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What the government is not saying about oil prices

Oil prices have been on a down trend since mid 2014 falling a whopping 73.90% from US dollars 115 to US dollars 30 per barrel. Using current Dollar-Shilling exchange rate of 101.90, oil has fallen from Kenyan shillings 11,718.50 to Kenyan shillings 3,057 per barrel.

Much has been said about the decline hence I will only highlight on the reason behind the decline and the impact in our local economy.

Decline in oil prices can be attributed to the simple economic law of demand and supply. The law states that for any given increase in supply of a product, there is an inverse reaction of decrease in price of the given product. For the last three decades, there have been five other episodes of oil price decline of above 30% or more in less than a year period due to shift in global demand and supply factors.

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Oil supply has been increasing as indicated by recent development in oil markets. United States shale corporations have doubled their production in the last few years whereas geopolitical developments like the Iranian nuclear deal which has lead to lifting of Iran economic sanctions and the stalled advance of ISIS in Iraq signify increased supply of oil in the global market. Unconventional oil sources like biofuels which have been on the rise since mid 2000 have only added volumes to the already glutted global oil market.

On the other hand, demand for oil globally has been declining as more efficient methods of uses are being developed and also because of the slowdown in global economy. Global economic slowdown means that there will be less demand for oil since most economic activities tends to be oil intensive especially for developing economies.

The increase in supply and decrease in demand for oil in the global market can be linked to the continuous decline of oil prices in the global markets. Prices will only revert when the supply-demand equation changes.

What this means for our local economy

Looking at the 73.90% drop in oil prices, the current fuel prices in Kenya does not reflect this significant drop. Comparing petrol prices in Kenya for a similar period, there is only a 24.12% decline in prices from Kenyan shillings 114 to the current price of 86.50. The percentage change in petrol prices increases to 34.88% from 24.12% when you factor in exchange rate fluctuations (from 88 shillings per dollar to 102 shillings per dollar) but still the price change is only half the global price change.

One may be tempted to attribute the difference to processing costs. This is not the case since much of the difference can be linked to the fixed cost of Kenyan shillings 48 per liter of petrol which the Energy regulatory commission (ERC) claims cannot be altered. The fixed costs include Kenyan shillings 33 in government taxes, 4 in distribution costs and 11 in wholesaler’s margins. This means that even if the price of oil falls to zero, Kenyans would still be paying shillings 50 per liter of petrol.

This shortchanging by the government from the high taxes and minimum scrutiny on customer protection regulations may seem trivial in the short run but the longer term effects can adversely affect your income levels and wealth in the future. Oil prices feed into your personal electricity bill, transport bill and also into manufacturing of most of the products you use hence increasing your personal expenditure and lowering your ability to save.

Since oil prices are projected to be low for the near future, oil importing developing countries like Kenya may largely benefit from the lower prices if they enact fiscal and monetary policies that may spur economic growth in the long term.

Decline in oil prices should support economic growth, reduce inflation and improved current account deficit. The central bank may establish accommodating policies to attract investors since there would be minimum risks of rising inflation and the government may introduce oil subsidies or reduce taxes on oil and oil related products.

This may reduce overall energy costs which will feed into reduced prices of manufactured goods and may allow surplus capital through savings and higher profit margins for companies to be accumulated in the economy which can be invested in newer ventures creating employment.

The government may also halt the current oil exploration campaign since the overall benefits to the economy may be negative if oil prices continue to hold this low. Prices fluctuate up and down hence the oil project may be more viable in the near future but the given resources for the oil project may be allocated elsewhere to earn a higher return for the local economy.

All in all, you should be concerned about the current fuel pricing in Kenya as it has direct implications in your income and expenditure.

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Posted by Timothy II Aperit

True believer in numbers. Statistics never lie. Bsc Financial Engineering MBA Finance ACCA