Oil prices send shock waves through world economies

THE latest oil shock has rekindled fear of high inflation and low growth for the world economy and SA. Brent crude hit an 18-year high of $35 a barrel last week, which is three-and-a-half times the price in early 1998. There are now concerns that a price of more than $40 is within easy reach.

While fear of a 1970s type stagflation are misplaced, there will be an effect. This will depend above all on how far and fast the price rises. For SA the latest surge adds to uncertainty over growth and inflation, but most of the gurus say the ultimate effect will be moderate and short term.

However, for some low-income energy importers like Zimbabwe this latest oil price hike could be precipitous.

Few analysts are prepared to commit themselves on the oil price. The meeting of oil cartel Opec this coming Sunday and a summit meeting towards the end of the month are likely to add to uncertainty over oil prices in the weeks ahead.

The reason for much of the nervousness is that Opec production quotas are not entirely to blame for the recent rise. There are forceful demand pressures from a strong global economy and capacity constraints on tanker fleets and refineries.

As this is not the sort of problem that can be dealt with by turning on a tap, it may take time for the extra capacity to come on stream and for oil prices to drop.

There will be winners and losers from the oil shock and SA should not come off too badly. Our extensive coal reserves means imported oil makes up only about 20% of SA's energy requirements. Coal exports make the country a net energy exporter, but the problem is that SA is an inefficient user of energy.

A Morgan Stanley Dean Witter study shows that on the basis of energy consumption and gross domestic product, the country ranks below some eastern European emerging markets in efficient use of energy. Against a benchmark of the German level of efficiency of one, SA has a rating of five and its position is deteriorating because of the economy's rising energy intensity.

Nevertheless, Bechara Mahdi, an economist who follows SA at Morgan Stanley Dean Witter says the effect of higher oil prices should be offset by higher commodity prices, particularly that of platinum.

Retailers and consumer goods manufacturers have already felt the effect of high oil prices. Higher oil prices cut into discretionary type of purchases and the latest surge will exacerbate this demand shift.

The SA bond market is already nervous about oil prices and what they mean for inflation and interest rates. This may be an overreaction induced by the pull-out of the speculators triggered by Reserve Bank Governor Tito Mboweni's reported remarks that the rise in the oil would mean the Bank would not be able to reach its inflation target. What he in fact said was that the oil price hike may hamper the Bank's efforts in reaching the target.

For some time the Reserve Bank has said that oil price hikes will push inflation up, but once they come down inflation will also come down. That they are still rising is of concern for the target, but the key is that the oil price rise so far has hardly been translated into what are called the second round effects on other goods and wages. The petrol price component is about 4% of the total basket of CPIX, the Reserve Bank's target inflation measure which consists of consumer prices without changes in interest rates on home loans.

Peter Worthington, an economist at JP Morgan, has calculated that a $5 increase on $30 per barrel oil price will push CPIX up by only 0,3 percentage points, assuming no change in the exchange rate. Morgan now sees CPIX inflation at 8,1% at the end of the year and 5,6% at the end of next year.

Moreover, there are strong structural reasons why inflation will decline in SA over the longer term. The economy is more open and firms are far more competitive. Once state enterprises face greater competition or are privatised, further gains against inflation can be made, according to Worthington.

The one consoling factor for SA is that we are not alone in being hit by the oil shock. Europe, Japan and many of the emerging markets that compete with us are also exceptionally vulnerable. So barring politics and bolts out of the blue, international investors may not be too concerned.

http://www.bday.co.za/bday/content/direct/0,3523,691412-6099-0,00.html

-- Martin Thompson (mthom1927@aol.com), September 04, 2000