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THE ECONOMY: How the Oil Price Impacts the Economy

 





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The oil price has gone from R5,49 at the start of 2006 to R10,09 in August 2011, an 83,7% increase. Congestion and a lack of public transport force many travellers to make use of motor vehicles on a daily basis, says Luke Morawitz, senior ratings analyst, Coface South Africa

A large portion of monthly disposable income is spent on transportation costs. The petrol price therefore has the potential to affect individual spending capacity, the cost of goods and ultimately the country’s GDP.

The composition of the petrol price is important in understanding how market factors could influence the price of petrol. The Basic Fuel Price (BFP) formula used to determine the petrol price includes the basic fuel price; a wholesale margin; a retail margin; transportation and delivery costs; and finally government tax. Prices are determined and changed on the first Wednesday of every month.

Where Does the Oil Price Come From?


The basic fuel price is determined by the spot price of oil. So assuming there was no movement in the oil price, there should be no change in the petrol price. The price used would be that of light sweet crude which is the price normally quoted on TV or in the daily newspapers. Sweet crude is the easiest oil to refine. Oil requiring more refining is known as sour crude. The basic oil price makes up approximately 55,9% of the total fuel price and is the most significant factor in the retail fuel price and the main driver behind the recent increases.

Next, the wholesale margins are added into that figure. This is the price that refineries charge service stations to purchase in bulk. This adds another 5,36% onto the price. The service station markup is 8,04%. This margin is regulated by government and is fixed around the country.

If the service station is inland an additional expense is added for transportation and delivery. Together this accounts for another 3,7% onto the fuel price. The last portion is the tax on fuel which makes up 26,91% of the final cost. This tax is made up of numerous items such as a fuel tax, a portion allocated to the Road Accident Fund and a customs and excise tax.

The Average Oil Price on the Up


The average price of oil in 2009 was $61,77 and in 2010 it was $79,03. The average price of oil for the month of July in 2011 was $107,88. While it appears that the current increases were partly due to the unrest in the Middle-East and North Africa, it is also apparent that oil as a commodity has seen a gradual increase in prices over the last decade.

An important factor in the cost of fuel is the rand/dollar exchange rate. Fluctuations in the rand /dollar exchange rate has an effect on the price of fuel. The average exchange rate from June 2011 to August 2011 was between R6,77 and R7,27. In June 2011 it was R6,77 and in July 2011 it was R6,76. With the downgrading of the US and the subsequent bounce back of the dollar, the rand/dollar exchange rate hit R7,27 mid-August. The weakening exchange rate shows why increases in the petrol price could continue.

Another element to consider is the supply of oil and the ability to refine it. There is a lack of capacity to refine oil. Oil refineries take many years to build and cost hundreds of millions of dollars to construct. So even if it were possible to extract larger quantities it could not be processed.

Global oil reserves are also in decline. A popular idea first introduced in 1956 was the Hubbert peak theory. The theory is able to predict with accuracy the supply of petroleum in many countries on the premise that petroleum production follows a bell-shaped curve. Global production of petroleum peaked in the 1980-2000 period with declining reserves expected in future.

As a counter to the decrease in the supply of oil, renewable energy sources are being looked at. There is some hope that ethanol fuels may be able to replace fossil fuels in future but there are many tradeoffs that need to be taken into account before we can all switch.

A significant stumbling block to using ethanol is the impact it has on the global food supply. One third of all US maize is now used to produce ethanol fuel and it is estimated that to produce one tank of fuel comprising solely of ethanol uses the same amount of maize required to feed a human for one year.

Clearly this is not the solution to our problems and it will be many years until cleaner and more efficient methods are developed to produce ethanol fuel for mass consumption.

It is clear that whilst numerous factors currently outweigh fuel as the major threat to business, this stands to change as demand outpaces supply. While we have focused on the impact faced by the commuter and the economic ramifications this might have, it should be remembered that petroleum is also an essential ingredient in numerous industrial materials.

The knock-on effect of an increasing oil price will have far reaching consequences on global economic growth. In addition to rising logistics costs, most industrial processes will feel the pinch of rising input costs.

Increases in the oil price have already had an impact on the manufacturing and consumer sectors. CPI figures already show a 21,4% Y-O-Y increase in petrol prices (this figures is obviously mirrored in the PPI figures for June as well). Going forward this is likely to become a more significant “push factor” in the CPI calculation, which effects the oil price.

 
 
 
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