The oil price roller coaster
In March, the price of petrol in Gauteng breached R11/ℓ, breaking the previous record-high nominal price of R10.50/ℓ set in July 2008. At R10.37, the wholesale price of diesel is still below the high of R11.43/ℓ recorded four years ago.
Adjusted for general consumer price inflation, however, the 2008 peak retail petrol and wholesale diesel prices would be equivalent to about R13.43/ℓ and R12.60/ℓ respectively, if measured in today’s rands. Still, the persistently rising fuel prices are putting increasing strain on household budgets and company balance sheets.
So, why are fuel prices stubbornly high, and where might they be headed?
Fuel prices in South Africa are deter- mined by the Department of Energy in line with an import parity pricing formula. The so-called basic fuel price (BFP) – which comprises about half the retail price – is benchmarked on international refined fuel prices. To this are added fuel taxes and levies – comprising about 30% of the final price – and retail margins as well as transport costs, which account for the remaining 20% of the price.
Only the BFP component varies from month to month – levies and retail margins are set once a year. The BFP, in turn, depends on two factors: the inter- national crude oil price – measured in dollars – and the rand:dollar exchange rate.
The rand has fluctuated between about R6.75 and R10.12 to the dollar over the past four years, but has been relatively stable for a couple of years and is now trading at almost the same level as it was in July 2008.
The major driver of local petrol and diesel prices over the past decade has been the price of crude oil. Between 1986 and 2003, the oil price traded in a remarkably stable and narrow range, averaging about $20/bl. From 2003, it rose steadily for several years and then spiked dramatically to reach an all-time nominal peak of $147/bl in mid-2008.
This oil price was more than the global economy could bear and, together with the financial crisis, it precipitated the Great Recession. Demand for oil fell steeply and the oil price plunged to around $40/bl in December 2008. Since then, the price has ratcheted up again, and has traded in triple digits since January 2011. Brent crude is now around $125/bl and, in euro terms, is at a record high.
Several reasons are frequently cited for the current high price of crude. Top of the list is the ongoing confrontation between the West and Iran over the latter’s nuclear programme. The sanctions that the US and the European Union have imposed on Iran’s oil and banking sectors are starting to limit Iran’s ability to export its oil. Further, threats by Israel to pre-emptively bomb Iran’s nuclear installations are adding a significant risk premium to oil prices.
Compounding the pressures are short-term disruptions to supplies from Syria – which is a year into its civil war – as well as South Sudan and Yemen.
But these short-term geopolitical factors do not explain the long-run trend in oil prices, which is driven by fundamentals of demand and supply.
Demand for oil is still growing rapidly in many emerging economies. China, which leads the pack, is expected by the International Energy Agency (IEA) to increase its oil consumption by about 400 000 bbl/d this year. Beijing has also begun to fill its new strategic petroleum reserve.
Meanwhile, glo- bal crude oil production has been basically stagnant for the past six years, apart from an increase in biofuel output that has, in turn, boosted food prices. The IEA says it is likely conventional crude oil output peaked in 2006.
Most new oil is being found in hard-to-access deep-water offshore fields, polar regions, Canadian tar sands and American oil shale. These sources typically have marginal production costs in excess of $85/bl or more. The world is rapidly running out of cheap, easily accessible conventional oil, and is being forced to turn to dirtier, more costly unconventional sources.
With the Saudi Arabians having ramped up production to offset losses from Iran and elsewhere, global spare oil capacity is now down to about 2.7-million barrels per day, according to the IEA. This means that the slightest market disturbance can trigger big price fluctuations.
The biggest short-term threat to oil prices is the Iran situation. A military strike on the Persian Gulf country would likely lead to a temporary closure of the Strait of Hormuz, through which a fifth of the world’s oil supply transits each day. In this case, the oil price would skyrocket.
On the other hand, if the eurozone debt crisis triggers a financial meltdown, the oil price could drop considerably, although probably not for very long.
So, brace yourself for more wild gyrations on the oil price roller coaster; better still, look for ways to get off it by reducing your reliance on petroleum.
Published in Engineering News , 13 April 2012