Why EPRA's pricing formula is under scrutiny

Fuel prices defied a Sh6.2 billion subsidy and a cut in Value Added Tax (VAT) to report a record breaking jump, a shocker that analysts say Kenyans are not ready for.

 Reacting to the new fuel prices, experts called on the government to implement further tax cuts to cushion the economy from the unfolding crisis, while also relooking at the Energy and Petroleum Regulatory Authority (Epra) pricing formula.

 Some even suggested that the formula be abandoned to let market forces determine retail prices.

 Epra announced late Tuesday the government would spend Sh6.2 billion to subsidise pump prices, with a litre of diesel subsided at Sh23.92, a litre of petrol Sh4.68 and kerosene Sh108.10.

 It also cut VAT to 13 per cent from 16 per cent. The measures, Epra had explained, would cushion from high landed costs. 

 But the prices surged, with diesel set at Sh206.84 and super petrol Sh206.97 in Nairobi. 

 Analysts say Kenya’s wobbly economy cannot support the high prices and that Kenyans should prepare for tough times ahead as many goods and services go beyond reach for many. Already, public transporters have increased fares.

 The economy has in the last few years experienced multiple shocks that included a drought that gave way to devastating floods, and debt sustainability crisis.

 University of Nairobi lecturer Prof XN Iraki says the economy has not fully recovered from the major shocks that it has been experiencing and is ill prepared for the another.

 “The cost of living was a major concern when Kenyans voted in the 2022. It has remained a big issue up to now. For us to have another shock at this time will compound the shock that we have had for the last three years,” he says.

 “In the last month, we have been expecting an increase. What we did not expect is the margin, which is quite significant.”

 He further explains that prices of fuel and food are major economic drivers in the country, and while the ongoing rains might bring some reprieve, fuel costs would still push up the cost of everything.

 “The worst is that we are not prepared for it. The government should have done more, like cutting taxes. In as much as the government needs the taxes, we also need the money and we should share the burden,” says the professor of business studies.

 Taxes and levies account for a significant chunk of the cost of petroleum. Despite the cut in VAT, taxes account for Sh82.09 or 40 per cent of the retail cost of petroleum in Nairobi. Taxes on diesel stand at 36 per cent or Sh74.90.

 Due to high taxes, fuel prices in Kenya are higher than in the neighbouring countries. In Rwanda, which relies on Kenya and Tanzania to import petroleum products, a litre of super petrol is retailing at about Sh203 (2,303 Rwanda Francs) and diesel at Sh196 (2,205 Rwandan Francs).

 And while Tanzania on April 1 increased prices by an equivalent of Sh50, prices are still lower than Kenya, with a litre of super petrol retailing at about Sh192 (TSh3,820) and diesel at Sh192 (TSh3,820).

 Martin Chomba, chairman Petroleum Outlets Association of Kenya, says the government needs to take a deeper cut in taxes.

 “It is a time of economic distress across the world and akin to what we experienced with Covid-19 pandemic. I expected the government to, probably, forego eight or 10 per cent of VAT. In as much as the government does not get money from other sources, it should have looked at the taxes it can suspend…  a Sh40 per litre shock is a huge shock for the economy of our size and we are likely to see serious ripple effects.”

 Chomba further cautions that there may be no relief next month.

 “We are in the eye of the storm. We do not know what this crisis portends.”

 The Institute of Economic Affairs (IEA) suggests reforming of petroleum products taxation. The lobby also calls for the disbanding of the price caps to let market forces determine prices.

 Fiona Okadia, an economist at IEA, notes that VAT is calculated on top of all other taxes and levies applied to fuel, creating a "tax on tax" effect that inflates prices unnecessarily.

 She argues that VAT should be applied only on the base cost of the fuel, while keeping other levies and stabilization mechanisms in place. Alternatively, she says, the government could keep VAT as currently applied but suspend or even remove excise duties.

 “While reducing fuel taxes can cushion the immediate impact of rising prices, combining such measures with strict price controls often creates conflicting outcomes. A more balanced approach would involve lowering taxes while removing price caps, allowing prices to better reflect market conditions without placing excessive strain on consumers.”

 She notes that prices setting must consider the central role fuel plays in the economy.

 “Changes in fuel costs ripple through transportation, production, and ultimately the prices of most goods and services. Attempts at central price-setting tend to overlook this complexity.”

 Iraki also notes that much-hyped Government-to-Government deal, which also has elements of price control, may not be giving Kenyans the best deal. “Any time the market is let to do its work, we always get better prices.”

 The sentiment is echoed by Albert Karakacha, president of the Matatu Owners Association.

 “We used to have liberalisation and maybe we need to go back there,” he says, noting that the Competition Authority of Kenya should crack down on cases of anti-competitive behaviour and consumer exploitation.

 Epra, when it set out to cap retail prices of fuel products more than a decade ago, noted that oil marketers were slow to pass the benefits of lower international oil prices to consumers. On the other hand, when global prices went up, the firms would increase pump prices immediately, sometimes even before the higher priced cargoes hit the local market.