13 Jan 2015 This time the oil price can stay low for longer
Looking at the oil price graph from 1996, it is clear that the oil price never stayed low for long after a substantial drop. In 1998 the oil price dropped more than 50% from over $20 to below $10, but it recovered back to $20 in only six months. Same 50% drop ($35 to $17) in 2001 with another short recovery. In 2008 it fell more than 70% from the record $145 to below $40. It took only six months to recover to $70 and just more than a year from there to breach $100.
Why will this time be different? All the previous declines were demand side driven, meaning they were caused by a decline in demand as a result of mostly weak economic growth. The recent financial crisis resulting in recessions in all countries except China is a case in point. This time weak economic growth has been with us since the crisis in 2009 as the US and Europe battle with QE measures to get growth going. Not much changed on the demand side over the last few years.
The current decline of over 50% is caused by the supply side with massive overproduction as well as a geopolitical change. Last year the US, formerly a huge importer of oil, became self-sufficient as a result of developing their huge shale gas reserves (fracking). Globally many countries are developing shale gas reserves, especially Russia. Once these reserves are developed there will be a massive oversupply.
And that is where geopolitics comes into the picture. Russia’s attempt to expand into the Ukraine has infuriated the West. Their allies, Saudi Arabia and Kuwait, are also worried about the potential oversupply created by Russia’s huge reserves of shale gas. For both it is feasible to have a low oil price now and to have it for some time, a few years at least. The effect will be to halt further development of shale gas in Russia as their cost of production will be closer to $100 per barrel. It will also drive out a lot of current high cost producers. The first companies already started to file for bankruptcy in the US. It allows the Saudis to protect their market share, albeit at a lower price. Further exploration and developments will likely stop now.
It is not possible to predict the bottom or where the oil price will stabilize. Saudi Arabia and Kuwait’s cost of production is less than $7, but they will have to scale down government expenditure as a result of lower oil earnings. For most Middle East countries the lower oil revenue will have huge impact on their fiscal accounts leading to big deficits. That will hurt the aggressive neighbours like Iran and Iraq as well. If I have to make a guess, I think the oil price will stabilize around $50 to $60 after making a low of who knows. Over the next few years it may slowly creep up to $75, but I don’t expect $100 for many years, unless off-course if we get the type of global economic growth we had before 2008, and that is unlikely.
The benefits for South Africa can be huge. With an oil price below $60 our GDP is likely to be boosted by more than 1%. Consumers will have more money to spend as this is an after tax bonus. Our Current Account of the Balance of Payment deficit is likely to benefit 1.5% to 2% or more. When rating agencies see our deficit at 4% instead of 6%, they will be much less concerned about at least that worry. This can prevent further downgrades that will leave us on the brink of Junk status which, if breached, will have a huge negative impact on the Rand and interest rates.
All positive, so why is the currency at R11.50 and the JSE lagging world markets? The main reason is Eskom. Unfortunately the problems created by lack of electricity supply by Eskom are likely to reduce economic growth by more than 1%, cancelling the oil windfall. Labour is another worry where long, violent strikes based on excessive demands can also reduce economic growth, worsen the Current Account and cause a rating decline in 2015 as it did in 2014.
I fully support increasing tax on fuel as an alternative to raising income tax or VAT. The Minister is likely to do one of the three in any case. Firstly the increased fuel tax will not be felt by consumers, the windfall is just less. Secondly it is a very efficient tax as everybody has to pay it, even taxi drivers who rarely declare income for tax. It is also very easy to collect and virtually impossible to evade.
I am confident that without the Eskom crisis, and yes it is a crisis (just ask any small business), the Rand would be sitting pretty at R10.50 now and the JSE would be closing in on a record high. Let’s hope and give Deputy President Ramaphosa and Finance Minister Nene our support to try and rescue the electricity crisis and fiscal overspending so that we can really benefit from this windfall.
– Gerhard Lampen
Head, Sanlam iTrade Online