Defying gravity: Why Kenyans would not get fuel at Sh50 even if oil dips to $0 a barrel

The Energy Regulatory Commission has revealed that more than half the amount Kenyans pay for fuel goes to at least seven Government taxes and levies. This means that even if the oil prices drop in the international market, Kenyans would still pay at least Sh50 for it.

Crude oil prices have hit 12-year lows, and motorists have expected these benefits to trickle down. It is now below $30 and comes after nearly five years of stability. Since August 2013, prices have dropped about 72 per cent.

Over this time, however, petrol prices in Kenya have only come down 21 per cent.

A litre of fuel comes saddled with over Sh48 in fixed costs, which include Sh33 in Government taxes, Sh11 in wholesalers‘ profit margins and Sh4 in distribution costs.

Let us assume the Government has stumbled across free crude oil somewhere in the Middle East, or been gifted a whole stockpile of petroleum products without charge for whatever reason.

According to the energy regulator, by the time the fuel is brought to Kenya and moved from the Mombasa Port to a petrol station near you, it would still cost at least Sh50.

And despite global crude oil prices closing last week at $29.70 (Sh3,038) a barrel, which holds about 159 litres, the Energy Regulatory Commission (ERC) has revealed it has little room to pass on these benefits to consumers.

A breakdown of fixed and variable costs it released last week show the regulator, charged with capping fuel prices since 2010, has no control over more than 50 per cent of the components that determine what the country pays for super petrol, diesel or kerosene.

The ERC’s latest statement shows that last month, the fixed component — which comprises mostly tax charges and the profit margins oil marketers are guaranteed to remain in business — accounted for Sh48.15 of the Sh88.64 motorists paid for a litre of petrol in Nairobi.

Supply chain

While this represents a 12.3 per cent decrease in prices since August 2015’s Sh102.65, the fixed component went up by Sh3 over the period to account for new levies the Government introduced in the amended excise duty law.

Of the amount paid at the pump for petrol between December 15 and January 14, the regulator can only play around with Sh40.49 of the Sh88.64 retail cost.

This variable amount includes the cost of purchasing the product, handling fees at the port and transporting fuel to retail stations, leaving little room for a meaningful price cut.

A breakdown of the Sh48.15 fixed component shows that taxes and levies account for Sh33 of the amount, while wholesalers and retailers’ gross margins take Sh11. A further Sh4 goes to distribution costs.

Kerosene attracts virtually zero taxes and duties, which partly explains why its prices dropped by at least Sh7 in the latest price review to retail at Sh46.10.

With the cost-plus method of pricing, which factors in the costs of importing refined oil and supply chain costs, lower prices will depend on how efficient the country’s supply chain system is.

What does not add up in the minds of many Kenyans, however, is that at a time like this last year, petrol retailed at Sh110, diesel at Sh104 and kerosene at Sh85 in Nairobi. Then, a barrel of crude oil cost $102 and the exchange rate of the shilling to the dollar was 86.

Today, crude oil is retailing at 12-year lows and though the shilling is trading at 102 to the dollar, consumers were expecting to much larger price relief at the pump.

Further, since August 2013, global oil prices have dropped by 72 per cent from highs of $108. In Kenya, however, the drop in fuel prices over this period has been about 21 per cent.

“If fuel prices in Kenya dropped by 72 per cent, the price per litre would be about Sh32. Add a tax rate of about 60 per cent, and the price comes to Sh51.20,” said economist XN Iraki in an opinion piece in The Standard on Sunday.

“The value of the shilling has depreciated about 15 per cent over the same period. Add this up and the new price is Sh60 per litre. Add miscellaneous costs of Sh10, and the price adds up to about Sh70 per litre .... Maybe my mathematics is not exact, but clearly we are not benefitting enough from the fall in oil prices.”

Further, matatu fares and manufactured goods, which quickly reflect increases in fuel prices, are yet to get significantly cheaper.

Taxes and levies

However, the ERC has said it is impossible to realise the kind of fuel pricing Kenyans are hoping for.

Imported oil products are subjected to at least seven different taxes — and the Treasury had said it plans to re-introduce a 16 per cent value added tax (VAT) on these products from September this year.

Already, excise duty was reviewed upwards from December 1 last year, adding Sh2.061 to the costs of a litre of diesel as the Government seeks to raise revenue for its operations.

Statistics show that Government taxes and levies per litre of diesel and kerosene now stand at around 34 per cent and 17 per cent of the total pump price, respectively. However, these percentages vary because the Government deliberately demands its cut in shillings, not as a fixed percentage of the total cost, which could see its tax revenues reduce.

These taxes include excise duty, road maintenance levy, petroleum development levy and the petroleum regulatory levy. Then there is the pipeline tariff and bridging rates.

And on top of these, an additional 16 per cent VAT is expected (see related opinion piece on Page 9).

At a press conference last year, National Treasury Cabinet Secretary Henry Rotich said the three-year tax holiday currently given to oil products will expire in September under the VAT Act, 2013.

