RSS Feeds RSS | Views on ITInews | contact | terms of use | privacy 

Editorial Categories:


Forthcoming Events:

No Upcoming Events

Save by getting insurance quotes

Proudly South AfricanInforming Consumers and Financial Advisors since 1988 | Click Here to Advertise
Car, household, life and business insurance quotes

News Article : A few thoughts on the slide in oil prices
Category: Economy & Global : Local Economy
Author:Jac Laubscher
Email:[email protected]
Posted:09 Jan 2015

 Email this article Comment on this Article  Print this article

The implications of lower oil prices for South Africa are numerous and mostly advantageous

The oil price has been much in the news lately because of its unexpected and dramatic slide since the middle of last year.

The benchmark Brent crude-oil price has more than halved since June 2014 from $112 per barrel to $49 at the time of writing (see the graph below).

Source: Nasdaq.

The sharp decline in the oil price in response to a changing balance between demand and supply once again demonstrates the danger of extrapolating recent trends when forecasting the future.

It is not long ago that “peak oil”, viz. the view that the rate of oil extraction has reached its peak and will decline from then on until oil reserves have been fully depleted, putting upward pressure on prices, was the dominant theme in oil markets.

The prevailing view was also that as far as oil reserves were concerned the low-hanging fruit had been picked and that marginal production costs would keep on increasing as producers were forced to exploit reserves that were more difficult and expensive to reach, for example at very deep sea levels.

Brent oil was trading at approximately $150 per barrel at the time and the expectation was that oil prices would remain high.

So once again a doomsday scenario regarding the depletion of the resources offered by planet earth has proved to have been adopted prematurely!

However, by implication one should also avoid the trap of extrapolating the current low prices into the distant future.

Just as $150 was not an equilibrium price, the reigning low price of around $50 is also not a stable equilibrium.

It will take some time for the market to adjust to the new reality and find a sustainable equilibrium.

What we are witnessing at the moment is a classic fight for market share that will continue until sufficient high-cost production has been removed from the market to bring supply and demand into balance.

Estimates of the marginal cost of producing a demand/supply-balancing barrel of oil vary but tend to converge around $80 and oil prices lower than this would therefore appear to be unsustainable in the long run.

For some people the slide in oil prices demonstrates the game-breaking power of technological development.

For others the slide is merely cyclical, viz. the result of reduced oil demand because of a weaker economic outlook for Europe and China in particular.

For the first group previous high prices and increased awareness of environmental damage, in particular the challenge of global warming because of the emission of greenhouse gases, served as encouragement for a reduction in the resource intensity of economic activity by lowering energy requirements and shifting to renewable energy sources.

But the greatest technological response was on the supply side where the development of fracking methods to exploit the possibilities of shale oil added a completely new dimension to the supply of oil, undermining the dominant position of OPEC, in particular Saudi Arabia, in setting prices.

(It is interesting to note that in an article on “The Innovative State” by Mariana Mazzucato in the January/February 2015 edition of Foreign Affairs, she points out that the 3-D geologic mapping technology used for fracking operations was developed by Sandia National Laboratories, part of the US Department of Energy, as long ago as during the 1970’s.)

For the second group lower oil prices are a temporary phenomenon, with weak primary demand being exacerbated by inventory reduction in anticipation of higher interest rates.

The biggest impact of sharply lower oil prices will be on the economic and fiscal position of oil-producing countries.

This highlights the wisdom for commodity producers of having sovereign wealth funds in order to smooth the long-term impact of their commodity wealth on their economies.

Countries that rely excessively on taxes from the oil industry to balance their fiscal books will be particularly hard pressed by the recent price slide in the absence of the stabilising influence of such as fund.

The implications of lower oil prices for South Africa are numerous and mostly advantageous.

The immediate impact will be to reduce inflation via lower fuel prices and possibly less rand weakness as a result of an improvement in the current account balance caused by reduced oil imports (although one should bear in mind that coal prices are linked to oil prices through the partial substitutability of oil and coal, reducing the value of South Africa’s coal exports.)

This should in turn restrain the South African Reserve Bank from raising interest rates.

However, the Monetary Policy Committee will have to bear in mind that this is a one-off positive shock that will in all likelihood be partially reversed at some future date.

Watching the trend in core inflation, viz. in prices excluding energy and food, will therefore become more important as a true reflection of inflationary pressures and its current close relationship with headline inflation (in November 2014, the latest available numbers, both measures were running at 5,8%) will probably not hold.

Although not enough to solve Eskom’s financial crisis, lower diesel prices should assist Eskom in dealing with its cash crunch given its abnormally high use of diesel fuel to feed gas-driven generators, while further cost savings should be achievable once long-term coal supply contracts can be renegotiated.

