22 Jan 2018

Oil note: communications of an early exit for Zuma, and the start of repair at Eskom

Annabel Bishop

Chief Economist

Communications of an early exit for Zuma, and the start of repair at Eskom, strengthen the domestic currency, signalling further petrol price cuts

  • The Brent crude oil price has reached US$70.2/bbl this year, but fell back to average US69/bbl as it failed to maintain the break above the US$70/bbl mark. The last time this oil price was above US$70/bbl was in 2014 when the commodity boom was unwinding. However, rand strength has aided a cut in SA’s petrol price in January, with another on the cards for February.
  • The rand recently strengthened first on Cyril Ramaphosa’s election to ANC president, then on the increasing likelihood of a Zuma exit from the Presidency of SA, which has mitigated the strength of the oil price for SA’s fuel prices. The announcement of a new board at Eskom also cheered the local currency as the utility is seen to risk default.
  • With Eskom’s looming default if it cannot repay loans falling due in the next few weeks, SA’s public finances are at great risk as SA guarantees Eskom’s debt, but does not have the cash to pay off Eskom’s loans, and so SA could see further substantial credit rating downgrades to the lower tiers of sub-investment grade.
  • Markets will be looking to SA’s deputy President, Cyril Ramaphosa, and Eskom’s new board to raise confidence in the utility in order to quickly restore ease of funding, which was increasingly cut off in 2017 by local banks. Additionally, a world bank loan is due, adding to the pressure on Eskom to improve its governance. 
  • Eskom risks suspension of its bonds by the JSE if its issues are not resolved, which would prevent it from raising debt on the capital markets. The seriousness of this risk cannot be under estimated as it would crush investor confidence and be severely credit negative at a time when SA is on the brink of losing its last investment grade rating from the three key agencies (specifically Moody’s).
  • The rand has strengthened to R12.04/USD, R14.74/EUR and R16.73/USD on the developments over the weekend (re an early exit for Zuma and new board for Eskom). Further strength is likely if substantial inroads are made to resolve the crisis at Eskom by eradicating any chance of default on the utility’s looming debt payments. 
  • Against the rand the oil price is R828/bbl, having climbed to R934/bbl late last year on rand weakness which is a level last reported in 2014.  There is another petrol price cut currently signalled for February, of 35c/litre after January’s, due to rand strength.
  • South Africa saw a huge petrol price increase of 71c/litre in December 2017 on marked rand weakness following climbing uncertainty as markets feared that the Zuma camp would win presidency of the ANC. This is set to be unwound for the petrol price if February’s building petrol price cut materialises, with potential for an even larger rand-strength-driven fuel price cut if a near term date is given for Zuma’s early exit.
  • On international oil prices, the surge from a low in Brent crude of US$27/bbl in 2016 has been supported by the upswing in global growth, supply reductions from OPEC, trading positions (although they are at risk of unwinding) and more recently, concerns the US may renew sanctions with Iran. 
  • However, the Brent crude oil price has not succeeded in convincingly breaking through the US$70/bbl mark with risks that the US may not waive sanctions on Iran when the three month rolling deadline arrives again. Additionally, US shale oil production is seeing marked acceleration, while inventory surpluses persist, with the first half of the year traditionally seeing inventory build-up. 
  • Petrol price cuts feed through directly into that month’s inflation, with CPI inflation set to drop below the midpoint of the inflation target of 4.5% in February, which would establish a lower base, and so a lower outcome for CPI inflation in H2.18, and therefore in 2019, the SARB’s inflation target period. This could ease pressure on interest rates, with the SARB currently still signalling two hikes of 25bp each.
  • An early Zuma exit could see the rand strengthen to R11.70/USD, and then move towards R11.00/USD providing that Cyril Ramaphosa can assume Presidency of SA without any conditions that hamper his ability to follow the free market reforms necessary to avoid credit rating downgrades, eradicate corruption (reclaim the public funds lost through corruption) and deliver rapid economic growth.
  • Substantial further rand strength would cause fuel price cuts, and place downwards press on CPI inflation. The rand could move towards R10/USD  if  the up case becomes a growing reality under a truly growth and credit positive Ramaphosa Presidency of SA (see “Risk update: will the market optimism on the outcome of the ANC elections be sustained, and meaningfully feed through into the economy?”, 18th January 2018, see website address below). 
  • SA consumers would gain from the savings from a fall in the petrol price, supporting retail sales growth and limiting the ascent of inflation. Consumer and business confidence was suppressed last year, but substantial political and policy certainty would likely feed through into the confidence measures, lifting investment, expenditure and GDP growth.