The Everything Shock

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00:00 – Introduction 

Jeremy:  Natural gas, fertilisers, chemicals, aluminium, shipping routes, aviation fuel and global supply chains.

The consequences of the Iran war are spreading rapidly through the global economy and markets are beginning to realise this is far more than an oil story.

Global inflation fears are rising again, bond markets are selling off sharply and freight costs are climbing just to mention a few.

Central banks, which only recently believed they were regaining control over inflation, are once again confronting a far more uncertain world. This crisis has indeed moved well beyond crude oil.

In doing so, it is raising bigger questions about energy security, logistics resilience and how countries position themselves in an increasingly fragmented and fragile world.

Hi, I’m Jeremy Maggs and this is No Ordinary Wednesday, Investec’s fortnightly podcast where we unpack the forces shaping economies, markets and investment decisions.

Today we examine what economists and investors are increasingly beginning to describe as an “everything shock”.

And importantly for us here at home, where does South Africa fit into this changing global picture?

Joining me for this discussion are Investec Investment Strategist Osa Mazwai and Commodities and Natural Resources Analyst Campbell Parry.

Osa and Campbell – welcome back to No Ordinary Wednesday.

01:38 - What makes this crisis different from previous oil shocks?

Jeremy: Campbell, let's start with this phrase that you've used repeatedly, and I quote, "The everything shock."

Maybe as a starting point to this conversation, explain what you mean by that and why this crisis is fundamentally different from previous oil shocks.

Campbell: Well, there's a couple of reasons why we believe it's an everything shock rather than something that's isolated to oil. In the context of oil, supply losses have dwarfed those of other prior shocks.

If you think about the current fourteen million barrels per day outage, that's much more than we've seen in other oil shocks, and there've been six of those shocks in the last sixty years. Inventory drawdowns have been greater than we've seen before. We know it's also not just about oil, so significant proportions of global trade in many other commodities have been impacted as well, things like methanol and sulphur and helium and natural gas and plastics and things like that.

We also know that it's not just about what goes out of the Strait of Hormuz. So we all know about what goes out, oil and gas, naphtha, jet fuel, fertiliser, but it also is about what goes in. So the Middle East consumes significant proportions of things like tea, flowers, global luxury cars. It's an important hub for global container traffic and it's a very important hub for global air cargo traffic through the hubs of Dubai and Doha.

There's a significant amount of the global coal chain, supply chain that goes through Dubai, for example, as well as pharmaceuticals through Doha. So it's not just about what goes out of the Strait of Hormuz. In addition, a significant number of oil and gas and related facilities have been damaged through this conflict, one-third of which are reputed to have to take up to three years to get back into full production.

And then finally, and perhaps most importantly, this is no ordinary shock because it happens at a time when there's important changes in the worlds geopolitical order; its supply chains, its energy flows, and its defense and trade infrastructure. So that's a very broad picture as to why we believe this is no ordinary oil shock.

03:38 - What are markets beginning to price in?

Jeremy: Campbell, I want to come back to you in just a moment. I want to discuss in a little more detail the scale of interconnectedness. Osa, let's talk about consequence very quickly. Markets initially appeared relatively calm, but I think over the past week or so, we've seen rising bond yields, renewed inflation fears, volatility returning to commodities and currencies.

What exactly then, in your opinion, are markets now beginning to price in?

Osa: Thanks Jeremy. It's always difficult to have a sense of what markets are pricing in because as you are aware, this changes on a day-to-day basis and really driven by a lot of news flow that comes out. When is a ceasefire expected? When is a permanent peace deal going to be agreed upon? and ultimately, when will the Strait of Hormuz be opened? And of course, that'll also be a function of how long it takes to get all that supply back onto line.  

You've mentioned rising bond yields globally, and of course, that does to some extent reflect an increasing inflation risk premium. The longer the war takes, then the more spillover effects you'll experience from elevated global oil prices. We can also see that coming through in what the market is expecting from central bank policy setting. A few weeks ago, just before the war, the world was or global central banks were expected to remain in cutting cycles, and now we're expecting hiking cycles, and that does, of course, have a spillover effect on what you expect from a growth perspective.

Equity markets not fully reflecting those dynamics as yet, and this has been, and Campbell will refer to some of the comparisons to other oil shocks, but we can see from an equity market perspective that equity markets have still remained robust through the period.

