30 January 2016

Kenya: Tax Is the Devil in Kenya's High Fuel Cost

Petrol in Kenya would cost as low as Sh55 per litre if the fall in crude oil prices were reflected in refined products such as petrol and diesel, a review by Nation Newsplex and the Institute of Economic Affairs (IEA) finds.

The analysis also reveals that taxes comprise by far the largest component of fuel prices in Kenya after fixed international costs, with a much smaller portion going to fuel marketers.

INTERACTIVE: Components of Kenya's fuel prices

If the average ratios of refined products prices to crude oil prices from 2005 to January 2016 were maintained, petrol would now cost Sh55. The prices of diesel and kerosene would also fall to Sh50 and Sh40 respectively.

Currently, of the super petrol price of Sh88, Sh41 (46 per cent) goes to international buying and freight costs, while Sh32 (37 per cent) goes to taxes and levies. Eight per cent (Sh7) goes to wholesale marketers while five per cent (Sh4) goes to retailers at the fuel pump.

The finding of modest margins for marketers comes as Kenyans react unfavourably to small drops in fuel prices. Motorists were angry when the Energy Regulatory Commission (ERC) recently reduced the prices of petrol and diesel by less than Sh2 in mid-January, after global crude oil prices plunged to a 12-year low this year.

From 2004 to January 2016 the price of Brent crude fell 24 per cent, from an average price of US$38 to US$29 per barrel, even if it peaked in 2011, at US$111 per barrel. On the other hand, over the same time, a litre of super petrol sold in Kenya increased 33 per cent from Sh66 to Sh88 per litre.

Increased oil production across the world, rising fuel efficiency and collapsed consensus among oil producers have all contributed to the collapse of oil prices.

REFINED PRODUCTS STEADY

A review of pricing ratios shows that prices of petrol and in Kenya diesel do not reflect the drop in crude oil prices, even after taking the exchange rate into account. Kerosene is an exception to this rule.

For example, in December 2005, a litre of petrol cost 2.5 times the price of a litre of crude oil. This ratio was declining until December 2008, when the same amount of petrol cost more than four times the price of crude, due to a sharp decline in crude oil prices.

From June 2009 to June 2014, petrol prices stayed below 2.5 times crude oil prices. However, from December 2014 to Jan 2016, the price of a litre of petrol increased sharply to reach almost four times the price of a litre of crude oil.

If the price ratios of petrol, diesel and kerosene to crude oil had been maintained at 2.4, 2.2 and 1.8 times that of crude oil, (the average ratios for the period 2005-2016), then the current retail prices would work out to Sh55, Sh50 and Sh40 per litre for petrol, diesel and kerosene respectively.

Energy Cabinet Secretary Charles Keter has urged the ERC to lower oil prices, by cutting marketer's margins, showing he was unwilling to reduce the taxes which account for the largest share of the price. In fact, the planned imposition of 16 per cent VAT means the tax burden will weigh even heavier on fuel prices.

As at January 18, Kenya had the cheapest diesel in East Africa at Sh77 a litre, 10 per cent below the world average price of Sh85. Compared to Kenya, the cost of diesel was higher by Sh1 in Tanzania, Sh9 in Uganda, Sh36 in Rwanda and Sh37 in Burundi.

Kenya also had East Africa's second-cheapest petrol. At Sh88 per litre, petrol costs 11 per cent less in Kenya than the world's average price. According to globalpetrolprices.com, petrol is Sh4 cheaper in Tanzania at Sh84 per litre, but more expensive by Sh18, Sh25 and Sh27 in Uganda, Rwanda and Burundi respectively.

While prices in Kenya and Tanzania are closer together, Uganda, Rwanda and Burundi have higher prices, mainly because of the high transportation costs they incur due to being landlocked.

Factoring in the purchasing power parity of the different countries would reveal an even wider gap between the prices of petroleum products in Kenya and the four countries, given Kenya's stronger economy, according to the IEA.

PRICES AROUND AFRICA

When countries from outside East Africa, including South Africa, Ethiopia, Mozambique, Zambia and Zimbabwe are included, the cost of fuel in Kenya remains in the middle of the pack. Of the selected countries, fuel is cheapest in South Africa, where super petrol costs the equivalent of Sh75 and diesel Sh61.

According to IEA, prices are lower there partly because the presence of low-cost coal has a downward effect on oil prices. Coal makes up 77 per cent of South Africa energy consumption.

Prices of the two products are also slightly cheaper in Ethiopia, where diesel costs Sh74 per litre and petrol Sh83. Ethiopia also produces a small amount of crude oil and has a lower fuel tax rate than Kenya.

In Zambia, diesel costs the same as in Kenya, while petrol costs Sh1 more per litre. Fuel is more expensive in Mozambique and Zimbabwe, where diesel costs Sh78 and Sh117 respectively, while petrol costs Sh100 and Sh130 respectively.

WHAT BELONGS TO CASESAR

The price of petroleum products in Kenya is not set by market interactions but by a formula that is set by the ERC. This formula has set the profit margin that every petroleum dealer may take for each litre of petroleum fuels.

According to the price controls, which have been questioned by the World Bank, the percentage of tax goes up as the price of crude fuel falls, thus denying consumers the full benefits of dropping global prices.

In Kenya, taxes as a share of fuel prices are highest for petrol and lowest for kerosene.

Of the super petrol price of Sh88, Sh41 (47 per cent) goes to international buying and freight costs while Sh32 (37 per cent) goes to taxes and levies. Eight per cent (Sh7) goes to wholesale marketers, while retailers at the pump get five per cent (Sh4).

From the diesel price of Sh79, 52 per cent (Sh41) goes to international and freight costs, 29 per cent (Sh23) goes to taxes and levies, 14 per cent (Sh11) to wholesale and retail margins and five per cent (Sh4) goes to distribution.

From the kerosene price of Sh54, 75 per cent (Sh41) goes to international and freight costs, one per cent (50 cents) goes to taxes and levies, 17 per cent (Sh9) to wholesale and retail margins and five per cent and seven per cent (Sh4) goes to distribution.

This means that on average, 33 per cent of Kenya's fuel (petrol and diesel) price goes to taxes. The average fuel tax rate in Kenya is close to that of Ethiopia (33 per cent) Tanzania (40 per cent) and South Africa (41 per cent).

In Ghana, where fuel is quite expensive despite the country being a petroleum producer and having access to the sea, about 70 per cent of the fuel price goes to taxes.

PROFIT MARGINS

After determining that pump prices of petroleum fuels in Kenya are lower than in other countries, Newsplex and IEA sought to determine the profit level of major firms in Kenya.

Using the data provided in the financial report of Total Kenya Limited, for the period ended June 30, 2015, IEA calculated that the return on capital for that trading period was less than nine per cent. The publicly quoted company has the largest market share among petroleum marketers in Kenya.

This, together with the fact that the overall profit before taxation had dropped by five per cent for that year, makes it difficult to support the claim of price gouging and super-normal profits by formal petroleum dealers in Kenya. That year's return on capital barely matched the Treasury Bill rates that obtained in Kenya the same year. The profit margin is close to the right per cent that ERC allows for wholesale marketers.

Compared to other major sectors of the economy the profit made by oil marketers is low. Data for US companies many of which have global operations, shows that on average in 2015, the profit margin across the oil industry was expected to be 2.1 per cent after the collapse in oil prices, compared to 21 per cent for health technology.

Pharmaceutical companies, on the other hand, are well known for attaining eye-watering margins. In 2013, for example, the US drug company Pfizer made profit margins of 42 per cent .

Additional reporting by Vincent Ng'ethe

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