Oil prices and the South African economy: A macro–meso–micro analysis

 

 The economic impact of high oil prices in South Africa

The results of implementing the methodologies discussed above are reported in this section. The discussion begins by focusing on specific characteristics of the South African economy. Then a discussion of the impacts at the macro-economic level is given, followed by a discussion of the impacts at the meso-economic level and finally the impacts at the micro-economic level are discussed.

The South African economy

 The economic performance of post apartheid South Africa has been relatively impressive,
averaging 3.3% for the real GDP growth rate and 1.4% in per-capita terms for the period 1995–2005. This growth trend was an improvement, if one compares with the rates of the 1985–1994 period, where the respective average rates were 0.8% and −1.3% (South African Reserve Bank database, various years, (www.reservebank.co.za)).
 

Final consumption by household and by government far outstripped the contributions made by the other components of GDP. It contributed 67% while net export and investment represented 20% and 13% of GDP in 2000, respectively. After a long period of increases, the unemployment rate has been declining over the last years. Inflation recorded successively a period of increase and decrease and has been on the increase since 2004. The tertiary sector, with an average growth rate of 3.8%, substantially outperformed the primary and secondary sectors (du Plessis and Smit, 2006). At the other end of the spectrum, the primary sector contributed the least to overall growth with an average real growth rate of only 0.4%. In 2000, the service sector (private and public) was the most important contributor to GDP, contributing 62%. The manufacturing sector represented a relatively important share of 29% of GDP, while the primary sector
(agriculture and mining) contributed less than 10%.
 

In terms of contribution to GDP, the 2000 Energy-SAM shows that “General Government” is by far the biggest contributor with 15.0%, followed by “trade services” with 10.3%. “petroleum industry” (including “crude fuel”) contributed 3.3% to GDP and ranked among the top eight contributors out of the 95 industries in the 2000 Energy-SAM.
 

The current account deficit of the South African economy has been growing sharply since 2003, reaching 12% of its GDP in 2007. The significant rise of the current account deficit means that the value of imports for goods and services has recorded a more important increase, in particular the import of oil and oil products, than the value of exports.
South Africa has a well-developed synthetic fuels industry facilitated by the country's abundance of coal resources and offshore natural gas. These permit the country to meet 35–40% of its domestic liquid petroleum requirements while 14% is exported. Thus, the country presented a high coverage ratio of oil and oil products in the year 2000 compared to a typical net oil- importing country. Petroleum was among the most export oriented industries in 2000.

The macro-economic impacts

We attempt to quantify the economic impacts of a sustained oil price increase above US$55 a barrel. Our analysis is limited to a 5-year horizon (2001–2006) during which the price of crude oil has more than doubled.8 The results reported are for the end of the period. When we assume zero elasticity9 for oil and oil products demand we found that a price increase will likely lead to an equivalent increase of the oil import bill as the quantities imported do not change. The oil import bill increases to 20,546 million Rands (R)10 which translates to 10.1% of the total import bill. The increase of oil and oil products values represents a significant shift in the import structure and the trade figures of the country. The value of South African total imports increases by 5.3%. The trade surplus drops by 42% while the deficit of the balance of payments (BoP) increases to R −12,590 millions from a value of R −2,317 millions. An increase of oil and oil- products imports is balanced by a decrease of other imports and/or an increase of export products in a budget constrained economy (no excess reserves and no borrowing) thereby putting downward pressure on the exchange rate. As a result, imports become more expensive and exports less valuable and consequently real national income drops. Lower national income reduces demand for imported and domestic commodities and investment, leading to a drop of GDP.

Next, the impact of a 100% increase of oil and oil-products prices on GDP is estimated allowing the economy (producers and consumers) to adjust following the oil shock. This is reflected through the use of an estimate of the oil price elasticity of demand from the literature (Smit et al., 2003). Using the above net import formulation we found that a 100% increase of oil and oil-products prices reduces GDP by only 0.2% in South Africa. The estimated value is lower than the 0.8% decrease estimated by the World Bank (2005) study for a sustained US$10 increase of crude oil prices. The primary reason for the difference between the two estimations is in the assumption on petroleum-products prices. We simulate increases of basic fuel prices11 and petroleum-products prices at the same time whereas the World Bank study focuses on the former prices. As South Africa's exports of liquid fuel products represented 14% of the country's total supply, the ratio of net imports oil to GDP decreases substantially12 when one adds petroleum-products to the simulation.
 

Higher-oil prices also increase input costs and reduce business profits and lead to a deterioration in consumers’ purchasing power. Tax revenues fall and the budget deficit increases because of rigidities in government expenditures. Together higher prices of oil and oil products, upward pressure on the nominal wage and business profits, and government fiscal and monetary management of oil shocks lead to inflation. Wage pressures together with reduced demand induce higher unemployment.

A large and sustained increase of oil and oil-products prices will not significantly impact South African economy. The availability of a large reserve of coal and a well-developed synthetic fuel industry has always been an alternative source of energy cushioning the economy from volatility of international oil prices. Although the oil prices shock tested above shows no major macro-economic impact, the distributional impacts among sectors and household groups might be important.
 

The UNDP/ESMAP (2005) study discusses a variety of oil shocks impacts on developing
countries, ranging from the impacts on GDP, balance of payments, per-capita income, the degree of self-sufficiency in oil production and oil dependency of energy use. The study indicates that the impact of a sustained US$10 a barrel price increase will cause a relatively more pronounced negative effect on the GDP of least developed countries (LDCs) than it will have on the GDP of developed countries. GDP in most LDCs or poorest countries (with GDP per capital below US$300) will generally decline by 1.5%. Those countries with larger per-capita GDP saw a loss of 0.5% of GDP due to the same price shock.
 