We can see that compared to the Gulf War, for example, at the time of the Gulf War, the S&P 500 fell about 15%. And just last week when we looked at the S&P 500 relative to the beginning of this war, then we can see that S&P 500 actually up 7%. So there's a whole range of things that we're continuing to monitor and, of course what is the market pencilling in? At this point, it's very unclear, but you are still having very strong earnings numbers, and perhaps that's why you've seen such robust equity market performance.

06:00 - Why the Strait of Hormuz matters to global supply chains

Jeremy: So Campbell, let's return now to the Strait of Hormuz if we can. Roughly 25% of global seaborne oil trade passed through the strait last year, so undoubtedly it is a significant corridor, one of the world's most important energy arteries.

So it's critical for multiple commodities, , among them fertiliser obviously, which is critical to South Africa's economy. Maybe just give us a sense of the scale then of interconnectedness and where the real risk lies right now. In other words, which supply chains are the most vulnerable if this disruption persists?

Campbell: I think they're all very vulnerable. And you're correct in that it's a quarter of global oil supply, and that relates to the transport sector. It relates to input costs for many different industries. But it's other things as well. It's 25% of global gas supply as that relates to power prices. Many European, I guess, like chemical businesses, paper and pulp companies use natural gas for power, so it directly affects their input costs.

And natural gas is used to produce ammonia as well, which feeds into fertiliser, as you've said. The Middle East also produces 25% of the world's naphtha. So naphtha is a raw material used by mostly Asian companies to produce plastics of all kinds, and so that affects that chain. We know what the effect on jet fuel and kerosene is, as it affects the global airline industry.

So the Middle East controls 15% of the supply of that stuff. Between 20 and 35% of global fertiliser, you mentioned fertiliser, Jeremy. It's about sort of 35% of the world's ammonia supply. So that's nitrogen-based fertiliser, but there's also phosphate-based fertilisers. So you think about the Middle East as a source of sulphur.

Sulphur, about 50% of it comes out the Middle East. Sulphur is used to produce sulfuric acid, one of the world's largest traded chemical commodities. One of the most important uses of sulfuric acid is in the production of phosphate fertiliser. The Middle East produces 30% of the global methanol supply and methanol is used as a gasoline additive to add octane, for example.

Iran, by the way, is the number two world's second-largest producer of methanol. 30% of global helium is not just about party balloons, but it's about use of helium in the medical sector, for example. So MRI scans require helium. The manufacture of semiconductors requires helium. And then finally, I guess 10% of odd global aluminum supply as it relates to all end applications for aluminum, and particularly auto sector. We heard last week, beginning of last week, from the big three US auto OEMs, Ford and, and GM and Stellantis talking about a $5 billion hit from, not only price increases in aluminum, but also tightening availability.

So there are many different end market impacts to consider here as we look at the world economy.

08:50 - Will this delay global interest rate cuts?

Jeremy: Well, let's stay with impact then. Osa central banks had only recently begun discussing rate cuts again. Now suddenly inflation concerns are returning. So I've got to wonder, how difficult does this make the global macro environment? And could this crisis delay monetary easing globally, do you think?

Osa: What I'd say is that it makes it increasingly precarious around how central banks will respond. You'll recall that earlier I referred to the fact that before the war, the market was expecting central banks globally to continue cutting rates.

And since the war has begun, there's been some uncertainty around the direction of interest rates. As of Friday, just looking at the various central banks over the next year, the US Fed is expected to hike by 25 basis points. The ECB is expected to hike by 75 basis points over the coming year. The South African Reserve Bank, the same story, as well as the Bank of England.

But now there's an inherent balancing act, of course, that one also has to consider. And that is when you look at the spillover effects of the global oil price shock. And it's once it goes from just hitting the headline components of inflation into the core aspects of inflation when it becomes slightly more structural and inflation remaining elevated for slightly longer.

But it's worth distinguishing, that some work done by the Dallas Fed, amongst others, has found that relative to the 1970s oil shock, oil shocks now have been less persistent in terms of the inflationary impact. So that brings to the fore the argument around this is an oil price shock could potentially lead to transitory inflation outcomes.

