2008 :

Global Markets – 1st quarter 2008 : Electricity – now a rare commodity in SA?

“Load shedding” and “blackouts” are words now used with frustration on a daily basis in South Africa. Nobody is immune to these frustrations and none can escape them. Most of us have a “load shedding” table handy at all times, having learnt how to make sense of them in a hurry. It would help enormously, of course, if the “load shedding” was implemented according to the table.

You may recall that this time last year, we wrote about this very issue and the growing concern about Eskom’s rapidly diminishing reserve margin. At the time of writing, experts warned that our reserve margin was just over half of what it should be and that it had been declining steadily since 2001. Clearly whatever reserve margin we had left a year ago is now no longer adequate to meet our daily requirements.

Articles about the impact of power cuts on the lives of all South Africans appear almost daily. A recent article describes how certain games scheduled for the Five Nations International Hockey Tournament (during which South Africa hosted players from Germany, Australia, Netherlands and Spain) had to be rescheduled because “Eskom could not give assurances that power cuts would not take place during the matches.” Another details how 500 tourists were left stranded on Table Mountain for 3 ½ hours following a power cut. According to The Times “some of those stranded were in two cable cars suspended in mid-air.” A spokesperson for the cableway reported that “the power cut at 8pm jerked key equipment on the two cars out of alignment, stranding the passengers …” This is the first emergency evacuation recorded in the 78 year existence of the cableway. The Mail and Guardian recently reported that three trains were set alight by angry commuters in Pretoria, after they had been left stranded for several hours due to a power cut. There is no telling what damage these reported incidents will have on how South Africa is viewed by the international community.

More disturbing, of course, is the impact on business and on the South African economy as a whole. On the 25th January, several large diamond, platinum and gold mines were forced to stop production at their local mines because Eskom could not guarantee supply – some of the mines reported losses of up to R60 million per day as a result. This news added to the upward trajectory of both the gold and platinum price, raising prices to record levels within hours. The potential impact of these events on our economy could be dire when you take into account that the mining industry alone, (which uses 15% of Eskom’s capacity), “accounts for 7% of the economy, more than 30% of exports and more than 25% of foreign exchange earnings.” Economists estimate that the impact of the power cuts on the economy could be apparent as early as the first quarter of 2008. It is also speculated that the losses could shave as much as between 1% and 3% off GDP for the year, should the severity of the “load shedding” continue unabated for the remainder of the year.

Patrick Craven, spokesperson for COSATU, made their viewpoint on the matter quite clear by stating “it has become a serious national embarrassment and could have a major impact on growth and job creation.” According to Eskom’s finance director, Bongani Nqwababa, “it’s a question of supply and demand. It would be irresponsible now to aggressively pursue energy intensive businesses.” He is quite right, of course – how can we encourage new projects when Eskom are unable to maintain the energy supply required for existing projects? This is not good news for local business or for attracting foreign investment into South Africa. ANC Secretary-General, Gwede Mantashe, encourages us to have a more positive outlook on the matter. He was quoted recently as saying “rather than being in a state of panic [we should] deal with the issue proactively because it is actually positive that the country is growing to the extent that we actually exhaust the energy capacity. That economic growth to us is positive rather than negative.” President Mbeki also focused on these “positives” in his State of the Nation address. Some South Africans appear to be less optimistic about the matter, however, with many investors now urgently seeking to increase their offshore exposure in order to diversifying more of their assets abroad.

A recent article in the Sunday Times confirmed that “according to the White Paper on the Energy Policy of SA, approved by the Cabinet in 1998, Eskom warned that its surplus capacity would be fully used by 2007.” This points to the fact that, government, perhaps even more so than Eskom, are responsible for the dire situation that we now find ourselves in. However, while getting angry about the situation may provide some measure of relief [be it only temporary], it won’t avert or remedy the national crisis at hand. With the situation expected to continue for at least the next 5 to 7 years [and beyond], the real issue now is how the matter is going to be dealt with and managed going forward. As we all know, there is no “quick fix” to remedy the situation.

