Why oil marketers are now in love with price controls

Gapco Company Limited trucks waiting to collect rejected fuel from the Kenya Pipeline Company storage tanks (PHOTO: GOVEDI ASUTSA)

Oil marketers who were once opposed to the capping of petroleum prices are now reaping big from the economies of scale.

Petroleum Institute of East Africa (PIEA) Chairman Powell Maimba says the capping of oil prices saw the birth of the open tendering system (OTS) that has helped the sector.

“In 2010, when oil marketers appeared before a Parliamentary Committee and asked to reduce the cost of living by lowering fuel prices, they said it was impossible since the cost of landing the fuel was high,” said Maimba in an interview with Financial Standard.

When the Energy Regulatory Commission (ERC) activated the price controls in 2009, it was a relief for consumers but a new chapter for oil marketers to run their businesses.

The ERC pricing formula factored in the recovery of landed costs such as offloading costs, depot costs, handling costs and the cost of margins, setting wholesale and retail margin.

Oil marketers were to make about Sh7 per litre sold while retailers were to make about Sh2.50. It was not easy for the marketers. “What became a problem was that we could not understand the build-up of the Sh7 industry margin as opposed to the proper buildup of dealer margin. The main issue was the expected return on investment,” says Maimba.

However, with the price controls, marketers stopped importing as individuals. Instead, the Ministry of Energy, together with ERC makes demand forecasts and advertises tenders through OTS. This has cured many ills for the marketers.

“If we remove OTS, we will expose the whole of East Africa to high prices. OTS gets us fuel at the best ever landed cost. On the day the Government announces the tenders, international oil suppliers make bids knowing that if they quote high numbers, they won’t win,” says Maimba. The local oil marketing companies act as agents of international oil marketers.

Since they don’t have the capacity to get ships out of places such as Arab Gulf, they approach the strategic partners who give them a price number to place bids. “If the number happens to be the best, that’s how a company wins to supply. This has enabled us to get the best premium cost,” he says.

Insurance costs

It gets competitive such that sometimes bidders offer negative premium. Premium is a combination of freight, insurance and other costs of landing at the cost.

Maimba, who is also the CEO of Galana Oil Kenya Company which participates in the OTS, observes that when prices are dropping, the international traders prefer to release their stock faster to reduce exposure. “It is competitive. Every participant is looking at what costs to cut so that their bid can win the tender. If we remove the OTS, there will be no such motivation. Each player will buy own fuel and cause instability,” he said.

As consumers benefit from reduced prices due to lower landed costs, the oil marketers get a mark up from the tenders won.

Because of its competitive nature, the PIEA chairman says sometimes making Sh1 million out 85,000 tones delivered is never easy. Sometimes, the successful bidder loses money. For example, in the tenders for oil to be delivered in November, the oil marketers who participated in the September OTS have already locked in the number.

If the prices in November go down, they will lose money.  

This has made the deal a reserve of about 10 to 15 big boys out of about 180 oil marketing firms.  Firms sometimes have to hedge so that if the prices fall, their risk is minimised.

“It is too risky for any simple guy to get involved. You can die. If you supply 85 million litres with a Sh0.50 mistake on every litre during the tendering, it will take you long to recover,” he says.

Once the oil has been delivered at the port, it is allocated to different oil marketers according to their demands submitted. About 500,000 tonnes are given to the rest of countries in the region. Through vessels scheduling meeting chaired by the Energy Cabinet Secretary, the marketers forecast their demand and plan on when to order. Currently, the supply for October and November is already locked.

With its competitiveness, marketers say it has given each firm a level playing ground, allowing each company to compete based on their financial strength and reputation in the market.

Mr Maimba argues that removing the OTS would eliminate economies of scale as each marketer will try to import on their own. “All these trades are covered by both local and international banks because you have to issue a letter of credit (LC) in advance. The trader will never supply you without LC,” says Maimba. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining purchase amount.

Within the OTS, there is a requirement that if one imports on behalf of the industry, then an oil marketer defaults to collect their stock and pay on time, their firm’s license will be withdrawn.

This has also saved the country from stock-outs. For the oil marketers, the OTS has helped them predict their margins thus increasing their access to credit. Even though players are divided over being handed back free hand on determining final price, they all agree on the benefits of OTS.

Every day, Kenya Pipeline pumps 750,000 litres per hour, which is just equal to the average fuel demand per hour in the region.

Managing stocks

Maimba feels that infrastructure is still limited and calls for accuracy and efficiency in managing stocks. “In its absence, there may be fuel speculation leading to unstable prices. Stable prices can only be there when there are regulations to control the prices of supplying,” says Maimba.

But even as marketers laud the gains in OTS, they have been calling for a review in their margins which currently stand at Sh7 per litre sold while dealers fetch Sh3.89. The Government has engaged a consultant to review the margin whose report will determine if the oil dealers’ bargain will be increased.

According to Maimba, inflation, interest rates and minimum wages to petrol station attendants have depressed their margins. “We may have a different stand on regulation or deregulation but our compromise is that whichever way, it should be a market in which we get a fair return on investment, cost recovery and cheap product for the consumer,” he told Financial Standard.

The industry has about 2,000 petrol stations with each employing between 10 and 20 attendants. According to oil marketers, the minimum investment in a petrol station is Sh50 million.