Tilman Friedrich’s Benchmarks Jan/Feb 2015
Oil, local equities and the Rand
The graph below shows a surprisingly high correlation between the Allshare index and the spot oil price in Rand barring the times when there was a rapid change in the oil price, such as over the last few months, where the Allshare index responds more cautiously.
One may thus rationally conclude that what is happening to the oil price will have a major impact on local equities and the Rand if it becomes a longer term trend. The question is – will it become a longer term trend? An indicator for this becoming a longer term trend is the demand/ supply situation. It would not become a longer term trend if the previous price levels were driven by the demand/ supply situation rather than speculative trading.
What can one expect the oil price to be?
The graph reflecting oil prices shows a long term increasing trend in the oil price and a few steep and rather rapid changes where we believe these were the result of speculative trading rather than any fundamentals. Without speculative trading the peaks would be reflective realistic price levels, else one would expect a more slowly increasing line that will be somewhere between the peaks and the troughs.
The next graph provides an interesting picture of the demand/supply balance of oil. At first sight one might conclude the gap between demand and supply is rapidly opening up. However looking more closely at the demand line one notices that an annual peak demand occurs in the 4th quarter whereafter the demand drops off significantly for 2 quarters only to move up again in a pretty consistent fashion. If one were to extend a straight line from the latest 3 demand peaks, one will conclude that demand should be pretty close to supply again by the end of 2015.
The question then is, what is a realistic price of oil? Rationally one would argue that if supply and demand is about in balance the price should be cost based. Following US CPI starting in January 1987 at US$16 per barrel, the price should now be around US$35 per barrel. From this one can conclude that the current level of the oil price is realistic in the context of production cost and, in fact, provides for some premium for the steady increase in demand and production costs over this period. We therefore believe that without a renewed speculative bubble, we should see current oil prices representing the new normal.
How will the oil price impact our economy and the investor?
The drop from US$135 per barrel in June 2014 to under US$50 at the time of writing aggregates to a drop of roughly US$3 trillion per annum, which is equivalent to roughly 4% of global GDP. Oil producers previously raked in these money flows produced by the global consumer and concentrated them in the hands of a few oil producers and market intermediaries. Most of this money avalanche traded hands in US$ and much of it was invested in emerging markets. Commodity exporting countries like SA and Namibia have been hit hard by the decline in commodity prices, mainly as the result of the decline in demand by the Chinese. The decline in the cost of fuel should be a welcome ‘windfall’ to these countries. To put this ‘windfall’ into a Namibian perspective, we assume that Namibia’s oil consumption should be approximately the same as SA’s, and the world’s for that matter, relative to the respective GDP (SA consumes 25 million litres per day). On this basis Namibia would consume just over 6 million barrels per annum and is now saving on its fuel bill something in the region of N$17 million per day or roughly N$6 billion per annum which represents nearly 4% of our GDP.
Imagine what this could mean for the government’s finances.
Magnus Heystek, investment strategist of SA Brenthurst Wealth recently suggested that the SA Government should use this opportunity to raise the fuel levy by one Rand per litre. Of course whatever the government passes on to the man in the street will make a noticeable impact on his spending power. This in turn should be positive for the economy and company profits.
Our investment view remains unchanged
As a local investor in this scenario, we have already seen equities decline in this process of adjustment and we are likely to experience more of this volatility. This is not the time to panic and worsen one’s woes by selling out of the market or by switching from local to offshore assets, but one should rather hold one’s investment position as any adjustment to it may just be at the wrong time. With the expected upswing in consumer sentiment and the global economy, one should see the demand for consumer goods and hence commodities increase again. Local sectors and shares driven by foreign investors, such as consumer goods and consumer services should now be switched for those shunned by them, primarily basic materials. Although we expect the local consumer to be impacted negatively as interest rates will drift upwards, lower fuel prices are likely to dampen the impact. From a macro-economic perspective the weakening Rand should advantage Rand hedge shares, exporters and manufacturers locally. With the prospect of interest rates increasing, we believe that fixed interest investments as an asset class should generally be avoided.