Tuesday, 13 January 2015

Low energy prices a boon for Kenya's economy 2015

LOW AND DECLINING energy costs are set to be the catalyst for economic growth in Kenya this year.  And - depending on how long the price of oil remains low- energy prices could remain key drivers in the short run. Analysts, including the World Bank expect crude oil prices to remain depressed into 2017.

This means Energy prices, coupled with infrastructure development, will determine the pace of economic growth, employment, investment, the shilling’s exchange rate and wealth distribution in Kenya. And going by the current energy trends, we may not be wide off the mark. 
Forget tourism, forget agriculture and insecurity.  Oil and electricity prices, coupled with infrastructure development, will drive growth in Kenya between 2015- and 2017.

 Let’s look at some numbers:  Crude Oil prices have declined from US$110 in January last year to US$43 yesterday, January 2015.  In January 2014, geothermal power provided only 179 MW or 24 per cent of the 747 MW produced then. Eleven months later, geothermal generated   323MW out of the 751 MW that is 43 per cent of the power generated in the country. The growth in power represented 143 Mw of new capacity. 

Last year, some 280 and MW of new geothermal capacity was added to the national grid.   Added to the existing capacity, some of which came after November, then geothermal capacity now stands at 459Mw of cheap and reliable power. This means that geothermal power production is now the leading source of power in Kenya.   We have noted significant declines in the price of electricity since August last year.

 Back to oil, the US$ 67 dollar decline is yet to be felt fully for pump prices are declining lethargically.  This is expected for price declines are rushing a head of the acquisition rate. In our case, it may be felt six week later.  Even the resistance downward by fuel price will soon fizzle out. Experts say that crude oil price will continue shrinking until investment in shale oil is unviable.

Economic theory tells us that, energy-oil and electricity- are important inputs in the process of producing and distributing goods and services. Consequently, the cost of energy will determine the price of the final product. We can therefore argue that energy determines the market size of goods and services: The higher the price of energy, the higher the cost of production, the higher the price of goods and services hence the smaller the market size as only a few consumers can afford.

 In Contrast, the lower the energy prices other things being the same, the lower the cost of production and consequently, the lower the price and the larger the market.  Local manufacturers have always complained about high energy costs keeping the price of local goods high and limiting their market.

 Now they have opportunity to fight counterfeiting of their products. Where law has failed, Price will succeed for the greatest incentive to counterfeit is the high price of genuine products.  If the price differential narrows or is eliminated, the incentive to counterfeit is also removed.  We expect that manufacturers will begin to lower prices in a bid to elbow out of the market the cheap substandard goods.  

The local manufacturers need a larger domestic market because larger market mean higher profits as the manufacturers expand capacity exploitation, which lowers the production cost per unit. Price declines put additional money in consumers’ pockets; it is more like a salary increase without taxes. This enables consumers to buy more goods and services, some of which were probably beyond their reach. As more people buy different products, demand for workers also rises.

 Low energy prices will also mean that fewer shillings leave the economy thus protecting its strength.  Kenya consumes an estimated 4.5 million tons of fuel products a year. In 2011, this was worth US$15.5 billion but as prices shot up, the bill rose to US$32 billion in 2012. That engineered a consumption decline as some Motorist parked their cars.  At the beginning of last year, the price of crude was US$110 per barrel. As the year drew to a close, crude had retreated to US$77 per barrel. To date the price is around $44 a barrel and is expected to shrink even further. The reason is simple, there is a glut in the crude market but the producers are not willing to cut supply. Suppliers in the Middle East are undercutting each other in the Asian market in a bid to maintain their market share there. This price war will not end soon.

 In the process, they are handing back to Kenya some US$60 per barrel going by the January 2014 price. Our crude import bill has been slashed by 60 per cent to around US$ 15 billion from the 2012 level of US$32 billion. In fact, a recent report by Kenya National Bureau of Statistics shows that by September, the oil bill was just about US$12 billion. This is an indicator that the oil bill last year did not exceed US$15 billion. We a made a massive national savings of US$17 billion from the oil bill alone. It could shrink further or remain the same.  Our balance of trade will be $17 billion richer. Consequently, US$17 billion in Kenya shilling equivalent or Kshs 1.5 trillion will remain in the country.

If the decline stays down for a long time, the government should renegotiate road construction contracts down. The prices of Bitumen and diesel, key inputs in roads construction are expected to shrink further, cutting the cost of building a kilometer of high quality road by half. Such reduction should be passed on to the government as budgetary savings which could be redeployed elsewhere. This is in addition to cost savings arising from low electricity and fuel prices.

 The government should start by re-negotiating the terms of the on-going PPPs for the construction of the first 2000KM of road through the PPP model. The project that will build 10,000KM of Bitumen roads by 2018 should be reviewed to bring down costs.  The savings so made should be used to develop water supplier to the large community thus employing more people.

 The 200KM project is expected to create some 20,000 jobs this year. Coupled with the construction of the standard gauge railway, which will create another 30,000 jobs and Konza techno city which will also create a large number of jobs, infrastructure development will be the driver of economic growth in the country. These are ingredients for economic growth. How far that growth will go we cannot tell for sure. However, we expect the economy to by 6-7 per cent this year.

 There is a downside though: The shrinking prices could slash investment in oil exploration.  In 2013, FDI into Kenya rose to more than US$500 million. Kenya has commercial deposits of crude oil and was expecting to start commercial production in 2017. Whether that goal will be affected remains to be seen. What is certain is; further exploration could be put on hold. 

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