Fuel prices in Kenya have remained unchanged for the third month in a row in the latest monthly review of fuel prices.
In a statement, the Energy and Petroleum Regulatory Authority the energy regulator said, “The prices are inclusive of the 8 per cent Value Added Tax in line with the provisions of the Finance Act, 2018, the Tax Laws (Amendment) Act, 2020 and the revised rates for excise duty adjusted for inflation as per Legal Notice No. 194 of 2020."
It added that the government will utilise the Petroleum Development Levy to cushion consumers "from the otherwise high prices."
This statement comes amid concerns by oil marketing companies over the government defaulting on compensation under its fuel subsidy initiative introduced mid-last year.
In November, EPRA cut margins for the oil marketers to keep pump prices unchanged, after a public outcry on the prices. Billions of shillings, however, remain unpaid, leaving OMCs’ cash flows dented.
They now want the government to pay interest on the delayed funds, a cost that will be passed to taxpayers. According to a local daily, oil dealers were paid Sh1.6 billion for two shipments in November-December, while two others are pending.
In December, prices also remained unchanged despite the then increase in crude oil costs, owing to the state subsidy that consumers have been enjoying. The concept of a price stabilisation fund or subsidy is a very misguided idea and from early signs, it is bound to fail.
To begin with, the reference to subsidy is a misnomer given that the product is already taxed. That notwithstanding, price stabilisation funds work on the basis that cash is collected when global oil prices are low and deployed to cushion pump prices when they rise.
So, how does this essentially work in Kenya?
The difference between the low and high international oil prices would be kept in a price stabilisation fund. When the barrel price rises above $50, the retail prices would remain unchanged and oil marketers would be compensated by the fund for selling at below the real cost. That is the theory in principle.
The practice though is that the billions collected into such a fund invariably ends up being used by the Exchequer for unrelated expenditure, pilfered by the fund managers or both.
It turns out that the Exchequer has already dipped its hands into these funds illegally. A parliamentary committee to probe the fuel hike said Treasury abused the Petroleum Development Fund by supporting payments such as for SGR in breach of the law.
Since the government started compensating OMCs by subsidising petrol and diesel prices, there have been calls from various quarters, including the media, calling for an end to this.
In fact, the Star covered the same in an editorial leader of January 18, 2022, terming the practice by the government as cheap populism.
In my opinion, this debate is correctly centred on the impact of taxes and levies, but omits critical factors requisite in the reform of petroleum pricing policies.
The persistence of subsidies towards fossil fuels stems from the political and lobbying power of the sector in many economies along with the slower pace of energy transition expected in emerging economies.
Subsidies persist for several reasons: Concerns over harmful impact on the poor and over general economic impact (inflation, competitiveness), weak macro-economic conditions such as in Kenya's sake; lack of disclosed information regarding the amount, distribution, and effects of subsidies; weak institutions unable to better target subsidies; lack of confidence in the government’s use of fiscal revenues from abolishing subsidies (especially in corruption-prone states), amongst other reasons.
However, abolishing these subsidies outrightly is also politically sensitive: Most of them benefit consumers who would probably object to the reductions, at least on the ballot, if not on the streets. This concern is also supported by the sectoral composition of the subsidies.
The largest share of subsidies goes to the transport sector. The cost of energy and transport have a significant weighting in the basket of goods and services that is used to measure inflation. Producers of services such as electricity, and manufactured goods are also expected to factor in the higher cost of petroleum. The economy also uses diesel for transport, power generation and running of agricultural machinery such as tractors, with a direct impact on the cost of farm produce.
Reports from the World Bank and the IMF show fossil fuel subsidies are regressive and mainly benefit higher-income groups, which tend to consume more energy than poorer households. According to the IMF, universal fuel subsidies are inefficient as the richest 20 per cent of households receive, on average, about six times as much subsidies as the poorest 20 per cent.
In this context, therefore, abolishing fossil fuel subsidies requires a holistic approach to secure a just transition. Abrupt measures will not work. What is required are comprehensive plans for phasing-in and sequencing price increases to enable the whole population to smoothly adjust.
This has to be accompanied by targeted cash transfers to poor households, eg expanded safety net programmes, increased spending on initiatives benefiting primarily the poor (targeted health, education or infrastructure expenditures), or temporarily maintained universal subsidies on common commodities used by poor households.
