Blog: 26 February 2017 (How long does it take crude oil price movements to feed into SA's inflation?)
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In today's blog we take a look at how long it takes before crude oil price movements affects South Africa's Consumer Price Index. Crude oil is the main input into petrol and diesel and these are essential into agricultural equipment used in the production of food. In addition to this petrol and diesel are used by vehicles used to transport consumer goods to retail outlets where consumers buy such goods.
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How long does it take for crude oil to impact our inflation rate?
The line chart below shows the year on year percentage change of Crude Oil prices (the blue line as measured by when the Crude oil arrives in South Africa). This is important to note as the crude price when entering South Africa has been invoiced and paid for (weeks and possibly months) before it arrives in South Africa. Part of this time lag is the amount of time it takes to ship the crude to SA (and then how long it takes before it is processed by the customs officials at the point of entry into South Africa). Thus we use Crude Import Unit Value Index (UVI) as published by Statistics South Africa.
The line chart also shows the CPI (red dashed line) and 3months lagged CPI (green line) year on year percentage changes. We lagged CPI by 3months in order to check if for example the November 2016 crude price correlates better to the January 2017 CPI. I.e does crude price movements in November 2016 only take affect in January 2017. The idea and theory behind this is the that prices feeds through the economy over a while and not instantly. So for example crude arrives in SA, refineries charge more to refine it as the crude is more expensive, transport and pipeline companies know crude prices are higher and charge more to transport it, trucking companies taking the fuel to depots and petrol stations now charge a higher fee as they know crude is more expensive (so they pay more insurance etc) and ultimately the higher crude oil price feeds through to increased transport and production costs for retailers and they then increase prices and this leads to a higher inflation rate.
The line chart also shows the CPI (red dashed line) and 3months lagged CPI (green line) year on year percentage changes. We lagged CPI by 3months in order to check if for example the November 2016 crude price correlates better to the January 2017 CPI. I.e does crude price movements in November 2016 only take affect in January 2017. The idea and theory behind this is the that prices feeds through the economy over a while and not instantly. So for example crude arrives in SA, refineries charge more to refine it as the crude is more expensive, transport and pipeline companies know crude prices are higher and charge more to transport it, trucking companies taking the fuel to depots and petrol stations now charge a higher fee as they know crude is more expensive (so they pay more insurance etc) and ultimately the higher crude oil price feeds through to increased transport and production costs for retailers and they then increase prices and this leads to a higher inflation rate.
Crude oil prices movements are shown on the left hand axis and the two CPI measures are shown on the right hand axis. First thing readers will note is the fact that the crude oil prices do drop substantially (to around -40%) while inflation on the right hand axis hardly falls below the 4% mark. Showing inflation is a bit more "sticky". The phenomenon is known as "sticky prices", where the prices of major inputs into inflation falls substantially yet inflation remains relatively high. The main reason for this is greed. As input prices drop retailers keep prices high as they know consumers are used to paying the higher prices (and this earns the retailers higher profit margins as costs are dropping but they keeping selling prices high).
Another problem in SA is the fact that petrol prices are regulated and taxes heavily so substantial drops in crude prices does not filter through into substantial declines in fuel prices (as majority of fuel prices are made up of taxes). And since fuel prices are major item in CPI basket (and it affects so many other items' prices), not seeing the substantial drops in fuel prices as reflected by crude due to regulations and taxes means that our inflation rate is less like to show the declines that crude oil shows, especially if greedy retailer behavior is taken into account too.
Another problem in SA is the fact that petrol prices are regulated and taxes heavily so substantial drops in crude prices does not filter through into substantial declines in fuel prices (as majority of fuel prices are made up of taxes). And since fuel prices are major item in CPI basket (and it affects so many other items' prices), not seeing the substantial drops in fuel prices as reflected by crude due to regulations and taxes means that our inflation rate is less like to show the declines that crude oil shows, especially if greedy retailer behavior is taken into account too.
So what does the numbers say? Which of the two CPI lines in the graphic above reflects the movements of crude best? The actual CPI or the CPI lagged by 3months? Well the correlation between crude oil prices and CPI not lagged is 0.27 (which shows a mild positive relationship between crude oil prices and the CPI). The correlation between crude oil prices and CPI lagged 3months is just 0.20. A weaker relationship than the one between crude oil and CPI unlagged. Part of that might due to the timing of when crude was paid for (invoiced) and when the crude gets to SA and is processed by customs.
There is no doubt that crude oil prices have an impact on South Africa's inflation rate, but trying to quantify just how big an impact would be extremely hard to do. As there are so many other variables and role players throughout the value chain leading from crude oil imports to the final goods being sold on retailers shelves. But one thing is sure, when crude oil prices increase significantly. Farmers and retailers are quick to blame price increases in it, but when we see significant price declines in crude oil, food prices, fuel prices and ultimately overall inflation is not nearly as quick to respond to such price declines. As both retailers (higher profit margins) and government (high taxes on fuel) are driven by greed and the urge to get more and more money. Ultimately leaving consumers to suffer the most.