Why you ought to pay Sh7 less for fuel

If Kenyan motorists think world headlines about plunging oil prices will mean a merry Christmas at the petrol pump, they might need to think again.

Logic would seem to dictate that if global oil prices are going down, local pump prices should go down proportionately.

The cost of fuel in the country has not fallen significantly even as prices of crude oil in international markets have slumped to four-year lows.

Crude oil, on Tuesday this week, was trading at $64 a barrel; almost 40 per cent below the price in June of $105, when it started heading South.

So how is that the price of Super petrol has fallen less than 7 per cent during the same period?

What you pay for a litre of petrol in Nairobi or elsewhere in the country does not depend only on global crude oil price.

The pump price is made up of other components such as taxes (excise and levies), refinery costs, shipping and storage costs, importer margin (the amount the oil companies earn to offset their operating costs, plus profit margin).

The pump price, therefore, is not expected to drop as much as the global oil price falls for a number of reasons;

First, a lot of the petroleum imported into the country is refined petrol.

Although the cost of crude oil is a factor in the cost of imported petrol or diesel, the market prices of crude oil, and refined petrol and diesel can each be influenced by different factors, and therefore international refined fuel commodity prices will not be perfectly correlated with that of crude oil.

Second, included in the fuel price are excise duty and various other levies. These taxes and levies amount to over 30 per cent of the cost per litre for Super petrol.

The excise duty on fuel, which forms the bulk of this cost, is levied on per-litre basis and not as a percentage of the price, which means when the cost falls, the tax remains at the same level.

Third, exchange rate fluctuations are a significant factor when comparing domestic and international prices. Refined prices are set in US dollars, so a drop in refined petrol prices can be offset by a decline in the shilling.

Finally, the Energy Regulation Commission (ERC) typically revises prices only once every month, which is why there is a lag before drop in global prices get reflected in the pump price.

Daily fluctuations in the price per barrel of crude oil cannot realistically be reflected in the price per litre of petrol at the pump due to the large amount of fuel already stored by the oil marketers in depots and petrol stations around the country.

This lag is approximately two months in Kenya, meaning the current pump prices are based on September crude oil.

The price of crude oil, however, has the most significant impact on the average price of fuel, contributing to more than 50 per cent of the retail price.

Which means a 1 per cent change in the price of the benchmark should lead to the pump price adjusting by at least 50 per cent of that, that 0.5 per cent (excluding the exchange rate effect).

Going by the recent ERC calculations, however, the drop in prices seems much lower than warranted. Consider this: The monthly average FOB price for Murban crude oil imported into Kenya from Abu Dhabi National Oil Company (ADNOC) in June 2014 was $111.65. In October, it was $87.35 or a drop of around 22 per cent.

However, during the same period pump prices for Super petrol reduced from Sh114.62 to Sh110.89; a paltry 3.25 per cent. The shilling depreciated a mere 1.8 per cent during the same period.

Note that I have chosen a four-month observation period to take out the effects of the price lag.

The expectation is that a decrease in the price of Murban of 22 per cent would have resulted in a decrease in the price of Super petrol of approximately 9 per cent even after taking into account the depreciation of the shilling during the same period.

Kenyans should thus have been paying around Sh104 and not Sh111 in October for Super Petrol.

That is Sh7 per litre benefit of falling global oil prices that the ERC and oil marketers have not passed on to the consumers.

These 'retained' benefits are even bigger given that the oil price has since dropped further to trade at as low as $64 on Tuesday this week.

How Super Petrol in Kenya today is retailing for more than Sh100 a litre, is something only the ERC can explain.

It is the duty of ERC to ensure the entire benefits of the falling oil price are passed on to the consumers and especially to the bleeding domestic manufacturers and airlines so it can help them lower their operating costs.

Given the current economic circumstances, Kenyans should be angry that pump prices don't fall as much as they should on the back of falling oil prices and low inflation.

Like global crude prices, we want to see pump prices fall like a stone, not a feather.