A number of countries are working on implementing such solutions to remove fossil fuel subsidies and use fiscal revenues elsewhere. For example, the World Bank helped Egypt adjust electricity tariffs and to phase the elimination of fuel subsidies between 2014-19.
The Philippines, Indonesia, Ghana and Morocco also introduced cash transfers and social safety net expansions for poor families to compensate for the removal of subsidies.
According to a study from the International Institute for Sustainable Development, 53 countries took steps to reform their fossil fuel consumer subsidies or to increase taxation on fossil fuels between 2015-18.
Countries that tried to implement such reforms without applying these steps have faced significant popular unrests, emphasising how sensitive the access to affordable energy can be for most people.
The abrupt removal of fossil fuel subsidies in Kazakhstan early this year almost toppled the government. Ecuador in 2019 triggered massive public outrage, mostly due to the sudden increase of gasoline and diesel prices. A diesel and gas price hike in Mexico in 2017 also ignited violent protests and disrupted the economy.
In France, a developed country, fuel tax increase lit up the Yellow-Vest movement. In such situations, governments are often tempted to backpedal rather than pursue reform efforts.
RECOMMENDATIONS
A key government objective when considering alternative fuel price adjustment mechanisms is fiscal sustainability.
If the regulated price is held constant over long periods, while the cost of fuel on the international market rises (or the currency depreciates), then the gap between the regulated price and the true cost of fuel widens.
This gap is filled by a subsidy, which can impose a significant burden on the government’s budget. This is what Kenya is faced with.
There are three objectives to any fuel price adjustment mechanism: Fiscal sustainability, minimizing fiscal volatility and reducing price fluctuation.
In fiscal sustainability, any price adjustment mechanism needs to ensure that regulated prices are on average, around the same level as the international price of fuel. It is not necessary for the government to ensure the prices are identical at all points in time. Over the course of a year, the net subsidy is guaranteed not to exceed an agreed amount or share of the budget.
In minimizing fiscal volatility, if there are rapid changes in the international price of fuel, while the domestic price is kept relatively stable, then, by definition, there are also rapid changes in the size of the subsidy from month to month.
Conversely, if the changes in the international market are matched by changes in domestic prices, then the size of the subsidy remains relatively stable. Hence there is a direct tradeoff between maintaining price stability for consumers and reducing the volatility of subsidy payments—more stability for consumers will mean more volatile subsidy payments and vice versa.
Fluctuations in fuel prices are painful for consumers, particularly those who do not have the ability to cope with significant changes in price.
As a result, a third objective for fuel price adjustment is that it should not produce major price fluctuations. This does not mean that the price has to remain fixed, but rather, when the price changes, the change should not be too large, so that consumers are able to cope with any changes relatively easily.
The government should embark on immediate fuel subsidy reform.
Kenya could significantly reduce the current levels of subsidy while improving the protection it offers to consumers from large price changes by adopting the following recommendations.
One, fuel price adjustments should be done using a transparent adjustment formula. The formula chosen should be based on international prices so that the net subsidy over a period of time is zero or, if a subsidy is desirable, then not more than a specified amount.
The Petroleum Pricing Regulations and its monthly price formula are sound and fair retail pricing systems, which should be supported but regularly reviewed and updated.
How can price stabilisation of fuel prices be achieved in Kenya?
The Petroleum Act 2019 has a provision for Petroleum Consolidated Fund to finance strategic petroleum stocks. In November last year, Parliament published a petroleum products tax amendment bill and started efforts to lower fuel prices.
The bill proposes to reorganize the Petroleum Development Fund and specify under what circumstances the fund can be used by establishing the Petroleum Development Fund Advisory Board.
The law guiding the Petroleum Development Levy demands that it support a subsidy when fuel prices shoot up and infrastructure upgrades in the energy and petroleum sectors. Further to this, the Petroleum Act 2019 empowers the Cabinet Secretary to formulate petroleum policies and set up regulations. Specifically, the petroleum pricing regulations pass through to consumers all taxes and levies approved by various Finance Bills, in addition to reviewing all petroleum supply chain costs and investor margins for monthly retail price build-up.
This also includes any other levy supported by the Petroleum Act.
Indeed, the Petroleum Pricing Regulations 2010 have already been updated by EPRA, including public participation.
