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23-months back you had to pay someone to take oil off your hands

11 March 2022 Gareth Stokes

There is no better illustration of the impact of external or macroeconomic shocks on the price of a commodity than the fall and rise of the oil price over the last couple of years. In April 2020, at the start of the Covid-19 pandemic, there was so little global demand for the fossil fuel that oil futures fell into negative territory. Today the exact opposite is true, with the price of Brent Crude and West Texas Intermediate (WTI) Crude futures contracts climbing strongly.

Why should we care? Allow me, dear reader, to answer your question with another question. Have you filled up your motor vehicle lately, or bought goods at the local store? The gas and oil price explosion currently underway on the back of Russia’s massive military incursion into Ukraine is driving the cost of energy and fuel through the roof, worldwide. In Europe, households are facing massive cost escalations in electricity and gas in addition to fuel price hikes. In South Africa we expect diesel and petrol to go much, much higher with a looming 20% jump in April. Of greater concern is the potential for shortages of refined fuels against the backdrop Eskom’s nine million barrel per day diesel appetite. The state-owned utility, already losing cash on its diesel generating fleet prior to the war, has been burning diesel flat-out through its recent week-long bout of stage four load-shedding. 

Scoping the speculator’s playground

There are few things you should know about commodity futures contracts to make today’s article more enjoyable. First, they are defined as standardised legal agreements to buy or sell a commodity at a predetermined price at a specified time in the future, between parties not known to each other. So, you can enter into futures contracts issued over corn, oil, soybeans, wheat or hundreds of other tradable commodities. Second, futures contracts expire at the end of each month, meaning that you could buy or sell oil today, based on your expectation of its price one, two or more months in the future. And third, a futures contract is actually an agreement to take physical delivery of the commodity at that future date, though delivery is seldom taken in practice. 

So, back in January 2020, you might have entered into a futures contract for NYMEX WTI Crude for delivery end-May at around US$25 per barrel… You would have suffered some minor losses holding the position through February and March without losing too much sleep; but things changed in a hurry when the extent of the Covid-19 pandemic became clear. In fact, over a couple of hours on 20 April 2020, the May 2020 contract futures price for WTI Crude plummeted from US$18 per barrel to around -US$37 per barrel in panic-driven trade. 

Speculators would have had three options: wait it out in the hope the market improved; find the money necessary to take delivery of the 1000 barrels of oil per futures contract in May, as well as space to store it while waiting for prices to improve; or pay someone to take the contract off their hands. PS… Many may even have taken a moment from their hectic schedules to get physically sick! 

Russia goes 2-0 over pandemic in oil price kickabout

Brent crude oil, which is one of many inputs to South Africa’s monthly diesel and petrol price adjustment calculation, hit the skids too. It had fallen from around US$70 per barrel at the start of 2020 to just US$9 per barrel on 21 April. The 2020 oil price collapse can be explained under the basic economic construct of supply and demand. Writing for Investopedia.com, Matthew Johnston offered two reasons for oil’s downward spiral. First, “worldwide demand for oil fell rapidly as governments closed businesses and restricted travel due to the pandemic” and second, “an oil price war between Russia and Saudi Arabia [had] erupted in March when the two nations failed to reach a consensus on oil production levels”. 

How ironic that Russia, recognised as among the top three oil producers globally, has had a hand in both the oil price collapse of 2020 and the price explosion we have seen year-to-date 2022. Back in 2020, oil supply went through the roof as demand fell off a cliff… with added downward pressure following Russia’s aggressive price meddling. Returning to present day, Russia’s war with its Western neighbour has triggered a more than 30% hike in oil prices in less than a month, with dozens of analysts warning of worse to come. Will the price go higher or settle down over the remainder of the year? 

Your guess is as good as mine, dear reader. After the craziness of -US$37 per barrel and US$9 per barrel in the April 2020 futures market, the WTI Crude spot price recovered to US$49 per barrel by year end, and Brent Crude to US$51 per barrel. So, the hope is that things normalise in the second half of 2022 too, though in the other direction. Of course, things could easily get worse, sending oil to US$200 per barrel or higher, as some experts have already hinted at. Much will depend on whether the major oil producing nations that are members of OPEC agree to increase their production… Historically, OPEC has often taken the lower production, higher price route. 

Africa and South Africa will feel the pain

Africa and South Africa will feel the pain of the Ukraine / Russia conflict in more ways than expected. “With the war on Ukraine sending the prices of oil, gas and coal spiking, the impacts here are already being felt,” wrote Ferial Haffajee, in an article published by Daily Maverick. “Economists predict another huge petrol price increase in April and [identify] South Africa’s reliance on open cycle gas turbines for emergency power is a major risk”. And commenting on EWN, Liquid Fuel Wholesalers Association CEO Peter Morgan said that the price of petrol was expected to go up again next month by about R2 per litre. “Anything is possible depending on what happens to the crude price,” he said. This writer reckons the increase will be more than R2. 

It is not just oil and fuel prices that will have a lasting impact on the continent, warned political economy analyst, Daniel Silke on LinkedIn. He pointed out that Africa imported huge quantities of wheat from both warring nations, with Russia and Ukraine first and third on the list of wheat exporters into Africa in 2020. 

Higher fuel prices will also contribute to inflation, which was already raising its ugly head domestically pre-conflict. The Bureau for Economic Research (BER) has warned that second-round price effects will compound the direct impact that the higher fuel price is having on measured South Africa inflation. “This is especially the case as a growing list of local companies are commenting that they can no longer absorb a sustained rise in input costs and will now start to pass these on to the end consumer,” they wrote in a March 2022 research note. 

Small businesses, including FSPs, under fire

What does this mean for the client-facing financial advisers and insurance brokers trying to keep their small and medium financial services practices afloat? Well, now seems an opportune time for the captain of South Africa Inc to swich on the ‘fasten your seatbelt’ sign, because the turbulence just got real. Having survived two years of pandemic, advice practices’ expenses look certain to escalate at a rate way higher than they budgeted for through 2022. And their incomes will undoubtedly take a hit too, as individual clients are forced to reconsider their life and non-life insurance covers as household budgets come under unexpected pressure.

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