REGIONAL COMMENTARY UNITED STATES OF AMERICA

The Federal Reserve cut interest rates aggressively during the quarter - by 1.50% to 3%. On the 21st January, the Fed surprised the markets by making an unscheduled cut of 0.75% - their biggest “once off” cut in 25 years (August 1982). The announcement (just one week before the scheduled meeting on January 29th and 30th) sparked a mixed reaction, with some viewing the move as the Fed acting in “obvious panic” while others responded to the news with cautious optimism. According to Keith
Hembre, chief economist at First American Funds, “this rate cut certainly leads to a better outlook in 2009, but it may not have any effect on the first quarter or even first half of this year.”

In addition to the aggressive rate cuts, the president announced a fiscal stimulus package (estimated at being in the region of $150bn or about 1% of GDP) aimed at providing a boost to the economy. The package will also provide tax relief to individuals and businesses. Commenting on the stimulus package, Mr Bernanke said “to be useful, a fiscal stimulus package should be
implemented quickly and structured so that its effects on aggregate spending are felt as much as possible within the next 12 months or so.” He warned that “stimulus that comes too late will not help support economic activity in the near term, and it could be actively destabilizing if it comes at a time when growth is already improving.” The slump in the housing market, continued sub-prime woes, and increasing speculation that the US is likely to go into recession this year have been the primary drivers of significant volatility in the region.

Growth for the last quarter of 2007 came in sharply lower at an annual rate of 0.60% (well below analysts expectations of 1.2%), compared to an annual rate of 4.9% in the third quarter. Overall the growth rate in 2007 was 2.2%, which is the lowest since 2002. Consequently growth forecasts for 2008 have been revised down to about 1.5%, but this forecast may well be revised again during the year.

EUROPE

The European Central Bank (ECB) left rates unchanged at 4% during the quarter under review. This was in line with expectations as, while growth is expected to slow, inflation remains well above the 2% target. Inflation was last recorded at 3.2% in January, which is its highest level since the introduction of the Euro in 1999. Commenting on their decision to leave rates unchanged, Jean Claude Trichet (president of the ECB) stated that “uncertainty about prospects for economic growth is unusually high.” However, Richard Snook from the Centre for Economics and Business Research didn’t necessarily agree with the ECB’s decision to leave rates unchanged for the last eight consecutive months - his view was that “its credibility is at risk because of signs of pressure on the financial sector, signs of slowing growth in the euro and the expansive action by other world central banks.” Howard Archer, from Global Insight, has the view that “…eurozone growth will slow markedly over the coming months. This will dilute underlying inflationary pressures and eventually compel the ECB to cut interest rates rather than to raise them.”

UNITED KINGDOM

In line with expectations and in an attempt to fuel the economy, the Bank of England (BoE) reduced rates to 5.25% during the quarter under review. While the UK economy grew by 3.1% in 2007, the impact of the “credit squeeze” became evident in the last quarter of the year. Growth for 2008 is expected to decline to about 2%, while growth in 2009 is expected to come in below this number. Speaking after the dramatic rate cuts by the US Federal Reserve, Mervyn King (governor of the BoE) stated that the UK faced “a period of above-target inflation and a marked slowing in growth. 2008 is likely to see higher energy prices, higher food prices and
higher import prices.” This is not good news for inflation, which remains stubbornly above the 2% target level and, while still benign (at 2.1%), is becoming a cause for concern.

According to a recent BBC article, Inenco (an energy and environment consultancy company) have indicated that “Britain is likely to face a shortfall in energy generation within five to seven years.” According to Michael Abbott of Inenco, “with the recent announcement about new nuclear stations, there seemed to be a collective sigh of relief. We believe that demand overtakes supply somewhere between 2012 and 2015, creating a serious ‘generation gap’.”

JAPAN

The Bank of Japan (BoJ) again kept interest rates unchanged during the quarter under review. Interest rates were last increased a year ago (by 0.25%), bringing rates up to their current level of 0.50%. Inflation increased to 0.80% over the last 12 months (to December). It is unlikely that this new figure will result in an increase in interest rates at this stage, however, as data indicates that this rise is attributable to manufacturers passing higher food and energy prices on to consumers, rather than as a result of an increase in consumer spending. Another factor supporting this view is the fact that the trade surplus narrowed in December due to a fall in exports, while at the same time rising oil prices increased the cost of imports. There is even speculation that rates may be cut should the current situation continue.

