Failure by the government to punish those engaging in fuel adulteration and diversion of transit oil into the local market is causing frustration in the oil industry.

It is also bringing into question the future of the much-hyped bio-coding project.

Widely touted as the panacea to fuel adulteration and dumping, the scheme, which involves secretly putting a marker in fuel destined for the local market and for export, then mounting random inspections at points of sale, has come a cropper.

Perhaps the reason is the apparent realisation by culprits that the government was in no hurry to prosecute them, at least not on the strength of the damning evidence gathered through the bio-coding process. And it would seem that the malefactors are now going about their business with impunity.

Fuel adulteration is the illicit mixing of two or more fuel types with the aim of maximising margins. Most preferred by the cheats is the mixing of kerosene with petrol or diesel because of the proximity of their chemical and physical properties, and because tariff differentials afford the dealers greater returns.

Kerosene is taxed at Sh6.12 per litre while diesel is taxed at Sh15.92. Premium and regular petrol attract a tax of Sh23.36 and Sh22.97.

Industry sources indicated that if 1.5 litres of kerosene was added to every 10 litres of diesel, the tax element falls by Sh1.50 which is the extra margin gained by the dealers.

It is estimated that some 3.5 to 4 million litres of kerosene was being diverted to motor fuel every month, with grave consequences to vehicles.

In Kenya, fuel on transit to other countries is zero-rated and is only liable for taxation in the importing, third country.

Unscrupulous traders have, however, been selling this fuel in the domestic market, making a bounty killing and costing the state an estimated $30 million (Sh2.2 billion) in lost revenue. Mostly targeted is fuel meant for the Great Lakes region, including Uganda, Rwanda, Burundi, DRC Congo, among others.

The bio-code exercise has been operational since June 1999 and is administered by Swiss quality inspection firm, SGS Ltd, in partnership with biotechnology concern Biocode, the developer of the secret marking system used.

But oil vendors said the project was expensive to maintain and was only effective if culprits found were punished.

"The programme was started to stem the tide of illegality in the country's oil market. If this can not be achieved because the authorities are not prosecuting, then the project's very existence can no longer be justified," said an oil industry executive who sought anonymity. His firm, he added, was already in touch with its parent company to stake a way forward and would announce a decision soon.

According to industry sources, the bio-coding arrangement costs the mainline dealers an average of Sh3.5 million per month.

The hefty imbalance between cost and result prompted oil vendor Kenol-Kobil to pull out of the scheme last August. And if the cases so far detected do not find their way to court, the mood in the industry is that the extra costs can not be justified.

BusinessWeek could not get a comment from Energy Permanent Secretary Mwanyengela Ngali, who was said to be out of the office.

"We withdrew from financing the exercise because it was not bearing results. While we could discipline our own errant sites by striking them off the roll, nothing was being done to the independent sites. It was sending all the wrong signals," said Kenol-Kobil managing director Jacob Segman.

And the statistics obtained from SGS would seem to concur.

The general skew shows that immediately the bio-coding arrangement was started in June for kerosene, the incidence of adulteration among sampled petrol outlets went down significantly, especially among the so-called independent dealers.

By August and September, 1999 no private sites were incriminated in the vice; this from four in July against three company sites in the same month.

This is the period when bio-coding was fresh and the culprits did not want to take chances. It was imperative to cover their flanks; to bid their time.

But an interesting statistical departure was to happen in October when after the two-month lull, some five private sites were found with their fingers in the candy jar. Intriguingly, the number of company sites "found guilty" seems to have taken a steady incline: from three in both July and August, to eight in September and nine in both October and November, perhaps debunking the notion in the mainstream quarters that adulteration was basically an independent-dealer racket.

But this could also be a statistical aberration brought about by one-off jobs financed by the big dealers on their sites and the fact that the implementers have unlimited access to company sites, unlike private ones.

Overall, the incidence of export dumping has fallen from 12 per cent when bio-coding was introduced to 3.6 per cent in the post-biocoding period.