278 | Restructuring the fuel levy to differentiate energy and mobility demand

There is a clear line in the sand embedded in rising interest rates. Ripple effects range from artificially containing inflation, to eroding currency values against the backdrop of a 0.1% GDP growth forecast. We import volumes of imported Crude Oil for two purposes now: to supplement energy, and to fuel mobility. This is a precursor of how energy demand will need to be differentiated when mobility is electrified, for example, and thus important policy questions are on the table.

This rising demand for fuel is filtered through our Basic Fuel Price to account for various aspects of the fuel supply chain, storage and other characteristics of the logistics behind fuel in South Africa (detailed discussion here). There are three key points that need to be understood, however:

  1. Movement in international prices of crude oil are influenced by how much supply is made available with respect to demand. This is subject to OPEC which essentially regulates the composition of supply of crude oil across most countries that pump it.
  2. Movements in the exchange rates inform how much it costs to purchase a barrel of oil at local currency. As such in the event that we have a weak Rand, at R20 to $1, it means that even if Brent Crude Oil prices are back down to near pre-COVID levels $70pb, it’s more expensive because of a weaker Rand.
  3. The difference is what the Central Energy Fund uses to determine “over or under recovery” of the Basic Fuel Price. Over recovery means that there is a positive or neutral balance between international prices and exchange rates, so that either prices or exchange rates are moving in tandem — this is where fuel price decreases come from. Under recovery means, that there is a negative balance between them — this is where fuel price increases come from.
  4. The price is then overlaid by the Road Accident Fund and Fuel Levy which are associated with road infrastructure risks and use, respectively (further detail here). Historically, this was useful for road users, but in the event that fuel is purchased for non-road use purposes, the volumes were not significant enough for policy consideration.

While the levies are relevant to fuel mobility, users of fuel for the purpose of energy supply should not be subject to these levies at all. Simply because the long-run inflationary effects can be significant from a food, beverage, services agricultural and industrial perspective. Especially with interest rates increases impact trade (i.e. importing inflation); and the cost of capital (i.e. to offset energy risks). South Africa needs to enter the carbon trading age, to reflect the dynamic nature of the future of energy economics today.

Interest rate hikes set the scene for worse-better

When interest rates increase excessively, the ripple effects are that markets believe there is a risk of a currency depreciating. This results in a weaker Rand because fewer markets want to keep it because it may or has lost its purchasing power (value). When this happens, importing fuel becomes more expensive, and as an input in so much of supply chain. Combine this with the cost of purchasing industrial generators, solar panels and others for hundreds of stores, at a higher cost of capital (high interest) — this fertilises a difficult climate for supply chains. Suggesting embedded inflationary pressure creeping up throughout the year as company balance sheets struggle.

Our most recent Consumer Price Inflation data only shows us that the biggest contributor are non-alcoholic beverages, contributing 2.4% of the total 7.1% in headline inflation. In much of 2022, transport was a significant contributor to CPI at over 2%, nearly constantly. It takes 8 months for this to ripple into final consumer products as the transport costs rise across the supply chain. As a result, the spike in food and non-alcoholic beverage inflation is only a bi-product of lag effects of transport inflation which occurred in 2022. This is also clear given the spike in Brent Crude Oil prices peaking at $120pb following the Russia-Ukraine war and OPEC attempting to gradually find an equilibrium (which can take over 10 months to ripple). This is a worse but better situation, which is far from the best.

How CPI risks can be offset by differentiated fuel levies for sectors

The real issue here is that the energy crisis in South Africa is forcing companies in retail and industry to have additional energy supply. Some have migrated to solar power over the years, but most have generators that need fuel to keep the lights on and retain sales volumes. However, this comes at a significant cost. Retailers like Pick n Pay, Dischem and healthcare giants like Intercare and others, clearly show the significant cost of diesel on their balance sheets.

They pay the full cost – including the Fuel Levy and the Road Accident Fund Levy for every litre they purchase. This will place even more pressure on the consumer prices and, again influence our CPI prospects as the energy crisis may be exacerbated through winter, and cost lag effects follow 6 months from now.

Excluding non-road infrastructure and use related fuel levies can reduce the unit cost for companies significantly, however, this may require an emissions levy to be imposed in order to incentivise the use of sustainable energy.

A need for a carbon market

This would need to be coupled with a more significant industrial solar power incentive scheme that uses the generator-emissions to subsidise sustainable energy investments. The Minister of Electricity and of Energy would then need to catalyse the carbon trading marketplace to further accelerate the growth of sustainable energy in a manner that companies can transition to effectively.

The tradable nature of energy today, requires urgent attention because the marketplace is not as linear as it was in the 1990’s – households can sell to the grid; retail and industry can off-set and transition; and the unit cost of energy with the right incentives and decline while supply rises with relatively low capital costs. This is where government intervention can bring high returns, and much of this can be done ahead of the lag effects described above.

Thank you for reading.

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