Rand, oil neutralise each other
Weak demand conditions likely to prevail in fuel market
ANYONE WHO WATCHED the rand break through the US$1/R9 level on 6 October would immediately have been worried about inflation. But concerns about the rand’s effect on inflation may be slightly overdone for now, given the fall in the oil price. The rand’s performance has largely been a story of US dollar strength; against the euro and the pound the local currency has not fallen as sharply.
The dollar’s strength may seem a weird phenomenon, given the dire straits in which the US economy finds itself. However, market players worldwide still believe the US administration will never default on its debt and are seeking the safe haven of US Treasury bonds.
One of the main ways in which the US dollar/rand exchange rate hits inflation is via a higher petrol price. But the oil price has dropped sharply, falling to below US$90/ barrel at the time of writing. The movements of the dollar/rand exchange rate and the oil price have largely neutralised each other.
For SA’s inflation outlook much rides on the future of the oil price. Rand Merchant Bank analyst Josiah Oliphant, in an analysis of the oil price, notes that during first half 2008 commodities extended their seven-year bull run with energy prices at the forefront of the rally, as low OPEC spare capacity, shortterm supply disruptions and weakness in the US dollar boosted oil prices. However, in a change of sentiment, the market shifted its attention away from supply shortages to deteriorating demand conditions in the major economies. That saw Brent crude plummeting more than 35% from its record high of $145/barrel reached during July.
Oliphant notes the US dollar strengthened more than 8% against the euro in the third quarter, prompting investors to move funds out of commodities. The price of crude tracked movements in the dollar 92% of the time during that period compared with a 70% correlation in the first half of the year. The average price of crude oil decreased from $133/barrel in July to $113/barrel in August to $99/barrel during September. “The recent slump in the oil price has been a reflection of both the market’s expectation that slowing global growth will dampen world oil consumption and the related strength in the dollar,” says Oliphant.
Crude futures also plummeted during August, despite news of hurricanes Gustav and Ike halting crude oil operations in the Gulf of Mexico (home to a quarter of US oil production.) The oil market also shrugged off news of the conflict between Georgia and Russia, while the decision by OPEC to cut supply by 500 000 barrels/day had no significant impact, further illustrating the market’s unresponsiveness to supply constraints.
Figures on fuel consumption illustrate the fall in demand. Oliphant notes that, according to the US Department of Energy, total gasoline and distillate demand in the world’s largest energy consuming country has fallen by more than 7% since the start of the year, whereas demand increased by 3% during the same period a year ago. In addition, Chinese customs authorities reported that during August China’s imports of diesel and gasoline fell by 9% and 37% respectively.
Oliphant says a combination of weakening global demand and prospects of rising supplies from non-OPEC producers had weakened oil market conditions. A rebound in global surplus production capacity is also expected to buffer the market against any supply disruptions in the near term. In addition, the lagged effect of record high oil prices earlier in the year is still expected to filter through the global economy, further dampening consumption demand worldwide.
“It seems on balance that weakening demand against the backdrop of rising supply conditions will determine the direction of the oil price for the remainder of this year. Consequently, we expect the oil price to trade within an $85/barrel to $115/barrel range over the next six months. The lower end would be consistent with a more pronounced slowdown in the global economy, while a severe supply disruption or rebound in global demand could see oil testing the $115/barrel level,” Oliphant says.
RMB economist Kay Walsh, in an exercise conducted before the latest market turmoil, found that with an oil price of $85/ barrel and a US$1/R8,60 exchange rate by April next year inflation would enter the target range in June 2009. However, the rand was already weaker at the time of writing at around US$1/R8,80.
Nedbank economist Nicky Weimar says the petrol price is likely to remain unchanged – despite the sharp fall in the oil price – due to the rand’s dramatic weakening. ETM economist Russell Lamberti says the petrol price is likely to remain flat to slightly weaker, as rand weakness and the oil price decline appear to have neutralised each other.