The parliamentary Finance Committee may wish to view these draft-pricing regulations, including a supply chain cost benchmarking study that advised the latest changes to the pricing formula. Strategic stocks assure the security of supply and can be simultaneously used to stabilise consumer oil prices when oil commodity markets are volatile.
A smartly implemented strategic stocks programme will stock products when global prices are low and release them to consumers when prices are high. This is one of the strategies that Kenya needs to undertake to stabilise prices, which is what Rwanda has implemented.
EPRA should draft a regulation to operationalise the Petroleum Consolidated Fund under Petroleum Act 2019, and introduce a Strategic Stocks Levy to be correctly labelled petroleum strategic stocks levy. This may end the regulatory confusion that prompted the parliamentary committee to go for their new Bill.
The policy justification for Petroleum Development Levy Act 1993 can be revisited, and if found to be relevant, included in an amended Petroleum Act.
PETROLEUM REGULATIONS
The Petroleum and Mining Ministry recently published the draft Petroleum (Strategic Stocks) Regulations, 2020 that provide a plan on the setting up of the reserves.
The proposed subsidiary law that is up for public participation aims at ensuring the country has adequate petroleum products that can last for up to 15 days in the case of disruptions. This is in addition to the minimum operational stocks that oil marketers are required to maintain, currently set at 30 days of sales for kerosene, 25 days for diesel and 20 days for super petrol. Petroleum products that will be stored in strategic reserves are super petrol, diesel, kerosene, jet fuel and cooking gas.
“The strategic stocks shall be shared on a pro-rata basis among OMCs based on their immediate throughput data as shared by Kenya Pipeline Company less transit volume,” reads the regulations.
While the stocks are largely for use in emergencies, they can be released to the market after “reaching the end of its shelf-life” after which it will be “unfit for use, consumption or sale”.
The Ministry will use funds from the Consolidated Petroleum Fund, created by the Petroleum Act 2019, to finance the acquisition of products that will be stored as strategic stocks.
The Fund will also be getting money allocated in the State’s budget and contributions from the oil industry players. Other non-monetary measures that Kenya has adopted, but still needs to further improve on, include the deployment of alternative energy sources, to diversify the potential energy options for users, and, where possible, to encourage the use of cleaner energy alternatives like solar energy.
If there are programmes in place that assist low-income residents in times when energy prices increase, the impact of these challenges on livelihoods is reduced. In some instances, the full market price for energy fuels can be passed through if the revenues that would normally be directed to subsidies are instead directed to more effective and robust social support programs. This can also assist with targeting supports to those that need them most.
Kenya introduced a programme of transferring cash to the elderly, such that they are assured of a guaranteed minimum income every month to cushion them. Such social safety net policies should be enhanced and widened. The stronger social programmes are in a country, the more resilient the population can be to increases in energy prices.
To allow oil-exporting countries increased flexibility in their production quotas, there has been a progressive movement towards forward commercial storage agreements. These agreements allow petroleum to be stored within an oil-importing country.
However, the reserves are technically under the control of the oil-exporting country. Such agreements enable oil-importing countries to access these commercial reserves in a timely and cost effective way.
For example, Kenya could negotiate to hold stock locally for Abu Dhabi National Oil Company at pre-determined commercial rates, which it could access whenever necessary. This will reduce unnecessary price fluctuations in the prices of petroleum products.
In conclusion, avoiding the recurrence of fuel subsidies requires a new approach to fuel pricing in many countries.
In countries with fuel subsidies, the government typically controls domestic prices. This creates the impression that price changes reflect government policy, rather than international factors, with political pressure to avoid passing through increases in international prices but to pass through decreases.
Approaches to managing fuel prices include ensuring long-term fiscal sustainability, limiting fluctuations and minimizing shocks.
There are options directly related to strengthening the fuel pricing mechanism, and strategies specifically to mitigate the impacts of higher fuel prices. Some of these options, which I will not delve into at present, include price smoothing, ratcheting and installation of price floors and caps.
What is for sure is that the Kenyan government does not have the funds to continue providing fuel subsidies to the Oil Marketing Companies. It has already defaulted several times and the Petroleum Development Levy Fund has been depleted and needs to be replenished. The dam is about to burst and all the secrets will be spilt in the open sooner rather than later.
Duncan Otieno Ogwang is a petroleum, gas and energy economist
