/ 12 January 2015

Cheaper oil price will be a boon for poorer families

The oil price has bobbed at around $110 a barrel for the first half of 2014 but from August
The oil price has bobbed at around $110 a barrel for the first half of 2014 but from August

The price of oil may have halved over the past six months but it has left consumers wondering when prices of other goods and services are going to decrease. 

But, with a little time, it will prove overwhelmingly positive for consumers, and not least help to keep inflation and interest rates down.

The oil price has bobbed at around $110 a barrel for the first half of 2014 but from August, as supply continued to outstrip demand, it began its steady plummet –and recently dipped below the $50 mark and R49.29 on Monday morning.

“It’s truly bringing a deflationary effect, meaning interest rates for consumer should be low,” said Mike Schüssler, director at economists.co.za. “Overall for the consumer, it is a great thing and for an oil importing country such as ours its good news.”

The first place to look for the lower oil price is the petrol price. Cumulatively, the domestic petrol price has dropped by more than R3 a litre since August last year.

“The average motorist, from the [oil price] high in May last year up until Wednesday, will save R440 a month … and for the average person that’s 4.5% of total disposable expenditure available to him,” said Schüssler.

Lower income groups to benefit
Government taxes and levies and distribution costs, not just the price of oil, make up the petrol price. The basic fuel price, which is largely based on spot prices quoted daily on international markets, in South Africa comprises only 55% of the price consumers pay at the pump, according to the South African Petroleum Industry Association, while taxes, levies and distribution costs make up the balance.

John Loos, household and property sector strategist at First National Bank, said a consumer price index inflation rate of about four percent or lower before the first half of the year comes to an end was not inconceivable. The inflation rate eased to 5.8% in November.

“Significant downward pressure on South African imported price inflation, notably food and oil prices but others too, emanating from the decline in global food and oil prices along with some renewed rand stability, promises to take consumer price inflation significantly lower.”

Lower income groups would probably benefit the most, Loos said. This is despite public transport inflation remaining high (7.76% higher in November 2014 versus November 2013). Private transport inflation slowed to 1.67% by November and deflation looks set to come soon.

However, “examining the food price effect, the direct inflationary impact of the decline in global food prices should be clearly far more in favour of the poor. The lowest expenditure quintile has a massive food spend weighting of 39.06% in its ‘expenditure basket'”, said Loos.

Food price drop lagging behind
With the producer price index inflation rate having fallen sharply from 13.3% in March 2014 to a lowly 1.1% by November, further decline in the consumer price index inflation rate for food looks highly likely.

“This is where the low income groups play some catch-up,” Loos said, but noted the food price drop has not been as extreme to date as the oil price drop.

He said the potential economic and interest rate benefits that could emanate from a lower inflation and oil price period could be expected to improve the overall financial situation of lower income households to a greater extent.

Consumers are also expectant of a drop in the cost of air travel, but this is not likely. Linden Birns, an aviation analyst, said the airline industry was already very competitive.

“They had to make some real improvements in the system when the oil price was super high and they invested heavily in aircraft and systems to make themselves more effective more efficient,” said Birns.

“You also have to remember the profit margin are slender, about 1% globally. Maybe now they can look at 4% or so. I can’t see it going down at all – not in South Africa anyway … The depreciating rand is important because a large portion of airline expenses are in dollars.”

Airlines have different fuel agreements that could, in some instances, have been secured five years in advance and often work on a sliding scale. “No one is sure how low oil prices will remain low,” Birns added.

Oil price won’t be low for too long
Tom Nelson and Charles Whall, portfolio managers at Investec Asset Management, said in a press release they believed the oil price was unlikely to stay this low for an extended period of time.

The sell-off has been driven by Opec’s surprise actions and not, as popularly believed, a supply glut. “We believe the oil price is unlikely to stay below the industry’s cash operating cost for too long … We expect the recovery in the oil price will likely surprise investors in its speed and scale.”

They said the realisation that Saudi Arabia would not moderate production to support oil prices has let loose the animal spirits of traders who continue to sell oil aggressively. “The change in Saudi behaviour cannot be overstated, and far outweighs the demand weakness that we expect to be transitory.”

Nelson and Whall forecast Brent oil will average $60/$70/$80/$85/a barrel in the four quarters of this year, to give a full-year average of $70-75 a barrel.