Although ours is not a full CGE study, its results compare well to those of previous CGE studies in South Africa. Similar results were obtained in a computable general equilibrium model by McDonald and van Schoor (2005) using a low elasticity of substitution of consumption for petroleum purchases by households of 0.8. In that case GDP fell by 1.01%. Similarly, in their CGE model Essama-Nssah et al. (2007) also find a fall in GDP by 1.8%. In both these papers the mechanisms are the same. There is an increase in the price level and in imports due to the oil price increase shock. The results differ partly because of the sizes of the simulations, the closures selected as well as other assumptions on parameters and their specifications. McDonald and van Schoor (2005) simulated a 20% increase in the crude oil price while for Essama-Nssah et al. (2007), among other simulations, the world price of imported crude and refined oil is increased by 125%.

The meso-economic impacts

Although the oil prices shock tested above shows no major macro-economic impact, the
distributional impacts among sectors and household groups might be important. We measure
sectoral oil intensity by the ratio of oil and oil products input cost to the value added. The ratio is computed for the 94 aggregate industries recorded in the IO table for the year 200013 (Table 1). It shows that “primary plastic” is largely the most oil-input intensive industry in South Africa. The industry's oil-input cost per unit of value added is estimated at 0.5. For simplicity, we focus on the top-ten and the bottom-ten oil-input intensive industries after ranking them from the most to the least oil-input intensity.

The electricity sector is among the least oil-input intense sectors in South Africa with a share of oil in the total energy input of 2.1% and an oil intensity of 0.6% (Table 1). It is highly intensive in coal which represents more than 70% of the sectors’ energy input cost. In contrast, transport sector is intensive in oil with an oil intensity of 29.3% ranking behind the primary plastics and the paints industry (Table 1). With a high share of oil-input cost in energy input cost, large-scale fuel substitution is less likely to occur in the transport sector without substantial financial support from the government. Therefore, high petroleum-products prices are expected to impact more on the cost of transport services and primary plastics as presented in Fig. 3. Comparing the sectoral results to those by McDonald and van Schoor (2005) and Essama-Nssah et al. (2007) shows that the general trend is the same. High oil intensive sectors such as transport services suffer relatively more than the other sectors. The magnitudes differ due to the sizes of the simulations, the chosen closures and other assumptions adopted in the different models.

The impacts of higher-oil prices in the transport and primary plastics industries accounts for the largest share of the effects in other industries. They play a key role in the distributional impacts of high oil prices among industries and households. In the next section, our analysis focuses on the impact of high oil and oil-input products prices on the cost of living. The analysis is limited to the petroleum-products and the transport services as they are the products that seem to play an important role in the channel of transmission of oil price shocks. Primary plastic products are not directly consumed by households (Fig. 4).

The micro-economic impacts

Shares of energy and petroleum-products in total household consumption expenditure

When distinguishing petroleum-products into domestic products, i.e. paraffin, gas and other fuel (e.g. petrol and diesel) and transport fuel, a significant difference is noted in the expenditure pattern of the lower and the higher quintile expenditure groups. Analysis of the income and expenditure survey for the year 2000 shows that the lowest expenditure groups rely primarily on paraffin as a source of liquid fuel and gas. In contrast, the highest expenditure groups used intensively more transport fuel than the poorest households. This pattern of fuel expenditures shows that significant distributional impacts between rich and poor households will be observed only when there is an important difference in the change in domestic fuel prices compared to transport fuel prices.

Transport service expenditure is an important component of the total household expenditure
(Table 5). It represented an average of 4.5% of the total expenditure in South Africa for the year 2000. For South Africa as a whole, and in both urban and rural areas, and among the “Black” population group, median quintile groups allocate a greater share of their consumption expenditure to transport services.16 The share of transport expenditure increases with the total consumption expenditure for “Coloured” and “White” population groups while the opposite is observed for the “Asian” population group.

After exploring the income and expenditure survey, we perform a simple exercise of doubling separately the price of major petroleum-products, i.e. paraffin and transport fuel and then measure its impacts on households’ cost of living, that is, the consumption price index (price of the same bundle of commodities) and the equivalent variation in consumer welfare.

Changes in consumer price index and equivalent welfare variation of doubling the
prices of paraffin

The expenditure pattern of paraffin (Table 3, Table 4 and Table 5) implies that the impact of the paraffin price rise would strongly be regressive, with the lowest quintile being much more impacted than the highest expenditure quintile. The impact of doubling the paraffin price on the cost of living presented in Table 6 shows that it is most burdensome for the poorest quintiles.

However, the most affected household group remains the lowest expenditure quintile group in urban areas with an increase of 4.3% of their consumption expenditure and a welfare loss
equivalent to 2.9% of the total consumption expenditure. Poor households in rural areas and
among the “Black” population in particular witness an increase of their cost of living by 3.4% and 3.9%, respectively. This is much higher than their corresponding highest expenditure quintile groups whose comparable cost of living increases are 0.3% and 0.2%, respectively. This study does not consider the fact that these poor household, particularly the rural based households, may be able to substitute paraffin by other sources such as biomass. In such cases, welfare loss as measured in this paper may be somewhat reduced.

 

Source:

 University of Pretoria

Department of Economics

Oil prices and the South African economy: A
macro–meso–micro analysis

Ismaél Fofanaa, Margaret Chitigab and Ramos Mabuguc
aLaval University, Québec, Canada

bDepartment of Economics, University of Pretoria, South Africa

cFinancial and Fiscal Commission, 73 Verbenia Street, Lynnwood Ridge, 0081 Pretoria, South Africa

Mozambique Doing Business - South Africa

2025

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