TOM NELSON and CHARLES WHALL, portfolio managers at Investec Asset Management, explain why they believe the oil price is unlikely to stay this low for an extended period of time.
The sell-off has been driven by Opec’s surprise actions and not, as popularly believed, a ‘supply glut’.
We believe the oil price is unlikely to stay below the industry’s cash operating cost for too long.
We expect the recovery in the oil price will likely surprise investors in its speed and scale.
ANIMAL SPIRITS OF TRADERS AND CHANGING SAUDI BEHAVIOUR Oil prices have fallen steadily since the Opec meeting on 27 November 2014. The realisation that Saudi Arabia would not moderate production to support oil prices has let loose the animal spirits of traders who continue to sell oil aggressively. Brent crude oil is hovering at $50 per barrel (bl), WTI is in the high $40s, and energy equities continue to underperform. As a reminder, the average price of Brent oil in 2014 was $99/bl. We must not lose sight of the fact that the collapse has been in near-term prices as evident through the longer-term futures price which is currently trading at $78 today.
The Opec meeting was a significant negative surprise to us and to the rest of the market. The change in Saudi behaviour cannot be overstated, and far outweighs the demand weakness which we expect to be transitory. Saudi Arabia has decided to defend market share at the expense of price for the first time since the 1980s, which will cause oil prices to fall excessively – beyond a level which rational supply/demand economics would dictate.
Without a market moderator to smooth the supply/demand balance – a role Saudi Arabia had played skilfully for a number of years – the traders can sell oil with impunity, at least for now. Opec’s decision has changed the way oil markets will function in the short term. This new era of volatility will cause a material slowdown in spending and investment which will balance the market – and this will lead in time to an oil price overshoot to the upside. Neither scenario is helpful for major oil producers: the net effect will be less investment, at a time when the sector is already struggling to combat steeper production declines and a startling lack of exploration success.
However, reflecting on the Opec meeting, we are at least now clearer on Saudi intentions, namely to slow down supply from key non-Opec producers: US shale oil and Russia. To recap, Opec had expected nonOpec supply to increase by 1.4 million bl/day in 2015. We think this scenario is optimistic.
HOW LOW CAN OIL GO? The rational, if unanswerable, question at the moment is ‘how low can oil prices go?’. We base our oil price analysis around the four pillars of supply, demand, marginal cost and Opec – but recognise that short-term trading momentum, driven by financial speculation, is still to the downside.
Opec: The next meeting is scheduled for 5 June 2015, but we should not discount the possibility of an emergency meeting being convened before that date. Brent was trading at $78/bl when they met in late November. In our view, Saudi Arabia is waiting for clear evidence of a slowdown in US shale oil production, which could come towards the end of the first quarter.
Marginal cost: At $50/bl Brent oil we are already well below the marginal supply cost, defined as the cost of pumping the last and most expensive barrel required to satisfy demand, for the industry. Spending is being reduced, projects are being delayed, and investment in the sector is falling. We estimate the marginal cost for US shale to be around $75/bl.
Demand: 2014 was a weak demand year, but still a year of demand growth. We believe that 2015 demand will be stronger, stimulated by lower oil prices (the traditional cure for low oil prices). To reiterate, the oil price collapse has not been caused by a collapse in demand, which was only 0.5% less than estimated. Chinese strategic buying of oil – for which there is ample storage capacity – could surprise the market in 2015.
Supply: 2015 is the most difficult year to model since 2008 due to the sharp slowdown in spending. Regarding US shale oil: we calculate that spending by US shale oil producers will fall by 30%. Most importantly, we estimate that US shale oil production growth – which has been 1 million bl/day for each of the last three years – will fall to less than 0.5 million bl/day. The challenge is pinpointing the delay between reduced drilling and reduced production. Such is the efficiency of drilling and tying-in wells, this lower spending will be evident with a drop in production growth coming towards the end of the first quarter in our view.
Outside US shale oil, 2015 is expected to be a lean year for new conventional field start-ups, as we have written before. The changing tax regime in Russia has incentivised Russian producers to boost production in December and January, but the effect of sanctions and underinvestment could pull Russian production materially lower in 2015.
OUR OIL PRICE FORECASTS FOR 2015 With all of this in mind we forecast that Brent oil will average $60/$70/$80/$85/bl in the four quarters of 2015, to give a full-year average of $70-75/bl, representing 40-50% upside in the commodity price from today’s level. We model no premium for geopolitical risk but note that Saudi Arabian succession, Venezuelan debt default and Nigerian elections stand out as supply-side risks.
CONCLUSION Overall, we are positioning the portfolio for a recovery in the oil price in 2015, as described above. We believe the sell-off has been driven by Opec’s surprise actions and we expect the equities to recover in anticipation of a move higher in the commodity price. The recovery is likely to surprise investors in its speed and scale, just as the sell-off has, and we fundamentally believe that we are approaching the bottom in terms of sentiment, investor positioning and valuation. We believe the oil price is unlikely to stay below the industry’s cash operating cost for an extended length of time.