Takeshi Minami of the Norinchukin Research Institute commented that “shipments to the United States will likely continue to be sluggish and those to EU could fall as there are some signs that the slowdown in the US economy is rippling out to Europe. Exports to Asia remain firm, but if the US economy slows further, the impact on the region will be inevitable.” China became Japan’s biggest export market in 2007, overtaking the USA. Exports represent approximately 15% of Japan’s GDP.

SOUTH AFRICA

As forecast in our last report, the Reserve Bank (SARB) raised domestic interest rates by 0.50% at their December meeting. This increased the Prime Lending Rate and the Repo Rate to 14.5% and 11%, respectively. This was the eighth increase in rates since June 2006 - a total overall increase of 4%.

The SARB kept interest rates on hold at their January meeting – a decision welcomed by the market. Commenting at the meeting, Mr Mboweni said “In the light … of heightened economic uncertainties, both domestically and globally, and some evidence of moderation in domestic consumption expenditure, the MPC has decided that it is appropriate at this time to leave the repo rate unchanged.” He went on to comment that “there are still considerable risks to the inflation outlook.” Analysts had been divided as to whether another rate hike was on the cards in January, particularly because the December inflation figure had been worse than expected at 8.6% (with food and fuel being the main drivers) - sharply higher than the 7.9% in November. The SARB expect inflation to peak at an average of 8.5% in the first quarter of 2008 and to fall within the target band (3% - 6%) in the last quarter. While this may well signal the end of this rates tightening cycle, it could also mean that we may not see any reduction in interest rates this year. When asked to comment on growth, Mr Mboweni said “we are forecasting growth will come down a bit but not to the extent of a recession. The risks to output growth appear to be on the downside and this is likely to be reinforced by electricity supply disruptions”

Homeowners are also feeling the impact of higher interest rates first hand. An article in the Business Day recently reported that the Alliance Group of auctioneers had recorded a 75% surge in forced home sales and that “it had experienced a 300% increase in inquiries from sellers trying to offload their properties as ‘quickly as they can.’ Coupled to that, instructions from banks in the form of insolvencies and foreclosures have increased 75% in January, compared to January last year.” Commenting further, CEO of the Alliance Group Rael Levitt, said “when interest rates start going up it can take up to two years for the financial effects to be felt. The recent slew of bad news in terms of the electricity crisis, as well as concern about global housing markets, particularly in the US, is unfortunately a double whammy for overstretched borrowers.”

The Rand, which has had an extremely bumpy start to the year, is expected to remain volatile for the remainder of the year. Economists at Stanlib recently revised their year end figures for the Rand to R8 to the US Dollar, R15.37 to the Pound and R11.45 to the Euro.


GENERAL – OIL AND GOLD

After reaching record highs during the quarter under review, the oil price ended the period at $100.32 a barrel. The continued volatility continues to be fuelled by supply issues.

The gold price continued to rally sharply during the quarter, ending the period at $970.90 an ounce, compared to a close of $793.35 at the end of November. Analysts have blamed the continued weakness in the US economy and a weak US Dollar for the rally.

However, contributing to the rally in late January was the fact that many of SA’s larger mines were forced to “suspend” production due to the fact that Eskom were unable to guarantee electricity supply. The news made international headlines, sparking supply concerns. Prices are expected to remain high with GFMS commenting that they “expect the surge in investment to be driven by those factors that fuelled the boom witnessed in the final four months of 2007.” These factors include” a weak dollar, record oil prices and their inflationary consequences, the US sub-prime (home loan) crisis and its threat to (economic) growth in the Untied States and perhaps elsewhere, and lastly geopolitical tensions.”


CONCLUSION

This has been an extremely interesting quarter, with volatility being the order of the day for markets across the globe. We expect the volatility to continue into the year – or at least until there is more clarity regarding the United States and whether or not their economy will in fact go into recession (a recession being defined as two consecutive quarters of negative growth). Some speculate that the US market may already have entered into its first quarter of negative growth. Both the domestic market and the Rand have not escaped the pain over the last few weeks, some of which has been caused by issues much closer to home. However, local analysts do expect the second half of the year to be a little “brighter” than the first half.