 60 per cent of that, or 0.6 per cent (excluding the exchange rate effect). Going by the recent ERC calculations, however, the drop in prices seems lower than warranted even after taking into consideration the time lag and the exchange rate movement.

“Yes, ERC has passed on some of the benefits but not all and that is the key issue,” he adds.

Wehliye says taxes and other costs don’t go up when oil price goes down. Currently, tax makes up around 25.8 per cent of the price, 60.6 per cent is the price component of the product and handling and demurrage charges take up 3.9 per cent and 0.12 per cent, respectively. Around 9.6 per cent is gross margin.

He argues that if something that made up 60 per cent of the price in June has come down by 50 per cent as at today, you would expect the impact on the pump price to be around 30 per cent meaning from June pump price of Sh114.62 for Super should be trading at Sh80 before you adjust for exchange rate movement.

The Shilling depreciated less than five per cent during the same period and even if you were to adjust for a five per cent rate movement that will give you Sh86 a little. His sentiments were echoed by Aly Khan Satchu, Independent Investment Analyst, arguing that given the current international prices, the price of super petrol should be somewhere between Sh75 and Sh80 a litre.

“There is a case for a four week lag as Kenya buys its fuel consignment once a month, but evidently the ERC has slowed down the transmission of lower global prices to a crawl and it would be good to know why,” Satchu asked. “We have sold $2.75 billion (Sh249 billion)of Bonds to the International markets and the signal from the fuel price is not a good one. It behooves the ERC to give a fit and proper explanation.”

Satchu believes the formula is being interfered with. “The economy (and more than 40 million Kenyans) desperately needs this much needed stimulus in the arm from a lower fuel price. The ERC is in fact toying with the national interest,” he added.

ERC would argue that their formula provides for the calculation of the weighted average costs of imported petroleum products and that there is a time-lag of at least a month between placements of orders for the petroleum imports and actual delivery in the country meaning that Kenyans are not able to enjoy immediately the accruing benefits of falling prices. “But does the difference between Sh102 and the rough current price estimate of Sh86! Justify this? I don’t think so,” Wehliye questions.

He says even if you were to give them the benefit of doubt and allow for 50 per cent of the Sh16 difference between their Sh102 price and our Sh86 estimate that will give Sh8. “You are still looking at the oil marketers pocketing at least Sh8 benefit that they should be passing to the consumers. And that will not go to the government either. It would up to their margins,” he adds.

“But that is the nature of pump prices. Like interest rates, they would go up like a rocket when prices are on the up and fall like feather when prices are on the down. It is called the ‘rocket and feather effect.”

Oil marketers previously had margins of Sh6 per litre at the wholesale level and Sh3 per litre on pump prices. From January 2014, the ERC raised the profit allowance to Sh7 per litre for wholesale and Sh3.89 per litre for retail. However, Eric Musau, research analyst at Standard Investment Bank (SIB) believes the price formula is working alright, both for the consumer and the oil marketers.

“For the oil marketers, we have seen a much more stable market with additional investments being made by downstream investors through the allowance of a fair profit margin in the formula,” said Musau.

Profit margin

For consumers, he says, the timing delay between global oil prices and domestic prices accounts for the bulk of the short term difference. Other factors include fixed costs (specifically taxes and the profit margin) as well as fluctuation of the Kenya exchange rate against the US dollar. “By having a fixed tax and profit per litre instead of as a percentage of the fuel price, it means when prices are higher; oil markers and government suffer as the consumer gets a bit of a reprieve from peak prices,” he argued.

“When oil prices are coming down, oil marketers benefit and have a better profit margin. Government also benefits from likely higher consumption. Under this scenario, consumers benefit less than the entire decline in fuel price. I think the true test of the price formula is to ensure it remains in place whether it favors you or not. Fuel prices will not be low forever.”

ERC started regulating oil prices in Kenya in December 2010 following public outcry about cartel-like tendencies in the market, which exposed consumers to exploitation through high prices.

Given the formula used by the ERC to fix pricing, the January review could still be marginal, at best. ERC says that the main determinant of its pricing of super petrol, diesel and kerosene is the landed cost – including the purchase and freight, which contributes about 56 per cent.