Episode Transcript
The Finance Ghost: Welcome to episode 291 of Magic Markets. We come to you in a week where AI is all over the headlines again, as usual. People calling for a slowdown there. But there's something else that is firmly in the headlines. That is oil, and that's what we will be talking about this week.
Moe will be taking you beyond the latest oil spike. We've got bottlenecks, we've got depleted inventories, we've got delayed supply response, we've got a whole lot of things that could keep the energy markets volatile long after the headlines fade this week.
And I'll be taking you through Sasol, which I suppose is the obvious choice on the JSE if you want to play that theme. I'll be talking about how Sasol is not as simple as saying, “Well, there's the Brent Crude price, hence Sasol will behave in a particular way.”
Over to you, Moe. Teach us about what's going on in oil!
Mohammed Nalla: Indeed, Ghost. Quite an interesting and exciting time if you're in the oil markets or even just a macro observer. I say exciting, but it's scary at the same time, because at the moment, at the time of this recording, we've got oil back above $100 a barrel (it’s around $110 a barrel), and that's driving a lot of the news flow.
But what I want to talk about this week is actually beyond that news flow. It's looking at what's happening with supply and demand. If you look at that, it's really this race between repairing a lot of the infrastructure that's out there (getting supply lines back in shape) and replenishment of reserves (which have been drawn down quite aggressively over the course of this year).
Now, the important question is really whether oil or the system in general can rebuild those buffers before we see another disruption, or if it can actually be done while the current disruption persists.
There are actually a couple of key points I want to touch on, the first being production capacity and available supply, because those have actually become very different things. Next up, we've got the replacement supply which can come on stream, but takes time – and how long that actually takes. And then the wild card, I guess, would be China, because they're currently a source of weak demand.
If you look at the latest Chinese data, you'll see that their imports of oil have fallen to these record lows, so a lot of people are trying to digest what's happening in China, how long before they need to restock the inventories that they've run down, and that becomes a bit of a wild card.
Let's start off with the bottlenecks. As we've mentioned, that's driving the short-term move in markets. That's because Saudi Arabia at the moment has been disrupted. They had actually built this very nice East-West Pipeline which was a means of getting around the bottleneck at the Strait of Hormuz, but over the course of the last week or so, that's been disrupted by attacks. That has driven the short-term move that we've seen in the oil price.
The important thing to note here is that, despite the fact that Saudi Arabia does have barrels that it can produce, that pipeline to market or route to market is what's actually causing the disruption. And that's why I mentioned the replenishment and repair of the infrastructure, because that goes beyond just looking at oil production levels.
Saudi has indicated that they've got supplies at the port which can keep shipments going for around four to seven days, but beyond that, we could actually see that disruption start to filter through into supply chains. And obviously, the spot price of oil is starting to reflect that.
Now, even if you see an improvement in the Middle East (and that is a big ‘if’), the normalisation of energy markets will take some time. That’s because infrastructure is going to have to be repaired, then you've got the shipping lanes that need to still be secured. You've got the issue around insurance, all those shipping containers or tankers out there (something we have discussed on the show in the past). All of that's going to have to fall back into place in order to see a real sustainable normalisation, in terms of supply and then price.
If you look at the International Energy Agency (IEA), they currently only expect Gulf supply to recover during 2027. Now, that’s their best estimate. I would see that as an optimistic outcome, certainly given the tensions and the temperature level that we're seeing in the Middle East at the moment.
And then the other bottleneck is not just the pipelines, it's also refining. This is because crude can begin flowing again, but diesel and petrol will then still remain scarce because we've got bottlenecks at the refining level.
Gulf exports of refined products are still well below their pre-war levels and recently we had attacks on Russian refineries. We've seen President Trump effectively calling Ukraine saying, “Hey, don't attack the Russian diesel refineries. It's causing us some problems there.”
That explains why diesel prices have actually risen a lot more sharply than you've seen in the underlying crude oil price. It's because of those refining bottlenecks. In fact, if you look at refining margins (other than in China, where there are some weird data issues), they are at record highs. I remember a time, in South Africa, certainly, where refining margins were negative. It led to the shutdown of a lot of refining capacity. Now we're dealing with that issue.
Lastly, we're talking about the inventory. Global oil stocks have fallen – wait for this, it's a really big number – by more than 500 million barrels since February. Those reserves absorbed part of the initial shock, but eventually you're going to have to rebuild those.
If you look at US reserve levels, they're now down at around a third of the peak levels that they had during the Obama administration, and maybe the early Trump administration. That shows you that even if things normalise, they will need to replenish those reserves. And if we had to just replace the volume lost this year in a manner that doesn't disrupt the markets too much, it could add as much as 700,000 barrels a day in terms of oil demand. So, pay attention to that. That's quite important.