Among the products that will be affected are petrol, kerosene, jet fuel and gas oil.

The Treasury agreed to raise taxes on petroleum products as part of the conditions set by the International Monetary Fund (IMF) for the Government to get approval for a $700 million (Sh71.6 billion) precautionary facility meant to cushion the shilling from forex volatility.

Stakeholders who spoke to Business Beat on condition of anonymity said Kenyans’ dreams of seeing pump prices come down in tandem with global prices would remain impossible if the Government does not remove some of the numerous taxes it has imposed on oil imports.

ERC Director General Joseph Ng’ang’a said he understands why Kenyans are agitating for much lower prices, but said it would not be possible to realise these demands.

“The Sh48.15 cannot change, and is not subject to changes in the prices of crude oil. From mid 2014 when prices of crude oil started dropping, we moved from Sh116.62 for super petrol to now about Sh88.64. The fact is that the changes in international prices can only affect a portion of our retail prices,” he told Business Beat.

Mr Ng’ang’a also quoted an IMF report that lists Kenya among African countries that have adjusted prices in line with global costs of crude oil.

“Changes in our prices are reflective of the market. Even IMF has looked at it and confirmed that we are among the five countries in Africa that have fully passed the benefits of the drop to consumers.”

However, Consumers Federation of Kenya (Cofek) Secretary General Stephen Mutoro feels that Kenyans are being robbed at the pump, saying “no scientific excuse can defeat the call for lower prices”.

“The oil companies cannot compete. With the Sh11 absolute figure for profit margins, they are assured of profits, whether it rains or shines,” added Mr Mutoro.

Oil marketers have indeed drawn their fair share of blame for the current prices, even as Ng’ang’a revealed they want a higher profit margin than the Sh11 they currently get.

Ironically, the Government earns more from oil imports than the operators themselves.

Oil companies

Insiders have pointed out that in as much as there are checks and balances during the open tendering process at the Ministry of Energy, the process is not foolproof, as it is the same players who time and again secure contracts to import oil.

Kenya has 72 companies licensed to import oil and oil products, but only handful of these win tenders due to the cost implications involved.

Attempts by Business Beat to secure more information on which company imported what products, and at what price this month were futile as those responsible were said to be out of office.

“The [tendering] process is quite transparent and there are international indices to guide the pricing of commodities, but the time lag and the cost of money are some of the factors that lead to the inflation of pump prices when all is said and done. Like any other system, one cannot also rule out foul play from time to time,” said an official in the energy industry who asked not to be named given the sensitivity of the matter.

Every month, there is an open tendering system co-ordinated by the Ministry of Energy. During the competitive bidding, one company wins the tender and supplies oil to the market. Only a handful of the 72 companies frequently win the tenders.

On its arrival at the port, the companies share out the oil, depending on their market share. But the process exposes the 72 companies to a situation where they act as a single player.

And by operating with an absolute figure in margins, there is no incentive to compete since their profits are predetermined.

Ng’ang’a defended this arrangement, saying: “We cannot allow every company to bring in oil every month, yet we only have one gateway. It will cause disorder at the port and also lead to high demurrage costs.”

He also pointed out that ships take about 30 to 45 days to dock at the port, meaning that the current oil in the market was ordered when a barrel was still about $49 (Sh5,012). Therefore, the current, much lower price will be captured in the next consignment, which will form the basis for mid-February to March prices.

And then there is the issue of the cost of credit in oil importing.

In July last year, the Central Bank of Kenya (CBK) resorted to open market operations to tame inflation and the shilling’s volatility.

The tight monetary policy led to a rise in interest rates from an average of 15 per cent to 21 per cent. The development meant that the cost of doing business — especially for companies that rely on loans, such as oil importers — increased.

Nearly all importers of oil use letters of credit to transact.

Refining costs

Kenya also suffers the impact of not importing crude oil, which exposes it to refining costs. In 2013, Kenya stopped importing crude oil after it closed down its Changamwe refinery, citing inefficiencies. The country’s oil is now mostly refined in Italy, Scotland or Amsterdam, and transported from there.

Going forward, stakeholders say the only way for pump prices to come down is to minimise taxes at the pump. But the Government is already running a Budget deficit and is looking to reduce its borrowing — oil taxes are a welcome source of funds.

Further, doing away with oil taxes would require a balancing act between the multiplier effect of low pump prices and the effect of Government spending on the economy.

“I think we are on the right side of the ladder curve and lower tax rates would lead to increased business activity, and consequently, higher tax returns and a better quality of life,” said Johnson Nderi, ABC Capital’s corporate finance and advisory manager.

The energy regulator is currently in the preliminary stages of looking for a consultant for a cost of service study that would re-examine the entire supply chain.

“We are missing an opportunity to stimulate the economy and make it grow faster,” said Dr Iraki.

“If the price of petrol falls to, say, Sh60 a litre, we could travel more, buy more cars and create demand for car-related parts, and transporters could reduce costs, leading to more economic activity. Money saved in one sector is used elsewhere – hopefully, more productively.”