Kenya: How does the fuel subsidy work?

Job Omagwa
By Job Omagwa

Lecturer - finance and accounting, Kenyatta University Dr Job Omagwa holds a PhD (Finance) degree and an MBA (Finance) degree- both from the University of Nairobi and a BBA degree (Accounting and Management- Magna Cum Laude) from The University of Eastern Africa, Baraton

Posted on Wednesday, 18 May 2022 13:07

Motorists queue to fuel at Shell Gas station amidst biting fuel shortage and increased prices. For two weeks now, fuel shortage in Kenya continued to be experienced with handful gas stations still dispensing it intermittently when stocks are available. Initially, oil marketers refused to release their fuel citing fears of incurring losses after the government failed to honor its subsidy obligation meant to relieve consumers from high prices. - James Wakibia / SOPA

Oil is an essential commodity for Kenya’s transport and industrial production, electricity generation and water provision. In 2008, as the world grappled with high oil prices, Kenya introduced price controls to cushion the blow for its citizens

The controls worked for over 10 years. But, since the start of April, there have been intermittent fuel shortages in the country. Job Omagwa has studied oil marketing and price controls in Kenya. We asked him to unpack the current fuel shortage.

How does Kenya get its fuel?

Kenya, like most of its East African neighbours, depends on imported refined petroleum products (petrol, diesel, jet fuel and kerosene) mainly from the Middle East. Oil marketing companies are the importers. The state estimates demand for the next import cycle and issues an open tender for the supply of petrol, diesel and kerosene.

Official records show that in 2021 the country imported 6.149 million litres of refined petroleum worth $3.48bn. The imports came mainly from the UAE ($1.41bn) and Saudi Arabia ($1.14bn). Other sources included India, the Netherlands and Kuwait.

The tender is only open to the country’s 93 oil marketing companies. The winner orders the products, which it stores and distributes via the network of the state-owned Kenya Pipeline Company to other marketers, according to demand quotas.

The established marketers do not have a countrywide reach. Smaller players have cropped up to fill that gap. These small retailers get their fuel from the established oil marketers.

How are the oil prices set?

Kenya has an oligopolistic petroleum market structure. A few big firms are able to influence prices. In Kenya, about four marketers can influence prices.

The government implemented a maximum price cap in 2011. It did this because marketers had raised the price of fuel in response to increases in international crude oil prices between 2007 and 2008, but didn’t reverse them when international prices fell at the end of 2008.

The price cap is managed by the Energy and Petroleum Regulatory Authority. It sets maximum pump prices every 14th day of the month for various towns and cities in Kenya. The regulatory price takes care of the international crude oil cost, exchange rate, transport, storage and the marketer’s margin.

But the actual retail prices are set by individual firms based on their unique circumstances. These cannot exceed the regulator’s caps.

What is the stabilisation fund and how does it work?

The stabilisation fund was envisaged in Kenya’s price control policy, right from the start, as a mechanism for cushioning the economy when global crude prices skyrocketed. The fund became operational in 2021. It is meant to cushion consumers from unpredictable swings in global oil prices.

In particular, the fund was to remain operational as long as international crude oil prices rose above $50 per barrel. By early 2021, international crude oil prices had risen to $55 per barrel. From each litre of petrol and diesel sold by oil marketing firms, KSh5.40 would go towards the stabilisation fund.

Without the fund, the forces of demand and supply would push retail prices beyond the regulatory caps, making the business untenable for oil marketers. In its absence, a litre of petrol currently retailing at KSh142 in Nairobi would, for instance, be going for about KSh173.

Compensation from the fund to oil marketing firms is based on a certain percentage of their respective fuel costs. Since the fund became fully operational in April 2021, the government has paid oil marketers a total of KSh49.164bn.

Why the fuel shortage now?

The shortages were initially attributed by the Energy and Petroleum Regulatory Authority to hoarding by the oil market companies in anticipation of higher international prices. This is because the established marketers had stopped supplying fuel to small retailers in the countryside, prompting consumers to crowd nearby towns.

But the government later accused the four major oil marketers of economic sabotage. There have also been claims by the petroleum ministry that the four big oil marketers exported some of their stock to neighbouring countries.

However, the problem is that the stabilisation fund had not paid oil marketers for some time. By early April, the government had accumulated KSh13bn in unpaid fuel subsidies.

Despite the approval of the release of KSh34.44bn by President Uhuru Kenyatta to replenish the fuel stabilisation fund, the threat of another national shortage looms large as international prices continue to rise.

Oil marketing firms have often experienced stockouts due to a significant mismatch between demand (largely driven by panic buying) and supply. It would equally take a few more days to get their next supply, hence dry pumps for some days.

In addition, these firms would not exceed their allocation of stock by the government despite increased demand for fuel. This could also explain why their pumps would run dry for some days.

How does Kenya prevent a future crisis?

In my view, the government can forestall future shortages by:

  • Compensating oil marketing firms (out of the stabilisation fund) on time to avoid settlement in arrears, which is believed to have compelled most of the oil marketing firms to export much of their oil supply to the international market, where they would be paid cash upfront.
  • Increasing the capacity of the state-owned National Oil Corporation to store much more in fuel reserves. Such a reserve would stabilise supply in the event the private oil marketing firms engage in hoarding or opt to export their stock to the international market.
  • Scrapping the stabilisation fund, which, though legal, is not entrenched in the Kenya Energy Act 2019 or the Petroleum Act 2019. This would mean higher pump prices but supply might be much more assured.The Conversation

Job Omagwa, Lecturer – finance and accounting, Kenyatta University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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