The partnership between Debswana and Botswana Oil Limited (BOL) which was announced a fortnight ago will create under 100 direct jobs, and scores of job opportunities for citizens in the value chain activities.
In a major milestone, Debswana and BOL jointly announced that the fuel supply to Debswana, which was in the past serviced by foreign companies, will now be reserved for citizen companies. The total value of the project is P8 billion, spanning a period of five years.
“About 88 direct jobs will be created through the partnership. These include some jobs which will be transferred from the current supplier to the new partnership,” Matida Mmipi, Head of Stakeholder Relations at Botswana Oil, told BusinessPost.
“We believe this partnership will become a blueprint for other citizen initiatives, even in other sectors of the economy. Furthermore, this partnership has succeeded in unlocking opportunities that never existed for ordinary citizens who aspire to grow and do business with big companies like Debswana.”
Mmipi said through this partnership, BOL and Debswana intend to impact citizen owned companies in the fuel supply value chain that include transportation, supply, facilities maintenance, engineering, customs clearance, trucks stops and its support activities such as workshop / maintenance, tyre services, truck wash bays among others.
“The number of companies to be on-boarded will be determined by the economics at the time of engagement,” she said. BOL will play a facilitatory role of handholding and assisting emerging citizen-owned fuel supply and fuel transportation companies to supply Debswana’s Jwaneng and Orapa Letlhakane Damtshaa (OLDM) mines with diesel and petrol for their operations.
“BOL expects to increase citizen companies’ market share in the fuel supply and transportation industries, which have over the years been dominated by foreign-owned suppliers. Consequently, the agreement will also ensure security of supply for Debswana operations, which are a mainstay of the Botswana economy,” Mmipi said.
“Furthermore, BOL will, under this agreement, transfer skills to citizen suppliers and transporters during the contract period and ensure delivery of competent and skilled citizen suppliers and transport companies upon completion of the agreement.”
Mmipi said the capacitating by BOL is limited to providing citizen companies oil industry technical capability and capacity to deliver on the requirements of the contract, when asked on helping citizen companies to access funding.
“BOL’s mandate does not include financing citizen empowerment initiatives. Securing funding will remain the responsibility of the beneficiaries. This could be through government financing entities including CEDA or through commercial banks. Further to this, there are financial institutions that have already signed up to support the Debswana Citizen Economic Empowerment Programme (CEEP),” Mmipi indicated.
While BOL is established by government as company limited by guarantee, it will not benefit financially from the partnership with Debswana, as citizen empowerment in the petroleum value chain is core to BOL’s mandate.
“BOL does not pursue citizen facilitation for financial benefit, but rather we engage in citizen facilitation as a social aspect of our mandate. Citizen facilitation comes at a cost, but it is the right thing to do for the country to develop the oil and gas industry,” she said.
Mmipi said supplying fuel to Debswana comes with commercial benefits such as supply margins. These have traditionally been made outside the country when supply was done by multi-nationals for a period spanning over 50 years. With BOL anchoring supply for Debswana, this benefit will accrue locally, and BOL will be able to pay taxes and dividends to the shareholders in Botswana.
PwC Africa has presented the eighth edition of the VAT in Africa Guide – Africa re-emerging. This backdrop of renewal informs on the re-emergence of African economies and societies which have been affected by the COVID-19 pandemic.
In this edition, which has been compiled by PwC Africa’s indirect tax experts, covers a total of 41 African countries. It is geared towards sharing insight with our clients based on the constantly changing tax environments that can have a significant impact on business operations.
Within Africa, governments continue to focus on expanding the tax net by improving revenue collection through efficient compliance systems and procedures. PwC Africa has observed that revenue authorities also continue to take a keen interest in indirect taxes as part of revenue mobilisation initiatives.
Maturing VAT system and upskilling SARS
“In South Africa, VAT is becoming more relevant as a revenue source for the government,” says Matthew Besanko, PwC South Africa’s Indirect Tax Leader. “Strides have been made to upskill South African Revenue Service (SARS) staff and identify VAT revenue leakages, particularly in respect of foreign suppliers of electronic services to people and businesses in South Africa.”
Broadening the tax base and digital economy
In the past year, South Africa, Mozambique and Zimbabwe saw updates to their VAT legislation, or introduced specific legislation targeting electronically supplied services (ESS), which is in line with the global trend of attempting to tax the digital economy. “The expectation is that Botswana will also introduce VAT legislation in due course, while the National Treasury in South Africa has also made mention of revising the rules to account for further developments in the digital economy,” Besanko says.
