How the Russia, Ukraine war will hit your pocket

Mbongeni Mguni | Monday March 14, 2022 09:20

As at the end of February, authorities at the Botswana Energy Regulatory Authority (BERA), estimate the local petrol pump prices were, on average, P1.25 below the actual cost of supplying the fuel. Diesel prices were on average P1.49 below cost while paraffin prices were about P3.50 below par, due largely to the fact that prices of the home cooking and lighting fuel was not increased in the last general adjustment in December.

With crude oil prices escalating around the world due to the conflict in Ukraine, these gaps between actual cost and price are rapidly widening and before long, authorities will have no choice but to pass on the buck to motorists, consumers and the general economy.

“We are at US$100 per barrel and it can even go higher so that by end of March, it may be US$300,” Mineral Resources, Green Technology and Energy Security, Lefoko Moagi told legislators this week.

“We are looking at this situation and what to do.

“It may mean we have to cut spending on certain things we are doing to help the situation.

“Where the National Petroleum Fund can help, it will help.”

The ominous signs are the first indicator of how a conflict thousands of kilometres away, can empty the pocket of the ordinary Motswana who may or may not have an idea why Russians and Ukrainians are engaged in war.

As explained by the US Energy Information Administration, Russia is the third-largest petroleum and liquid fuels producer in the world, after the United States and Saudi Arabia. It is also a major exporter of crude oil.

“Since mid-January 2022, the geopolitical risk related to Russia’s further invasion of Ukraine has contributed to higher and more volatile crude oil prices,” the US government agency said in a note released last week.

“Stronger petroleum demand as the COVID-19 pandemic has begun to ease and slower crude oil production growth have also put upward pressure on global crude oil prices.”

Sanctions imposed by Western countries and major refiners such as BP and Shell, have cut off Russian oil supplies, with the uncertainty around availability of the commodity worsening speculative pricing in the global market.

Botswana, which has no oil production or refining capability of its own, is dependent on the transit fuel that is sourced mostly through South Africa. Pump prices in that country rose by an average of ZAR1.46 on March 2, meaning motorists there are paying more than ZAR21 per litre (P16). Analysts expect that the pump prices could rise by another two rands in April, based on current trajectories.

BERA’s Merapelo Tautona explains that all Southern African Customs Union members use the same methodology to price fuel. The regulators use a slate, which is a formula calculating the cost of fuel, including transportation, labour and other factors.

The difference, however, is the individual processes that lead to an adjustment of pump prices in each country. South Africa’s processes are more independent and automated and as a result, pump prices are adjusted upwards or downwards on the first Wednesday of each month.

In Botswana, BERA monitors the slate and submits a report with recommendations to the Energy ministry. Considerations are made such as the sustainability of the debt government owes oil companies for the difference between the actual cost of supplying fuel and the prevailing pump prices.

In addition, the Minister also looks at the impact on consumers, such that where BERA has recommended a certain increase, this may be reduced to help affordability.

Under-recovery, or the situation where pump prices are below actual costs incurred by oil companies in importing fuel, has been obtaining for an extended period in the country, despite the five fuel price increases made last year. The National Petroleum Fund (NPF), which acts as a buffer by paying some of government’s debts to oil companies, has been rebuilding gradually from its erosion a few years ago, but it has not been able to successfully resolve the under-recovery. In addition, the NPF, which is funded by the fuel price levy, also has other competing purposes that include developing national oil infrastructure such as storage.

The runaway global crude prices are building pressure on policymakers.

“If international oil prices are going up at the rate that they are right now and there’s no corresponding upward price adjustment of pump prices, the under-recovery worsens and this means the debt to oil companies grows,” explains Tautona.

“It is an exponential growth at the moment and that is a lot of pressure on the NPF.

BERA would ideally prefer smaller, more regular upward or downward adjustments of fuel prices, but in the absence of this, motorists can expect a shock increase given the prevailing trend of global oil price movements.

Even if the increase is made smaller, pump prices would have to be lifted more frequently to keep up with the under-recovery, unless, as Moagi hinted, transfers are made to the NPF from other parts of the budget.

For motorists and the broader economy, higher fuel prices will mean across the board increases in the prices of goods and services, a hammer-blow to ordinary citizens who are have already been suffering under the highest inflation in a decade.

