The determinants of light diesel prices in Kenya

Abstract

This study was motivated by the important role diesel energy plays in the modem economy and the persistent increase in pump prices over the past decade. Automotive diesel is a quintessential commodity in the modem economy playing a critical role as input product in transport and many other productive processes and therefore a causal factor for economic growth. Increases in the price of automotive diesel poses inflationary pressure to the economy whose effects to the productive segments of the economy is negative. Frequents draughts, lack of alternative sources of energy in Kenya, constrained foreign exchange earnings and the oligopolistic nature of petroleum market have made petroleum prices a stable topic in every day discussions. Diesel continues to be a major source of commercial energy in Kenya given the lack of potential economically viable substitutes with no known crude oil reserves and the high costs involved in exploration, extraction and refinery. This study sought to answer the important questions of what actually determines the pump price of diesel and how this pump prices reacts to changes in primary input components of crude oil, foreign exchange and taxes. The study used an error correction model in analyzing changes in diesel pump prices given dynamism in the input components and the ensuing price making mechanism. The study established a strong relationship between cost of inputs and pump prices of diesel and a strong price adjustment process as measured by the error correction term. These findings are important because they lay bare the specific vulnerability the country faces in terms of dependence on imported crude oil and the market inefficiencies which don't encourage price competitions and therefore, the findings forms a strong foundation for the development of appropriate policies in management and regulation of petroleum pricing in the country.