So then that is the balancing act. Do central banks increase rates in environment where the inflation hit is potentially transitory? And that is, of course, the key consideration that will be faced by central banks.

10:47 - Are geopolitical risk premiums returning to markets?

Jeremy: So no doubt a balancing act, as you say. And also fair to say that we're witnessing the return then of geopolitical risk premiums after years where markets have largely ignored the consequence of geopolitics.

Osa: I wouldn't phrase it as markets ignoring the geopolitics entirely. I think the critical assessment when it comes to geopolitics is how those geopolitics pose a systemic risk to global growth. And what we mean by that is you look at what is the potential disruption to global supply chains? What is the potential disruption to global prices?

For example, in this instance, the impact on oil prices. So you are having to consider what are the systemic implications of an oil price shock, and that is why then you'd see in this environment that geopolitics being material rather, as far as markets are concerned. Other geopolitical events, sometimes you'd experience this look through the noise kind of narrative, and that's largely a function of whether that geopolitical event poses a systemic risk.

For example, we've made the point before that geopolitics in themselves don't result in rising oil prices, but what you tend to see is that once there's an impact on the supply chain of oil and the hitting of critical infrastructure, then you see the kind of response that we've seen over the last few months or so.

12:16 - Break: Introducing Investec Minds

Jeremy: We’ll continue this conversation in just a moment with a closer look at what this means for South Africa, including inflation, trade, logistics and potential opportunities emerging from the crisis.

But first, I’d like to tell you about Investec Minds – a new podcast series that has launched on Investec Focus Radio SA. On the show, equity analysts from Investec Corporate and Investment Banking interview former CEOs that helped define some of South Africa’s biggest industries, from banking, to mining, retail and telcos.

The first episode features an interesting conversation with Stephen Koseff, former Investec Group CEO, about his views on the financial services sector and South Africa’s future. Next up is Mark Cutifani, former CEO of Anglo American and AngloGold Ashanti.

To make sure you don’t miss it, follow Investec Focus Radio SA wherever you get your podcasts. 

Now, back to the discussion.

13:12- How exposed is South Africa to rising oil prices?

Jeremy: All right, let's return now back to the discussion and Osa back to you again. I want to bring South Africa into the discussion. Historically, rising oil prices have been negative for the South African economy due to inflation, due to fuel costs and pressure on the rand. How exposed is South Africa this time around?

Osa: As you know, South Africa imports the vast majority of its oil, and that leaves us vulnerable to external oil price shocks.

What has been helpful in this environment has been elevated commodity prices. It's probably why we've seen a relatively muted impact on the rand due to this oil crisis. So that's the first consideration, is just looking at the terms of trade. Now, looking at the South African context holistically, while the rising oil prices do have an impact on the inflation outlook, and that would have an impact on monetary policy setting.

We'll recall that the National Treasury announced a new inflation target at the time of the midterm budget policy statement last year, and the anchor is 3% with a tolerance band of one percentage point on either side of the 3%. But the implication of this kind of rise we've seen in oil prices is that it looks like inflation will breach that 4% upper band level for the inflation targeting regime, and that implies that the central bank will likely hike interest rates in this environment.

But there's a double hit, right? Because consumers are faced with, number one, rising inflation, which in itself erodes the spending power of consumers. But then you have a potential double whammy when the central bank is increasing rates and how that would impact consumption expenditure as well. So holistically looking, this environment is negative for the South African economy. If monetary policy has been incredibly set, then the SARB is in a position to potentially try and look through the shock as much as they can.

But of course, what the SARB is principally concerned about is second-round effects of inflation, and what they will try to do is to curtail that impact as much as they can. So it does look like the South African Reserve Bank will be hiking rates and, of course, then that is broadly negative for the South African outlook.

But again, worth mentioning that the structural reform program in South Africa has been quite helpful.

15:38 - Are South Africa’s structural reforms providing a cushion?

Jeremy: Let me just pick you up on that very quickly then. So you refer to the structural reform program. Is it providing any cushion at all, very quickly?

Osa: Yes, there has been a cushioning effect, and I think it is a relative assessment. If we look at the performance of the rand over the last 24 months or so, and if we look at the performance of our bonds over the last 24 months or so, that has been broadly positive. For example, since the formation of the GNU, the strengthening of our structural reform program, we've seen incredible momentum building from an energy security perspective and a logistics capacity perspective.