South Africa’s strategy for expanding future energy supply will also have to reckon with the changed outlook for carbon fuels.

Not only will the position of nuclear power relative to coal-fired power stations be affected, but the viability of exploiting shale-gas deposits in the Karoo will have to be reconsidered and the abnormally high free-carry (20%) the government intends to claim looks more onerous by the day.

Lastly, lower fuel prices will create space for the government to fill part of its revenue gap by increasing the fuel levy in the coming National Budget by more than what would have been acceptable under normal conditions.

The fact that last year’s increase in the fuel levy was limited to a mere 12c/litre, resulting in a drop of nearly 2 percentage points in the ratio of taxes to pump prices to 24,2%, also points to a more hefty increase this time round.

The 12c/litre increase in 2014/15 was expected to contribute an additional R2,565 billion to government revenue.

Upping the fuel levy increase by, for example, 36c/litre could therefore cover a third of the additional tax of R15 billion that needs to be raised in the coming fiscal year as indicated in the Medium Term Budget Policy Statement last October.

However, it is still an open question at what level oil prices will eventually settle.

Jac Laubscher is an Economic Advisor with Sanlam

There are no comments at this stage. Be the first to comment!
Please Login To Comment On an Article - Click here To Login

ITInews invites comments at the foot of each of its articles in which readers can respond freely - anonymously if they wish - to various topical issues and industry debates. However, comments submitted by readers that are defamatory or deemed, by the editors, to be racist or obscene will be deleted from the database. Furthermore, ITInews's editor would like to caution potential posters on its websites that while it welcomes robust debate, it will not hesitate to make the IP addresses of the authors of such defamatory statements available to the authorities, in the event of a court order compelling them to do so.

Get car, home, life and business insurance quotes in 3 easy steps

Join us today

Insurance Quotes

Car Insurance Quotes
Household Insurance Quotes
Business Insurance Quotes
Funeral Insurance Quotes
Life Insurance Quotes

Read the InsuranceQuotes Blog

Economy & Global - Local Economy
Disaster Insurance
Global Economy
Local Economy

More in Economy & Global : Local Economy
Can South Africa avoid junk status? (Part 2)
The risk of a downgrade in the near future is relatively high
Can South Africa avoid junk status? (Part 1)
The South African government does not have a growth policy
South Africa falls short of national savings ‘pass rate’: first Savings Index launched
Investec GIBS Savings Index
Aligning monetary and fiscal policy
Is a tightening of monetary policy in conjunction with an unavoidably tight fiscal policy the best o
The effect of indigenisation, such as BEE, on financial development
Indigenisation as an economic intervention is frustrated by high levels of corruption
The insolvency U-turn
Euler Hermes Economic Outlook 2015-16
Where will growth come from? Part 2
A possible growth strategy in the current global environment
The (not-so-) hidden message of the Medium Term Budget
South Africa needs to reconstruct social consensus behind a path of accelerated economic growth
Where will growth come from?
The absence of an inherently independent growth dynamic in the economy
Contracting GDP detrimental to SME development
2015 was expected to be a better year ...
The SARB and the carry trade
Trying to support the exchange rate of the rand by hiking interest rates is an exercise in futility
Why small business does not create jobs
In South Africa we are self-employed out of necessity
The state of South Africa’s political economy
A pragmatic rather than an ideological approach
The Fall in Private Investment
South Africa’s potential growth rate has suffered long-term damage
The Management of Government Debt
South Africa runs the risk of its credit rating being downgraded
SA consumers cut back on socialising as tough economic conditions
But gifting still a significant portion of budget
Visa African Integration Index shows improvement
But long way off the global median
South African digital economy the most developed in Africa – MasterCard Index
South Africa, Egypt, Kenya and Nigeria are quickly moving towards digital evolution
The threat of secular stagnation
It is generally accepted that structural reforms are the only answer
A medium-term budget: an effort to draw the line
Weak economic performance has enforced material consolidation of fiscal policy

Join ITInews in supporting

Available Recruitment:
No Vacancies Listed...

ITM Website Design Cape Town
Copyright © 2005 - 2015 ITInews Online Publications (Pty) Ltd. All rights reserved Insurance Times & Investments Online and ITInews. ..::ISSN 1995-1256::.. No part of the materials including graphics or logos, available in this Web site may be copied, photocopied, reproduced, translated or reduced to any electronic medium or machine-readable form, in whole or in part, without specific permission from ITInews Online Publications (Pty) Ltd. Distribution for commercial purposes is prohibited.