Risk of unfolding oil aggression
Risk of unfolding oil aggression
In recent years I have taken the view that oil could only go to $150-$200 on the back of the
That scenario died only last year. The nuking part, that is. The oil bit is now being revived on pure demand-and-supply fundamentals.
This is not looking good, people. Better prepare that bunker at the bottom of the garden, for the equivalent of economic nuking may be staring us in the face.
Why oh why?
Global growth remains resilient. The Asian and commodity producer (emerging market) part now contributes well over half global growth and remains mission-driven. Led by infrastructure investment, there is also consumer spending liveliness.
Although commodity-led inflation is rising everywhere, some of the fastest growing emerging countries continue to shield their consumers through subsidies and controlled prices. This is allowing growth to be maintained rather than transmitting the incoming price discipline more fully, thereby preventing needed changes in demand that could undo the global commodity bubble. Thus the global imbalances continue to deepen in new ways rather than quickly adjusting.
Commodity demand in most parts remains strongly growing, despite the
Then also the global supply side remains constrained, severely so in some instances. In food, drought plays a role in some regions. In oil, it is the inability-cum-unwillingness to expand oil investment fast enough. Biofuels siphon off food supplies. Infrastructure bottlenecks hamper coal and base metal supply additions. Producers at country and corporate level generally remain extremely intelligent about their own interests in this kind of world.
And so commodity prices keep rising, with the interesting fundamentals also attracting a financial speculative following.
As a working assumption, $200 oil within two years suggests a doubling in price since the start of 2008. If we assume a $70 average increase from early 2008 levels by calendar year 2010, what consequences could such a further $12-$13bn or R100bn in import costs have for us?
First, do we get compensation elsewhere in our make-up?
Yes, coal export prices will also escalate. As to our other commodity exports, we can’t just assume that the world will favour us. But if oil is rising because of its demand-and-supply fundamentals, this will also continue to play in some of the other commodity channels, until this GENERAL fever finally overwhelms global growth.
But I don’t as yet want to explore breaking-of-the-fever scenarios, because that descent lies over the hill, and isn’t the climb still facing us on the present hill face.
With global inflation set to remain very lively on a $200 oil-and-food price scenario (via the drawing power of biofuels and cost-push of oil-based agricultural inputs), we presumably may assume some kind of inflation risk premium for our precious metals?
But how much? Could it be exactly 100%? Or even 200% (oh happy days!)? Or only 50% or less?
On a 100% compensation scenario (the coming oil price surge to $200 would have a neutral impact on the trade account) we are left facing the inflation implication.
Spread out over two years, it could keep our CPIX inflation in 12%-15% territory through 2010 (also assuming Eskom gets its full tariff increase this year).
With 200% oil compensation, we would be joining the ranks of OPEC as we will have an additional R100bn export earnings coming in. Together with consumer purchasing power loss eroding consumption spending, implying reduced imports (what do you think R20/litre petrol and diesel will do to your driving habits?), our current account will probably move into slight surplus in 2010.
That could attract global attention anew to our underlying commodity attractiveness and could possibly bury us under incoming foreign capital. Implications could include a Rand reaching again for 6:$, limiting inflation after all to 10%-12% through 2010, but the stronger Rand generally making life difficult for non-commodity domestic producers.
But what about the 50% compensation scenario? It would imply an R50bn shortfall on top of the current R150bn current account deficit. Still, the purchasing power loss and eroding consumer spending growth and lower imports will probably neutralize that increase. So we would remain with an R150bn current account deficit at over 7% of GDP. Implications for the
What about 0% compensation? Impossible as coal exports will still earn more? Yes, except that if global growth does get affected in certain respects (global car demand collapses, and with it platinum demand declines?), demand for other commodities could suffer.
That could mean declines in some other commodity prices, neutralizing the coal bonanza, and leaving us with the full R100bn surcharge for oil. Deducting for loss of consumer spent and imports, it still suggests a current account deficit potentially rising to over R200bn, over 9% of GDP.
What would that potentially do to the
All these scenarios create quite a risk spectrum, from a current account deficit of 0% to 9% of GDP, with CPIX inflation in the 10%-15% range for at least the next three years.
The Minister of Finance could face a rapid deterioration in his fiscal accounts as the slowing consumer growth implies lower tax revenues, also for corporates, even as all the food clamouring asks for more subsidization of the poor.
So the budget surplus is gone, and in its place we will again have a budget deficit, potentially a large and growing one through 2010, depending on the policy choices political populists want us to take. But it would support growth to a degree, limiting the falloff.
That leaves the SARB.
How would the SARB want to conduct monetary policy under such extreme, if still hypothetical conditions?
There would already be growth sacrifice implied by the rising cost of living. So our present throttling back in non-agricultural GDP growth from 5.5% last year to half speed (below 3%) this year could easily become extended through 2009-2010 as oil would increasingly corrode like a rising tax.
So growth sacrifice would already be built into the bottom line, as 2%-3% GDP growth would become the starting assumption for a $200 oil scenario. To this the SARB would have to apply its risk-prevention assessment.
CPIX inflation of 10%-15% could call forth wage and salary adjustments of 12%-20%. Not a good idea longer term if CPIX inflation is to be contained at 4.5%.
Also, the balance of payments condition could be a major risk under such assumptions. But we must not only focus on the trade account. There is also the capital account.
Ironically perhaps that at this very difficult moment in our collective lives, global suitors may start arriving in droves for MTN, the latest corporate darling attracting foreign appetite. Its price tag could be in the $40-$50bn range overall. At least half such a number could flow in by way of hard currency if a deal was to be consummated and it wasn’t all paper.
Such a capital windfall would be TWICE the cumulative oil surcharge we could face through 2010. In other words, an MTM deal in 2008 could comfortably pay for two years of oil surcharges, with spare change to boot.
That might just neutralize the external risk for the time being. It still leaves the inflation risk and more growth sacrifice to neutralize it if interest rates were to be increased further to head off the shock to inflation expectations.
Deeper recession in key domestic sectors could then result through 2010, especially in credit-dependent consumption sectors such as passenger cars, housing and related durable goods. Not a pleasing prospect if it were to eventuate. Meanwhile, some commodity sectors could be positively booming. But which ones exactly?
To that question there is no exact answer as we don’t know how this cookie will crumble. That is, assuming we face $200 oil.
As to what would break the fever, probably pure price fatigue as global consumers finally abruptly pull back, causing sudden commodity oversupply, rising inventories, liquidation of open speculative positions and consequently a durable collapse in commodity prices.
That is the way it has always happened in the past, along with a supply overreaction. So far, neither demand nor supply seems to be shaping for an early break. And so the working assumption remains that commodities will continue to feverishly reach for higher price levels.
Great for the favoured commodity producers among us. A severe shock for all consumers and those dependent on them. And a monumental headache for many policymakers the world over.
