Falling crude oil prices tricky for Kenya

In the past few weeks, oil prices have been on a downward trend, hitting their lowest levels in the past four years. Oil prices have declined more than $30 per barrel since the mid-June high of $115 per barrel.

The decline in the crude oil prices can be attributed to a number of factors. Higher supply in the US and a slowing demand because of worries about global economic slowdown are the underlying causes. But the immediate cause of the downward trend was Saudi Arabia's reduction of its crude oil prices without cutting production.

An apparent strategic shift in Saudi policy, which has now shifted to maintaining or increasing its market share by offering lower prices rather than cutting production to keep the oil price high, has caught the market off guard. Other producers in the region also followed suit and offered discounts on their crude oil in order to maintain their market share.This has led to the price of crude oil falling sharply.

The slide in crude oil prices, at least in the short run, is a big positive for Kenya which currently depends on imports for all of its oil consumption. Oil contributes a significant 20 per cent of the overall imports bill.

With lower crude oil prices, import bill decreases, Current Account Deficit (CAD) eases, and the upward pressure to do the politically difficult task of ERC increasing pump prices wanes off. Our imports of crude oil according to Kenya National Bureau of Statistics (KNBS) are approximately 4.5 million tonnes or about 32 million barrels every year.

If, as most energy analysts predict, crude oil prices average about $80 per barrel in the second half of the current fiscal year compared to about $109 per barrel it averaged in the first six months of the fiscal year, the country's import bill will fall by approximately $460 million (about Sh40 billion).

This is almost 20 per cent of the current account deficit of the 2013-14 financial year. A crude oil average price of around $95 per barrel would thus mean that our CAD will likely reduce to less than four per cent of the GDP at the end of this fiscal year. The easing of the crude import basket will be a major relief for the Jubilee administration at a time when it faces economic pressures from lower tea and tourism revenues and weakening economies in Kenya's major export markets.

Lower oil prices will also help reduce the cost of living for the average Kenyan. Decline in oil prices translates directly into a drop in the consumer price inflation and has also got indirect impacts like lower food prices because of cheaper transport costs.

Many businesses would benefit from lower petrol prices at the pump and while it is expected that these businesses will retain part of the gains, the rest will get passed on downstream and will help lower inflation. A lower inflation rate would most likely serve as a cue for the Central Bank of Kenya (CBK) to reduce interest rates, a move that could boost economic growth.

The global plunge in oil prices is, however, not necessarily good for us in the long run. Whereas the sharp fall in oil prices is likely to provide the much-needed relief to the economy in the short run, it would come to hurt us if oil prices keep going down and then stay there long enough.

This is because our status is about to change from that of an oil consuming country to that of an oil producing country. The last thing we would want to see, therefore, is oil prices going down to say $60 and then remaining depressed at those levels for a long period.

Sustained low oil price will not only impact on Kenya's future earnings from oil but will also negatively affect the investments and job growths that we have started to experience in this industry. Furthermore, if the prices continue to fall and remain depressed for a long period, investors in the oil extraction business may even close shop and walk away.

A drop in oil prices reduces the profit margin of investment in our oil resources, raising concerns for the oil sector investors in the country. This would affect the likelihood of their further investment in oil extraction in the country.

For our oil resources to be economically developed and produced, oil prices would need to remain high in the long-term. With the current costs, it is expected that the overall oil exploration will drop with a downturn of oil prices.

If oil prices drop below the range of economically profitable production, the drilling of new wells will mostly slow down or stop all together. And all that, in turn, could outweigh the short-term economic benefit of the cheap fuel. While dropping oil prices is good for us now, they're potentially devastating for our ambition to becoming an oil producing country in the near future. The falling oil prices is definitely a double edged sword for Kenya.