Africa and the oil price trap

by John Etkind

The rapid rise in oil prices over the last two years is unquestionably the biggest problem facing the international economy, more particularly those that can least afford them -- the emerging countries.
Inflation is rising as a result and threatening global economic growth: slowdowns are already apparent in Europe, USA and China. Africa’s hard-pressed financial resources are grappling with oil prices that have trebled in as many years.

According to Absa Bank’s fourth quarter Economic Perspective, demand for commodities and oil is expected to expand in emerging markets over the next several years and could overtake such demand in developed market economies within the next 10 to 15 years.
“However,” it says, “over the shorter term, prices may have risen too far for the global economy to absorb and this has now started to impact negatively on growth. The longer-term prospects for the oil price appear bleak for oil consumers owing to the supply-demand profile and future trends.”

Price is a first cousin of demand and as skewed as the supply side of oil and its derivatives may be, along with the shenanigans that go on behind the scenes, the fact remains that oil is a finite resource and the convulsions the world is witnessing now might be the beginnings of oil’s death throes, and the start of a new economic ice age.
These are the views of African and international oil experts who caution that if prices are not regularised, consumption slowed and affordable and adequate alternative energy sources quickly found, we’re in for a rude awakening.

The African Development Bank (ADB) addressed the issue with its release in November of The Impact and Policy Implications of the Oil Price Increases in Africa and noted that the price of a barrel of crude oil has risen from an average of $ 26 in 2002 to an average high of close to $ 60 in 2005.
“In real terms, except for the 1979 oil shock, this is the highest price of crude ever,” says the ADB. “The high price of oil is likely to persist, confirmed by oil price futures for end-December 2005 and end-December 2006 being above $ 60 per barrel. Effects resulting from higher oil prices relate mainly to lower economic activity, higher inflation, increased poverty, the financing shortfall in the balance of payments, and the impact on public finance.”

In Africa, there were 18 producers of crude oil in 2003. The 5 top oil-producing countries (Nigeria, Algeria, Libya, Angola and Egypt) account for more than 80 % of the continent’s production. Hence, as oil production is highly concentrated, any benefits from the current high price of oil will accrue to a few countries.
Africa’s oil production is mostly exported and only 26 % is consumed locally. Paradoxically, Africa is also a major importer of oil products. It imports 39 % of its total energy compared with the world average of 19 %. This imbalance is partly due to the continent’s very small refining capacity (3.6 % of the world’s total).

The oil price knock-on
--Economic activity and growth: The increase in oil prices affects the domestic price of petroleum products, raises the cost of many intermediate inputs, as well as the overall cost of production.
-- Inflation: The ADB estimates indicate that the current oil price increase would translate into a higher average inflation of 1.3 and 2.6 percentage points for oil-importing African countries in 2005 and 2006 respectively.
-- Poverty: The lower employment perspectives and the higher inflation rate will lower the purchasing power of the poor who have fewer (if any) instruments to hedge against the oil price increase.
-- Public finances: High oil prices can exert a heavy toll on the budget, both on the revenue and expenditure sides. Expenditure could increase wherever governments subsidize oil products or programmes which make intensive use of petroleum products.
-- The tax base will be eroded if the profitability of oil-consuming companies is adversely affected and if unemployment increases.
-- Financing gap and debt issue: Non-oil producing African countries face balance of payments constraints and may be compelled to reduce both oil and non-oil imports.
-- Oil substitution: The current high price of oil should be viewed as a signal to reduce the heavy reliance on oil.

South Africa is the continent’s biggest oil importer and supports a number of refineries that supply the country and its neighbours’ needs through a clutch of competing oil companies, mainly multinationals.
Some countries in the region such as Swaziland, Namibia, Lesotho and Botswana lack refining capacity and must buy their petrol readymade, most of it from South Africa.

“These are policy matters,” says McClelland, director of the South African Petroleum Industry Association (SAPI). “Botswana or Namibia are not obliged to buy petrol from South Africa, they could import from Saudi Arabia, for example. Their pricing mechanisms are similar to South Africa’s, but decided upon by their own governments.”
“Similarities exist because of the history of the region, having developed together over the past 40 years or so. But the systems are increasingly growing apart. Botswana now has a very different fuel regime. People often complain that Botswana and Swaziland have lower fuel prices than South Africa; and that’s true because their taxation on petrol is lower.”

South Africa’s neighbours, especially those in the South African Customs Union (SACU), are bound by the economic courses taken by South Africa, including those on fuel. The SACU, a kind of mini free trade common market of South Africa, Swaziland, Namibia and Lesotho, enforces certain disciplines in how members go about things.
Fuel issues are regulated by the Interstate Oil Committee; for example the imposition of unleaded petrol in South Africa knocks on to SACU members who must follow suit because of supply and roads usage. Newer South African cars are fitted with catalytic converters that require unleaded petrol and must be available SACU-wide for visitors.

“It’s quite a problem for some countries,” says McClelland. “South Africans tourists with new cars simply can’t go to those countries that don’t have unleaded petrol available. So these issues need to be harmonised.”
In McClleland’s view, it’s important to have a local refining capacity.
“South Africa has a choice: do you have a domestic refining industry or do you import finished product? If you rely on finished product you have to enter world markets to buy it. The world is short of refining capacity. In the long term, one can be concerned about the availability of crude oil, but in the immediate future, we have the problem that demand has grown ahead of the ability of refineries to make the stuff. But that will be fixed. Refineries are being built in China, for instance, and elsewhere.”

The recent World Petroleum Congress conference in South Africa heard that last year’s oil price hike was due in most part to the lack of refining capacity, brought about by petrol companies’ reluctance to commit hundreds of millions of dollars in new plant that could take up to six years to construct while biting their nails over oil price volatility.
“The thing that would worry me if I was to invest in a new refinery,” observes McClelland, “would be to understand the crude oil supply situation. Who wants to build hugely expensive oil refineries only to find that the ‘peak oil theory’, a lack of crude oil, prevails?”

The audit committee of the Petroleum Agency, an organisation that encourages oil exploration in southern Africa, believes “that onshore, throughout the world, has been so thoroughly searched that we’re unlikely to find major new oil fields”.
The rate at which oil is being consumed exceeds the rate at which it is being discovered.
“Demand is growing exponentially, at around 2 % to 3 % a year,” says McClelland. “We’re using 85 mm bpd. If you grow that 2 % a year for four or five years you’ll need an extra 10 bn barrels a year. That’s what Saudi Arabia produces. Will we find a new Saudi Arabia in the next few years? Where will that 10 bn barrels come from?”

OPEC member countries currently produce about 30 mm bpd, and not only “do you have to produce for the demand growth, you have to produce for the fact that some of the older fields are already in decline, so you have to find big new reserves just to stand still”.
McClelland believes that current persistently high oil prices are indicative of free market supply and demand.
“Watch this space,” he counsels. “The next four or five years are going to be very interesting.”