Energy price regulation has outlived its intended purpose
What you need to know:
- This policy initiative was sold as a mechanism to moderate price increases and to reduce the tendency for firms to collude in price gouging.
- Instead, the price of petroleum in Kenya exhibited great volatility with the monthly announcements of new recommended prices.
- This was a perverse incentive for the reason that it assured traders of a return while setting an arbitrary nominal profit.
- Immediate revocation of the regulations of December 2010 would improve public welfare in Kenya and act as a reminder that legislation, however popular and well-meant, is no substitute for clear economic thinking.
In 2006, Parliament passed the Energy Act to replace an obsolete law. Contained in the new statute were provisions that granted discretion to the Minister for Energy to draw up subsidiary legislation.
In 2010, the Minister for Energy summoned powers under section 102 (w) of the Energy Act to publish subsidiary legislation.
The most enduring and significant policy change was the introduction of the petroleum pricing regulations that established a formula for publication of recommended maximum wholesale and retail prices for petroleum products in Kenya by the Energy Regulatory Commission.
Because petroleum prices had been on an upward trend from 2003, this policy initiative was sold as a mechanism to moderate price increases and to reduce the tendency for firms to collude in price gouging.
Parliamentarians were persuaded that the Energy Regulatory Commission would ensure that private firms would not keep raising prices to the detriment of consumers.
NO SUNSET CLAUSE
The popular measure was carried through, notwithstanding sensible arguments that this price regulation mechanism was not only unnecessary, but also unlikely to achieve the intended price reductions.
While neither the Energy Act of 2006 nor the subsidiary legislation of 2010 had a sunset clause, circumstances in the international petroleum markets today present an opportunity to review this price regulation mechanism.
This review leads to the unequivocal finding that the regulations regarding the price-setting role of the Energy Regulatory Commission should be abolished.
The first reason for this is that despite the claim that the price regulation formula would ensure prices of petroleum products in Kenya would not rise, the experience is that this was not achieved.
HOARDING FUEL
Instead, the price of petroleum in Kenya exhibited great volatility with the monthly announcements of new recommended prices.
An unintended effect of the monthly adjustments was that petroleum hoarding, long queues and fuel shortages occurred on a significant scale for a few months after the introduction of the price-control formula.
The reason for this was that in anticipation of the adjustments, retailers had to consider whether to sell the entire stock of fuel within the month or hoard it and try to raise their margins in the subsequent month.
A dispassionate review of the performance of the formula would have to lead to the conclusion that it was a grand symbolic policy gesture that failed to solve the problem that it was meant for.
BELOW $80 PER BARREL
That history aside, this requirement has become an unnecessary burden to the Energy Regulatory Commission (ERC) since the international prices of crude petroleum have been falling again.
In the last week, prices of the index barrel of crude petroleum in Europe and the United States have both fallen below $80 per barrel. The high prices that justified the introduction of the formula for wholesale and retail prices no longer obtain.
The Cabinet secretary for Energy ought to rescind the sections of the regulations related to price regulation, since the conditions that justified the price control mechanism are no longer a reality.
While this price regulation policy was intended to protect Kenyan consumers from exploitation in the form of price hikes, the design of the formula had a particularly bad condition.
ARBITRARY PROFIT
The market process was undermined by the fact that the formula fixed a Sh6 premium in all prices and thereby assured all wholesale and retail traders of a profit for their sold product.
This was a perverse incentive for the reason that it assured traders of a return while setting an arbitrary nominal profit. In these circumstances, the incentives for competition and innovation in the retail and wholesale portions of this industry were effectively blunted.
Clearly, the revocation of the regulations would reintroduce the need for competition and innovation among firms.
It is important to ask what the effects of the revocation of the price control formula would be.
IMMEDIATE REVOCATION
While reduced prices of crude petroleum at the international level have rendered the price-regulation formula redundant, other regulators such as the Competition Authority of Kenya would be at hand to respond to the possibility of collusion in Kenya.
Immediate revocation of the regulations of December 2010 would improve public welfare in Kenya and act as a reminder that legislation, however popular and well-meant, is no substitute for clear economic thinking.
The last four years of the regulations are a good reminder that Kenya’s Parliament needs to, as a rule, consider sunset clauses for all laws and regulations. Otherwise, the country may end up with immutable laws when the circumstances that justified their enactment are long gone.
Kwame Owino is the chief executive officer of the Institute of Economic Affairs (IEA-Kenya), a public policy think tank based in Nairobi. Twitter: @IEAKwame
