oil

Prices & Inflation

extract from ECOBULLETIN 18-Jan-01

OPEC's production cuts will limit inflation's fall but might enhance oil price stability

OPEC's cuts reverse 60 percent of last year's output increase

OPEC's decision to reduce its output quota by 1.5 million barrels of oil per day, from 26.7 million barrels per day to 25.2 million barrels per day is perfectly in line with consensus expectations. Output cuts announced yesterday reverse 60 percent of the increase introduced last year. The principal fear is that with global economic activity reversing last year's strength, the demand for oil might fall to such an extent that oil prices could fall back to the $10 per barrel level which they reached in December 1998. Given that the output cuts announced yesterday were in line with expectations, oil prices were not materially affected by the announcement. Prices did fall back marginally, but this was more as a sign of relief that some of OPEC's hawks such as Iraq did not get their way to increase output by more than the expected 1.5 million barrels per day. However, output cuts should prevent oil prices falling to the extent that might otherwise have materialised.

In theory OPEC's attempts at managing the oil price by increasing or decreasing output in response to global demand should help to stabilise the oil market. Greater certainty should contribute to improved global economic activity in the long-term. Whether the price still remains at $25 per barrel will depend crucially on the course of global economic activity. The cause of the price spike to $37 per barrel last year was the fact that US economic activity grew much faster than had previously been expected. Additional growth tilted the balance between supply and demand at the margin in such a way that prices soared. Conversely, should US economic activity continue declining by more than had been generously anticipated (and yesterday's shocking news of another significant decline in US industrial production, the third month in a row) the balance between demand and supply of oil could continue favouring the downside for oil prices. In such an event one should expect further cutbacks in production by OPEC to limit the extent of the decline in price.

Relationship between oil prices and SA economy double edged

On the one hand the fact that oil prices might not fall to the extent that some people might have hoped for will limit somewhat the decline in inflation anticipated over this year and next. To this extent it will limit the magnitude of any interest rate declines that may come about. However, to the extent that stability in oil prices might contribute to improved long-term economic growth globally, OPEC's move yesterday might enhance South Africa's export potential and economic performance in the longer term. If global economic activity turns out to be weaker than currently expected and oil prices fall much further as a consequence, then one should expect inflation to turn out to be lower, but exports will suffer and in the final resort it is difficult to draw a conclusion as to whether the South African economy will derive any benefit from such an oil price fall.

Rand's decline has neutralised much of the benefit of recent fall in oil prices

As much as one has been gratified by the decline in oil prices since November, amounting to about a third from their peak, much of the benefit of this has already been eroded by the decline in the Rand/Dollar exchange rate. Accordingly, earlier hopes of a steep 20 to 30 percent decline in fuel prices domestically now look like pie in the sky. Whilst a further decline in the price of petrol next month of the order of 10 cents per litre looks like a certainty, price cuts in future months may be somewhat limited. In addition, one must bear in mind that the government is likely to take advantage of the lower oil price in raising the fuel levy by more than inflation when it presents next month's budget. A substantial increase in the fuel levy of this sort however, might mean that fuel prices do not decline to the extent warranted by the Rand price of crude oil alone.

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	e c o n o m e t r i x		18-Jan-01