South Africa’s National Treasury has also drafted legislation with the intention to introduce a reverse charge on gold, which is expected to come into effect later in 2022. While in Zimbabwe, revenue authorities have introduced a tax on the export of raw medicinal cannabis ranging between 10% and 20%, which came into effect on 1 January 2021.
ESG and carbon tax
Key strides have also been made within the Environmental, Social and Governance (ESG) space. “ESG leadership, strategising and reporting is essential now for organisations that wish to flourish and remain relevant,” Kabochi says. He adds that companies need to consider how ESG and tax intersect, since tax is a significant value driver when businesses need to deliver on their ESG goals.
In South Africa, a carbon tax regime, which is being implemented in three phases, has been adopted. The second phase was scheduled to start in January 2023, however phase one was extended by three years until 31 December 2025.
Until then, taxpayers will enjoy substantial tax-free allowances which reduce their carbon tax liability. At the beginning of 2022, the South African government increased the carbon tax rate to R144 (about US$9), which is expected to increase annually to enable South Africa to uphold its COP26 commitments.
With effect from 1 January 2023, carbon tax payers in South Africa will also be required to submit carbon budgets and adhere to the provisions of the carbon budgeting system which will be governed by the Climate Change Bill. Where set carbon budgets are exceeded, the government plans to impose penalties. “At PwC, we are continuously focused on our renewed global strategy, ” The New Equation,” Kabochi says. “Through this strategy, a key focus area for PwC Africa is to support clients in adding value to their ESG ambitions and building trust through sustained outcomes.”
The New Equation is also an acknowledgement of the fundamental changes in the business environment in which PwC’s clients and other stakeholders operate. PwC continues to reinvent and adapt to these changes as a community of problem solvers, combining knowledge and human-led technology to deliver quality services and value.
Local and international economists have lowered their projections on Botswana’s economic growth for 2022 and 2023, saying the country is highly likely to fail to maintain high growth rate recorded in 2021 hence will not reach initial forecasts.
Economists this week lowered 2022 forecasts for Botswana’s economic growth rate, from the initial 5.3% to 4.8% and added that in 2023 growth could further decline to 4.0%. The lower projections come on the backdrop of an annual economic growth that recovered sharply in 2021 with figures showing that year-on-year real Gross Domestic Product (GDP) growth increased to 11.4%, up from a contraction of 8.7% in 2020.
Economists from the local research entity, E-consult, this week stated that the 2021 double digit growth that exceeded projections made at the time of the 2022 budget may be short lived due to other developments taking place in the global economy. E-consult Economist Sethunya Kegakgametse stated that the war in Ukraine has worsened supply problems in the global economy and added that before the war, macroeconomic indicators were seen as improving and returning to pre-COVID levels.
According to the economist the global economy was projected to improve in 2022 and 2023. Recent figures show that global growth projections have been revised downwards from the initial forecast of 4.9% in 2022 with the World Bank’s new estimate for global growth in 2022 at 3.2%.
The statistics also shows that International Monetary Fund revised their growth projections for 2022 and 2023 down by 0.8% and 0.2% respectively, falling to 3.6% for both years. “The outbreak of war has severely dampened the global recovery that was under way following the COVID-19 pandemic,” said the economist.
She stated that despite Botswana being geographically removed from the conflict, the country has not and will not be exempt from the disruptions in the global economy. “The disruptions to global supply chains resulting from the war will have a negative effect on both Botswana’s growth and trade activities.
The economic sanctions against diamonds from Russia will add uncertainty to the market which will have knock on effects to Botswana’s growth, exports, and government revenues,” said the economists who added that the disruptions are driving prices up and result with very high inflation in the local economy.
Kegakgametse projected that in an attempt to limit inflation Bank of Botswana will be forced to raise interest rate “Should the sharp increase in both global and local inflation persist, Bank of Botswana much like other central banks around the world will be forced to raise interest rates in a bid to control rising prices. This would mean an end to the expansionary monetary policy stance that had been adopted post COVID-19 to aid economic growth,” she said.
In the latest projections, the UK based economic research entity Fitch Solutions lowered 2022 real GDP growth forecast for Botswana from 5.3% to 4.8% “In 2023, we see economic growth rate decelerating to 4.0%,” said Fitch Solutions economists who also noted that the 2022 and 2023 economic growth projections may come out lower than the current forecasts, as it is possible that new vaccine-resistant virus variants may be identified, which could result in the re-implementation of restrictions. “In such circumstances, we cannot rule out that Botswana’s economy may post weaker growth than our baseline scenario currently assumes,” said the economists.
According to the projections, Fitch Solution stated that there is limited scope for Botswana government to increase diamond production and exports, following the economic sanctions imposed on Russian diamond mining companies operating in Botswana. The research entity added that De Beers is unlikely to scale up diamond output from Botswana in order to prop up diamond prices.