Continued Upward Surge in Fuel in 2018

When the Energy Regulation Board (ERB) adjusted fuel prices upwards, it certainly reduced the purchasing power of most household’s disposable income. In it press release the ERB attributed two fundamental factors that led to the adjustment; the depreciation of the local currency and the volatility of international price crude oil.

Unfortunately, this will not be the last upward price adjustment on fuel prices this 2018 because of the model that the regulator has adopted. If ubiquitous predictions are to be noted, crude oil prices will average $62/b in 2018 and in 2019. For example, according to the World Bank, energy commodity prices surged 9 percent in January, the seventh monthly gain in a row, led by an almost 30 percent increase in U.S. natural gas prices, the World Bank’s Pink Sheet reported (In January 2018, oil prices briefly hit $70/b) prices averaged $69/b, the highest monthly average since 2014. This has mainly been due to OPEC that cut production levels. Oil prices are almost triple the 13-year low of $26.55/b on January 20, 2016. Six months before that, oil had been $60/b (June 2015). A year earlier, it had been $100.26/b (June 2014). This somewhat justifies the oil prices volatility mentioned by ERB.

In most cases the price adjustments has not been in tandem with the price changes in international prices, due to the current pricing model being used by ERB. ERB uses the Cost-Plus Pricing Model (CPM).  The CPM is used to determine prices for each cargo and provides for longer intervals of price stability.

A cross check with the South African department of energy shows that their domestic prices of fuels are influenced by almost the same factors attributed by ERB: international crude oil prices,  international supply and demand balances for petroleum products and  the Rand/US Dollar exchange rate. The South Africa energy regulator (NERSA) interestingly uses the import parity principle which ERB discontinued its use in 2008. The import parity model is an elegant, arms-length method of basic fuels price determination to ensure that local refineries compete with their international counterparts. This promotes cost efficiency and astute crude acquisition strategies to ensure survival in a volatile and competitive international environment, thus eliminating domestic inflationary pressures. Could we then revert to the previous model and fine tune it, given fuel prices in South Africa are lower than ours?

Another antidote to the volatility of fuel prices is the use of Forex swaps (foreign exchange swap), Forex swap is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward) and may use foreign exchange derivatives. This type of derivative allows sums of a certain currency to be used to fund charges designated in another currency without acquiring foreign exchange risk. It permits companies that have funds in different currencies to manage them efficiently. Applying the theory of swaps to our current situation could help in mitigating the volatility that is associated with currencies and changes in oil prices.

Furthermore, since international oil prices are sometimes subject to speculators who gain arbitrage from oil price spikes, it would be vital to hedge from volatility using commodity derivatives. If the $80/b predictions due to geopolitical forces in 2018 by the largest Private Equity firm Blackrock (according to Bloomberg) come to pass, then we to see more upward price adjustments by ERB in line with the current model this is being used.



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