The Bank of Botswana, which monitors inflation, has already warned that the geopolitical tensions in eastern Europe are an upward threat to the expectation that inflation could gradually decline later in the year.

The war between Russia and the Ukraine is also causing uncertainty in the country’s most economically important sector – diamond mining.

Russia, through the mining group Alrosa, is the world’s largest producer of rough diamonds by volume, with Botswana coming second. In 2021, the two countries accounted for 28% and 20% of global output, according to Anglo American data. The United States, China, Japan and India were the world’s biggest markets for diamond jewellery., accounting for 51%, 11%, seven and six percent respectively in 2021.

While on the surface, Western sanctions on Russia would appear likely to reduce global production and thus raise prices for “clean diamonds” from Botswana allowing the country to top the table, industry experts caution against such a simplistic view.

The situation has to be read much more broadly.

“Current US sanctions on Russia’s Alrosa will not reduce the supply of rough diamonds,” Rapaport chairman, Martin Rapaport said this week in response to Mmegi’s enquiries.

“India, where about 93% of the world’s diamonds are manufactured, will enable money transfers without using dollars, euros or the SWIFT system.

“Americans will continue to legally buy polished diamonds from Indian or other cutters who have sourced the rough from Alrosa, as the diamonds themselves are not subject to US sanctions.”

More importantly, the world markets may not necessarily be in a position to want to buy more diamonds, due to the impact of the war. In the US, which this week slapped sanctions on Russian oil and gas, President Joe Biden warned his citizens to expect higher fuel prices and tougher conditions as a result.

Rapaport, a veteran diamond industry analyst, concurs.

“Global economic warfare will significantly boost inflation, which was already rising due to overstimulation of the money supply and economy in response to the Covid-19 pandemic,” he said.

“Expectations of double-digit inflation are not unreasonable.

“Higher inflation will reduce disposable income and broad-based US diamond demand.

“It will also drive higher interest rates, which will further reduce disposable income, consumer wealth and consumer demand.”

In essence, rather than Botswana enjoying a boom in diamond prices due to sanctions on Russia, the war and its impact on the global economy could lower demand for rough diamonds this year, impacting heavily on local budget revenues. For the 2022 – 2023 financial year, the Finance Ministry had projected that mineral revenues, royalties and taxes would amount to P24.1 billion.

Much of this income comes from diamond mining and at that forecast, would account for more than a third of government’s expected expenditure of P74.8 billion.

As war rages in Ukraine, various ministries in Botswana are currently presenting their budgets before Parliament based on a revenue forecast anchored largely by diamonds.

Lucara Diamonds’ CEO, Eira Thomas expresses the uncertainty in diamond markets about the impact of the eastern European conflict. Late last month, Lucara, which is the only other diamond producer in Botswana outside of Debswana, announced that it expected revenues of up to US$225 million (P2.6 billion) in 2022.

“This is a very tough question,” Thomas said in response to Mmegi’s enquiries on Tuesday.

“We have all been watching to see what it will mean.

“In the first week of the crisis, the response was that the sanctions would be really focussed on certain people and it’s now, I think, becoming more problematic for Russia to distribute its diamonds like in the past.

“However, they have the ability to sell through India and China.

“I would say it’s too early to call but clearly the US market is going to be watching this much more closely.”

Other experts say should the global consumers of diamonds mount an ethical boycott of Russia’s diamonds, this would reduce prices for Russian diamonds while increasing prices for documented African and Canadian diamonds.

Even here there is uncertainty. Firstly, while Russia may be under a broad range of sanctions, Alrosa’s diamonds are not specifically sanctioned from the global market and even if they were, identifying them after they are processed, in places such as India, may be difficult.

“Additional US sanctions on Alrosa targeting the diamonds and not just the money flow will reduce supply, although it is unlikely that US customs will be able to ascertain the sources of polished diamonds being imported into the country,” says Rapaport.

The authorities charged with monitoring the threats and opportunities to the country’s budget, have their hands full in the next few months, tracking an ever-changing conflict that, while far from home, has all too real consequences for Botswana.

Ordinary citizens, meanwhile, will be bracing for impact.