Oil price and its effect on Kenya

The international prices of crude oil are dropping at an unprecedented speed. In six months, the price per barrel of Brent has dropped to below $50 per barrel.

Oil trading experts believe that this price at $50 might not be the bottom but rather the ceiling for the foreseeable future. The prediction is that the price of oil could drop to as low as the pre-1973 price levels where a barrel of oil cost $3.

The cause for the price drop is not clear. Some analysts believe that it has more to do with the Crimean war in Ukraine where some say, the United States is punishing Russia for annexing part of Ukraine. Russia's economy is almost fully dependent on the export of oil and any sanction could only include hitting them where it hurts most.

Still others suggest that the price war has more to do with Saudi Arabia fighting back regarding any possibility other producers coming up with new extraction methods, including producing the commodity from shale oil as is the case currently in the United States.

Shale oil is abundant around the world. And shaling (extracting oil from shale formation in the sea) is considered cheaper than conventional methods.

Even China, one of the largest consumers of petroleum products, has unlimited deposits of shale oil. There are more than 20,000 new wells in North Dakota and Texas, United States.

This alone has boosted America's oil production to nearly 10 million barrels a day near or equalling that of Saudi Arabia, the world's biggest oil producer. There is now a surplus of oil in the world.

Oil production in the international market is influenced by demand. Some experts think that by refusing to lower production, Saudi Arabia is attempting to discourage those countries with large shale formations from exploiting their newly-found riches.

One method the Saudis are using to fight back is to allow prices to tumble and increasing production, thereby 'punishing' investors who have taken huge loans by making oil 'worthless'. This inhibits oil firms from breaking even. Any price below $70 per barrel makes it unattractive to produce due to high cost of production.

What is then the effect of all this to the Kenyan economy? Cheap oil is good for our economy, in the short term. A fall in the cost of oil has a consequent result of a fall in the cost of living. But then, the first major casualty in the price war is our own expected oil production in Turkana.

Tullow and Africa Oil indicated late last year that any attempt to continue with the pumping out process of our own oil at Ngamia 1 will very much depend on the international price of crude oil.

These two companies will soon make known their direct investment decision. But seeing the unfolding events in the international oil markets, the guess is easy to make. No investment might be forthcoming from these multinationals.

Shaling is relatively cheap when considered against conventional oil exploration that takes more time to realise. A shale could take a week to drill. It takes up to five years and billions of shillings for oil to flow out of a conventional well.

The long-term effect on the Kenyan economy is depressing. The Government had hoped that earnings from oil would absorb the effect of the high cost of borrowings.

Recently, the National Treasury raised the national debt ceiling to Sh2.5 trillion raising our burden of servicing sovereign debts to more than Sh400 billion annually making it the largest single recurrent cost for the Government.

Equally, the Exchequer is dependent to a large extent on the taxes imposed on petroleum products including the fuel levy. The drastic drop in oil prices will severely cut down revenue.

Right now, more than a quarter of the price per litre goes to the Government as revenue. This does not include value added tax and other taxes that are levied on these products.

The Treasury might then impose taxes on other commodities to make up for the loss in revenue. There is however the unseen aspect to this whole matter. Despite the drop in oil prices, the dollar in Kenya continues to be expensive.

The energy sector has traditionally been one of the largest consumer of foreign currencies. However, the drop in international prices of crude oil and the recent influx of dollars through the Eurobond has not really dampened the demand for the dollar.

The cause for this anomaly is not clear. The cost of buying the dollar continues to climb despite the relative declining price of oil.

The drop in price of crude could also means that the automobile industry is simply outgrowing dependence on oil-based products for turning engines.

Former Saudi Oil minister Sheikh Zaki Yamani once quipped: "It is not the shortage of stones that led to the decline of the stone age, but rather innovation of human beings that rendered the oldest industry obsolete."

Similarly, oil as we know it today might become valueless in the not-so-long future if new ways of powering industry are discovered. Not because oil will be in shortage, but technology might make it obsolete.