Then I mentioned the fact that infrastructure takes some time to be repaired. We've still got lots of big projects on stream in the US, in Canada and so forth, but those projects don't happen overnight.
If you want to break this down into timeframes, over the shorter term, if you look at a really short-term impact, you'd need to see some sort of stabilisation in terms of the Middle East. Yes, governments can continue to release those reserves, but this just buys us time.
But the longer-term picture, if you look at six to 12 months out, is the impact of US shale. And those projects take around 6 to 12 months in order to come on stream again, so it's not this instant, “Hey, we turn the tap, the oil starts to flow.”
And then longer term, beyond that, as we get into 2027, those other projects I've mentioned could add to supply. But then that's going to come against the backdrop that if you see a decline in prices, a lot of those big countries are going to start refuelling their strategic reserves.
Now, Ghost, to bring this back home to our listeners in South Africa: why is all of this important? Because South Africa is very exposed to energy imports. South African refining capacity has halved over the past decade. And so, as a result, imported refined product (I'm not talking about crude) now actually takes up more than half of domestic fuel demand.
That leaves South Africa not just exposed to crude prices, but also to those refinery margins I'm talking about, the shipping costs, the insurance that comes, and then you've got to superimpose on top of that the rand, which generally tends to do badly in events where you see a risk-off move in markets.
So, that's a very toxic conglomeration of aspects that could come through, and that's filtered through into the SARB's deliberations. They recently did a paper this year in terms of sensitivities to the oil price and how that filters through into the economy. So, I think that's going to contribute to this continuing caution that you've seen from the SARB.
In closing, the next week is going to matter. Do we see some sort of peace or stabilisation in the Middle East? But remember, that just addresses the short-term impact. The longer-term impact is really going to be driven by how quickly we can actually repair some of the infrastructure that has been damaged, and then how quickly some of those longer-term projects can actually come on stream. And that, I think, defines the longer-term story on oil.
I've been bullish on oil from around this time last year. I didn't think we'd get to levels above $100 as we're seeing right now. I think there is some short-term downside risk if you see any stabilisation. But over the longer term, I'd be very surprised if you actually saw oil collapsing back down to the $50s or $40s.
Yes, that would be good for consumers, but then that starts to choke off the investment on the other side of things. I'd prefer to see a much more stable supply and demand that actually sees the oil price stabilise between $60 and $70 a barrel. I think that's where both sides of the equation actually seem to get something out of the mix.
The Finance Ghost: And this is why they call it cyclical, right, Moe? Because you have this kind of push and pull and squeeze and weird bottlenecks, and then things catch up and then they lag. And it's all demand driven, and supply can't respond as quickly, it's not as elastic, and that's why you get these dislocations, right? It's a cyclical market 101.
Mohammed Nalla: Absolutely. And I mean, that applies to any resource market at the end of the day. Investment takes some time to catch up to the overall trend. When it does, that in effect actually chokes off the rise in prices that you've seen, and that then filters through to a curtailing of that investment cycle. And that contributes to the overall longer-term cyclicality of that industry. That makes it very difficult for companies which operate in that space, which I think you're going to take us through now with your view on Sasol.
The Finance Ghost: Yeah, let's jump into that. So, the Sasol share price – up 120% year-to-date. But Brent Crude is up 70% year-to-date in dollars, or around 63% in rand when I looked earlier (we're recording this on a Monday, in case it moves wildly in the rest of this week). It's easy to just assume that Sasol is a leveraged play on Brent Crude, and in some respects it is, but it's nowhere near that straightforward.
Firstly, the Brent Crude oil price is not necessarily the right price to use for everywhere in the world. More of a technical point – there are different oil prices depending on where you are – but it's something to just keep in mind.
For the real story, I'll refer to this piece from the recent Sasol earnings covering the period to June. They said this included “a 4% increase in sales volumes associated with” – here's the important part – “improved production”, as well as then “a 7% increase in the average US dollar price per barrel of Brent Crude, and a more than 100% increase in refining margins following improved fuel differentials”.
So, a few distinct points there.
First one: Sasol's performance is impacted by volumes. Particularly in a manufacturing business, higher volumes do mean a more efficient overhead absorption profile, and that means your margins tend to be better regardless of what's happening with oil prices. So, more volumes mean yes, you sell more – that drives revenue – but also, you are absorbing overheads a lot better, and that's good for your margins. Now, management deserves a lot of credit here for the improvements they've made to operations like Secunda.
Then you've got the points around refining margins. And obviously I'm just ignoring the one here about the average increase in the US dollar price per barrel of Brent Crude, because there we understand, “oil price goes up, good for Sasol”. The one that's more interesting is refining margins, which have more than doubled. That's where it gets pretty juicy.
Now the diesel crack spread (just an example of something you might have seen on social media that people are talking about), that's measured as the diesel selling price minus the crude oil cost. So, it's a measure of margins.