All of those things have been positive for our currency and our bond yields. We've seen the announcement of a new inflation target, which has been positive from an inflation risk premium perspective, but we've also seen National Treasury sticking to their fiscal consolidation plans, which have also played their part in terms of the strength we've seen in the rand and the kind of performance we've seen in our bonds.

So of course, this has been broadly positive. One can imagine the kind of inflationary fallout we might have seen if the rand was at 18.50 or 19 as opposed to where it was just before the beginning of the war at 15.93 or so, and has been hovering around a level of 16.50. So that does have a positive impact on at least the inflation outcome.

Inflation is elevated and trending up, but it is better than otherwise might have been the case, which is a function of structural reform, a function of the government of national unity, the newly announced inflation target, and a commitment to fiscal consolidation.

17:18 - Where could South Africa and Africa benefit from the crisis?

Jeremy: So Campbell, let me continue then with the broader positive theme. Despite the risks that we've discussed in some detail, your research also suggests that South Africa and more broadly the continent could also benefit in certain ways from the crisis. So where would you see the opportunity?

Campbell: That’s an interesting question because I think you have to take your clues from what happened after the 1970s oil crisis.

After the 1970s twin oil shocks, there was a move to improve energy consumption efficiencies. There was a move to look for oil outside the Middle East. So the North Sea, Siberia, Alaska, for example. Those were new provinces after the '70s oil shocks. The third thing that happened was they looked to replace oil with things like, at the time, coal and nuclear, and then the last thing they did was they began to hoard oil through the IEA's efforts to get strategic inventories built in OECD economies.

All of that I see happening now 50 years later is electrification and efficiency improvements, I think are going to continue probably even at an accelerated clip. The IEA is actually talking about this today. I think there's going to be a move, like after the '70s, there's going to be a move now to find more oil outside the Middle East.

There are not many prospective regions left in the world, but I immediately think about Africa as a underexplored or relatively underexplored area, as well as like Asia, LATAM. I think about replacing oil use, and I think immediately of nuclear and renewables with batteries, which are already available at scale and relatively affordable in many cases.

And then we also are already starting to hoard more oil and other commodities in strategic inventories. So that sort of gives you some sort of background to how South Africa, and Africa more broadly, can benefit. So for example, we have enormous, oil and gas endowment off our west coast, and for many reasons, the monetisation thereof has been stalled, and we think that the efforts to find oil in other parts of the world actually plays into our favour. And as long as we put the right regulatory regime in place, I think we can do very well by developing our offshore oil and gas resource, which according to what's happened in Namibia, has massive potential.

I think we should also be pushing hard on solar in particular. We have a renewable energy program which I argue has been one of the envies of the world, so why not keep pushing hard on solar? The Northern Cape is one of the top 10 places in the world to site a solar project due to solar irradiance, so why shouldn't we continue doing that while battery technology gets better and better every day?

And then the last thing I'd say we need to do is embrace EVs, because I think we are expecting to see fossil fuels lose share in transport, and part of that means more EV purchases and our South African auto industry, which has been very strong in the past, needs to basically improve its capabilities in EVs and start investing behind that.

So that's a couple of opportunities we see South Africa benefiting ultimately.

20:19 - Why energy and infrastructure opportunities matter now

Jeremy: And those initiatives or opportunities then, Campbell, become even more strategically important now than ever.

Campbell: They definitely do. I just hope that we have the commercial and political wherewithal to pursue them

20:30 - How important is logistics reform for South Africa?

Jeremy: Osa, let me return to you now. Logistics remains one of our biggest vulnerabilities. I think that's fair comment. If the global economy then is shifting from the so-called just in time to just in case, how important does logistics reform become for South Africa's competitiveness? I don't think we can underestimate that.

Osa: Yes, of course. logistics reform is important. We've seen some good news coming out recently from a logistics reform perspective. We've seen ports performing at some of the best levels we've seen in many years. We've seen a swift recovery in rail and the ultimate objective, I suppose, from a South Africa perspective to take advantage of the opportunities of the future, and that is building a strong industrial base with the economy. To build a strong industrial base, you have to have an expanded logistics network, and you have to have expanded energy security. So that really is going to be behind whether South Africa can meaningfully participate in the opportunities of the future. We need investment in the economy, whether it's foreign direct investment or local investment.

