Question

South Africa: Oil prices drop: What will fuel the energy industry post-COVID-19?

On April 20, 2020, the global petroleum industry witnessed a historic plummeting of benchmark US oil below $0 a barrel. Brent crude oil also has fallen nearly 70% from the beginning of the year. The drop in oil prices raises questions about the future of the global and regional energy industry as well as the role of fossil fuels in the transition towards a more sustainable energy future after the pandemic economic lockdown.

Use the extract above to write an essay in which you discuss the following:

• The name of the shock mentioned in the extract                              (2)
• The effect of the decline in oil prices on economic growth in South Africa (to discuss this point sufficiently, an AD-AS graph and detailed explanation are required.)

Answer 1

Soln:

The West Texas Intermediate (“WTI”) contract serves as the benchmark for crude oil prices in the US while Brent crude oil remains the international oil price benchmark. The steep fall in the WTI oil price was due to oversupply of fuel and declining demand for the same during travel restrictions and economic lockdowns. Many economies have strictly been closed to prevent the spread of Covid-19 which has resulted in major decrease in demand for oil as transport almost came to a hault. According to the US Energy Information Administration (“EIA”) report, road transport in countries under lockdowns dropped 50 percent below 2019 activity, while air transport declined more than 90 percent. As a result of this the demand for oil fell by 10.8 million barrels per day year-on-year, pushing the Q1 demand in advanced economies down by 2.3 million barrels per day by 3.3 million barrels per day for the rest of the world.

Even as the global oil sector was sufferring from the decline in oil prices owing to the price war between Southi Arabia and Russia, the rise of Covid-19 aggravated the conditions. Even the OPEC failed to reach an effective agreement on the cut of oil production.

This oversupply of fuel resulted in lack of storage facilities as the land based storage tanks were already completely full in anticipation of recovering oil prices. Moreover, the traders are looking at very large offshore floating storage facilities and rail tanker cars, which has their own issues.

This type of condition is defines in economics as Demand Shock where there is sudden or considerable shift in spending behavior of consumers either in form of consumer spending or consumer investment. This condition of sudden economic downturn is a result of crash in stock or home prices due to economic disaster or calamity or serious global condition like Covid-19 where the demand of a particular commodity reduces to a great extend while the supply remains the same and the economy reacts by cutting down sharply on cumsumer spending.

Impact on Sub-Sahara Africa

The general decline in the oil price and increasing lack of storage capacity has ripple effects on the global oil industry and specifically in sub-Saharan Africa.
• Nigeria, Africa’s biggest oil producer has 60 per cent of the country’s foreign revenue and 90 per cent of its foreign exchange dependent on oil sales. Oil revenue currently comprises 9 per cent of Nigeria’s GDP. And with decline in oil prices, oil revenue will drop by 3.4 per cent, which will have a severe impact on their economy.

• Angola, the second largest producer of oil in Africa, produces an estimated 1.9 million barrels a day accounting for a third of its GDP and 90 per cent of the country’s exports. It is expected that the lower oil price will have a severe impact on this country’s economy

• The economies of emerging oil countries like Ghana, Kenya and Uganda, will also be negatively affected.

• In South Africa, the Saudi-Russia price war resulted in a fuel price cut of R2 per litre in April 2020.