The consumer buys petrol and diesel. We buy that for our cars. We don't buy oil, we buy the refined product. So refining capacity, to your point, Moe, makes a big difference. If refinery supply tightens, then the crack spread can go up. Why? Because if there's demand in excess of supply, they can charge more. Simple as that. That's applicable to literally any refined product, which would all have its own margins. The diesel crack spread is just one example.
Now, this is all part of what makes Sasol so difficult, because it can underperform a period of seemingly good oil prices, depending on what happens with crack spreads. It can also outperform the oil prices if refining margins really ramp up, as we've seen this year and as has continued.
So, when they report the next set of results over at Sasol, investors have a bunch of things that they need to look out for. Because yes, we can see the Brent crude numbers, we can see some of the crack spreads perhaps, but we don't know yet exactly what that would have meant for volumes, and we don't know what that would mean for the rest of the group's numbers.
The market knows that more profits are coming. That's why Sasol has more than doubled this year, in terms of its share price, versus adjusted EBITDA for the financial year being up by around 17%.
Now, here's the additional complexity at Sasol which is important: the extent of chemicals exposure, not just fuels. Now, this is obviously affecting adjusted EBITDA, and it's affecting the valuation as well, because Sasol is not a pure play on oil. It's not a pure play on crack spreads. It's not even a pure play on fuels, full stop.
In the latest period, the Fuel segment EBIT jumped from R5.2 billion to R19.9 billion. That's a massive swing of R14.7 billion, which is fantastic, but the group numbers were only up by R6.9 billion. So, where did the rest go? There's almost R8 billion that we just can't see here.
Well, one of the answers (actually, the main answer) is Chemicals Africa, which swung wildly from a R5 billion profit to a R3.3 billion loss. That offset more than half of the benefit we saw in the Fuels segment.
Diversification at energy companies means that if you want to actually go and play a specific commodity (so if you're really interested in oil), it's actually quite difficult to do it in a place like Sasol. Because yes, there's a Fuels element, but not only is it affected by refining margins, but the group numbers are also going to be affected significantly by what happens in Chemicals.
So, if you want to play oil, then go and play oil. If you want to do oil with leveraged exposure, then look at derivatives. If you want to buy Sasol, then you need to buy Sasol. You can't just see it as a proxy for oil. It's really not that simple.
One other point that I do just want to make, by the way, as we talk about the noise in trying to understand Sasol: as an equity investor, you would be interested in free cash flow because that's what is going to fund dividends down the line, share buybacks, etcetera, etcetera.
Now, earnings were up, and then capital expenditure in the latest period was down 18% as major projects were concluded, so you may be tempted to think that it was a bumper period of free cash flow for Sasol. But free cash flow was actually down 5% because net working capital was under pressure due to the elevated inventory levels as prices went up on the fuel. So, really interesting. Lots of different things going on here.
Net debt was down by 11%. That's something that investors will like. They'll also like the fact that cash fixed costs were maintained at R70 billion for the third year in a row, so management's efficiency drive is doing well.
And these numbers have been out in the market now for a while. These are not hot-off-the-press numbers. But what's going on with oil is hot off the press, and obviously that's going to affect the Sasol share price now, ahead of what it could mean for the next set of numbers at Sasol.
Final point, Moe, and a fun one here: at time of recording, over the past week (and by the way, Sasol's at close to its 52-week highs, so lots of good momentum here), Sasol was the second-best share price performer on the JSE. Number one on the list? Oando, an energy company in Nigeria. So, oil is all the rage, even on the name that no one ever talks about.
Mohammed Nalla: Ghost, that's super interesting. I have exposure to the oil or the energy sector in general. Not to Sasol, I've preferred some of your global majors. And then a lot of the midstream operators. So, I like the pipelines. I like that value chain in general, because it de-risks some of the moves that you're seeing in the crude price.
If we do see somewhat of a correction there, yes, they do get hit, but probably not as hard as some of the majors. That's because they earn royalties along the line and so forth. So, remember, there are many places where you can actually play this value chain.
The other interesting thing I just wanted to touch on with Sasol is that sometimes they do actually put hedges in place based on where the oil price is going, and so sometimes that feed-through from the crude price is not as obvious in terms of the company's underlying performance. Always just keep an eye out for those kinds of dynamics. It is very important to note that sometimes these companies do operate in that market to mitigate the risk, but that could also sometimes cap your upside.
Ghost, I think that's a fantastic wrap. There's a lot going on in the oil markets this week, so we hope you've enjoyed the show. As our listeners, let us know. Hit us up on social media.
It’s @MagicMarketsPod, @FinanceGhost and @MohammedNalla, all on X, or go find us on LinkedIn. Pop us a note on there. We hope you've enjoyed this.
Until next week, same time, same place. Thanks and cheers.
The Finance Ghost: Ciao.