We need investment to pick up for that to meaningfully transform into GDP growth, into employment creation, and the fundamentals of attracting investment is things like the regulatory environment, but then importantly is around the industrial capacity of the economy. You have to be able to ensure that you have uninterrupted energy supply, and you have to be able to be moving goods to where they need to be.

22:04 - Rethinking South Africa’s long-term energy mix

Jeremy: And Campbell, talking about energy supply, and a little earlier you were talking up the importance of South Africa and renewable energy. How do you think this country then should be thinking or rethinking its long-term energy mix in this volatile environment?

Campbell: Well, I think they should be open to being flexible. We are a coal-based economy, and I only use the example of what happened in Europe as a case in point. You can't shut coal fire and try and rank renewables at the same time. But if you just think more cleverly about it and you get more people involved, as we've seen the renewable energy program, it's an example of what can happen when people get their thinking aligned.

If we continue, obviously with our coal base of the economy, as that declines in contribution to the energy mix, we need to be thinking very carefully about introducing gas as a coal replacement into some parts of our generation system. I think we need to push renewables, particularly solar, as hard as we can with the right incentives in place and we need to be thinking very carefully about more nuclear energy in this country.

So there are many opportunities, but if we have the wherewithal and we start getting the private sector to work with the public sector and big business, I think we can do a very, very good job about keeping the right balance because, you know, we don't want to throw the baby out with the bathwater, focus on coal, but add stuff to the side that can make us a cleaner generation system, but also one people can make money from.

23:29 - What might markets still be underestimating?

Jeremy: Osa, investors are now trying to distinguish between short-term cyclical shocks and longer term structural shifts. What do you think markets may still be underestimating right now?

Osa: It's not so much as the market underestimating, but rather a market that is still trying to make sense of this oil price shock relative to previous oil price shocks.

And by saying that, we are trying to assess then the degree of the inflationary shock, the persistence of the inflationary shock, and what that means then for monetary policy setting, but also what it means for a global growth. And this happening in environment where you've seen the rapid rise of AI and a world that is also trying to grapple with what that means for future global economic activity.

So the market may be underestimating the severity of the shock. Only time will tell. Campbell has painted a neat picture of the fact that it's not only about what goes out of the Hormuz Strait, but also what goes into the Hormuz Strait and the Middle East area in general. And that is ultimately what it's going to boil down to.

The discussion needs to move beyond thinking that it is a oil price shock, because in assessing an oil price shock, then you would come to certain conclusions. But if you expand that beyond the oil price shock itself and consider all these other elements that Campbell has mentioned, then that will then give us a sense of what the overall market implication may be, how extensively that might hit global growth, and what that means for global monetary policy setting.

25:25 - Five years from now: what lasting impact will matter most?

Jeremy: All right, gentlemen, as we come to the end of this conversation, a quick question to both of you. Campbell, I'll come to you first. Let's assume hypothetically we fast-forward five years. Difficult to call, but what lasting consequence of this crisis do you think will matter most for the global economy?

Campbell: I think the shock has just jolted the electric age forward That's it.

Osa: I agree completely with Campbell, and I think it's worth mentioning based on Campbell's earlier comments around what happened during previous oil price shocks and looking for opportunity elsewhere, finding new sources of oil, new sources of other sources of energy, then I think it's worth mentioning that there is an opportunity for South Africa and Africa, and you just hope that, as you say, what we see in five years' time, seizes this moment as far as looking at our energy endowments and trying to play a meaningful role in the energy supply perspective on the global stage.

26:21 - Closing remarks

Jeremy: And that's where we are going to leave it. Osa Mazwai and Campbell Parry, thank you so much for joining me on this edition of No Ordinary Wednesday. Now, a new episode of No Ordinary Wednesday drops every two weeks. To ensure that you don't miss out, search for Investec Focus Radio SA wherever you get your podcasts and hit that follow button.

Until next time, goodbye from me, Jeremy Maggs, and the entire Focus Radio team.

Disclaimer: The views expressed are those of the contributors at the time of publication and do not necessarily represent the views of the firm and should not be taken as advice or recommendations. Investec Limited and subsidiaries, authorised financial service providers, registered credit providers, and long-term insurer.

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