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Will the oil price surge hurt South Africa’s recovery?

Oil fuels economic activity and growth, which South Africa desperately needs to revive its battered economy and address record unemployment levels.

Revised GDP forecasts indicate that 2021 will likely deliver economic growth of 4.6% year-on-year, beating previous estimates (of 3.9% y/y), as the global recovery and the marked strength of commodity prices benefits South Africa’s exports with other areas, and the country’s GDP growth also gains traction.

However, rising oil prices have the potential to affect the country’s economic recovery by increasing the costs of living and doing business, primarily through higher transport and production and manufacturing input costs.

These rising input costs result in higher prices for products and services, which directly impacts inflation, as measured in the consumer price index (CPI). And the resultant fuel price increase indirectly affects inflation through the potential pass-through effects on food and other goods prices due to higher transport costs.

Overall, rising inflation affects sentiment, erodes disposable income and reduces affordability, thereby constraining consumer and business spending.

Net oil importers are particularly vulnerable to escalating oil prices, especially when local currencies lose value against the dollar — the currency used to purchase oil on the global market. For instance, a weaker rand could amplify the effects of rising oil prices, particularly as South Africa has become a net importer of petroleum products.

Despite holding crude oil reserves, local refineries are currently offline or not operating at their optimal level, according to the Investec securities commodities team. As such, domestic demand exceeds available supply, which means South Africa is importing more refined oil.

While oil prices collapsed in 2020 amid the pandemic-induced economic slowdown and a lack of cooperation between OPEC+ producers, the group subsequently agreed on a record output reduction of almost 10-million barrels a day. This decision coincided with rising global demand on the back of vaccine roll-outs in advanced economies that have normalised economic activity and supported growth in global trade.

Consequently, the oil price recently hit multiyear highs above $70 per barrel of oil. According to the Investec securities commodities team, the Brent spot oil price is expected to average around $75 in the second half of 2021 and into 2022, compared to $65 per barrel in the first half. Some forecasters even predict an increase to $100 in 2022.

The value of South Africa’s oil imports will also likely rise in the second half of 2021 at a faster pace than that experienced in the first six months of the year, at a time when oil and petrol prices continue on their upward trajectory.  

The fuel price increased by a cumulative 267 cents per litre for inland 95-octane unleaded petrol between December 2020 and June 2021 after international oil prices rose from $51 to $70 (an increase of 37%). The appreciation of the rand has partly contained the increase to 25%.

Potential demand-supply gap

With expectations that the oil price could rise by $10 per barrel, South Africa could experience cumulative fuel price increases of around 60c/l in July and August. This upside risk to the forecast emanates from a potential demand-supply gap. On the demand side, global growth is forecast to remain strong, which will sustain demand-side drivers. Domestic demand is also rising in 2021, although to levels below 2019 as real economic output remains below pre-pandemic levels.

The main caveat to continued rising demand pertains to a renewed increase in Covid-19 infection rates and/or a shortage in vaccines, which could lead to sideways movement in the oil price.

On the supply side, an oil “shut in” due to lockdown restrictions could reduce output, which would require more fixed investment to increase output. A zero target for emissions in Europe could impact investment, says the Investec securities commodities team, with greenfield investment taking up to three to five years to come on stream. Additionally, a return to production from Iran or developments in Saudi Arabia could also affect supply.

Fortunately, the local economy has other factors working in its favour. For instance, the balance on the merchandise trade account is expected to remain in surplus, although somewhat lower.

While commodities prices experienced a downward correction over the past month, commodity prices remain firm, and the global economic recovery continues to support global trade. This is reflected in South Africa’s strong terms of trade (export prices divided by import prices), which remain at the highest levels since 2011. Furthermore, weak domestic fixed investment continues to curb demand for capital goods imports.

South Africa’s biggest trading partners — the US, Euro area and China — are also moving to a post-pandemic phase due to widespread vaccination roll-outs. The resultant spill-over effect from these developments in these advanced economies benefits South Africa directly and continues to accelerate global growth. The close synchronisation between South Africa and the rest of the world is therefore also positive.

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Tertia Jacobs
Tertia Jacobs is an economist at Investec

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