Lower oil price won’t cause food and beverage price drop, says consultancy

6th March 2015

By: Mia Breytenbach

Creamer Media Deputy Editor: Features

  

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While there has traditionally been a positive correlation between the global oil price and the global food price over the past decade, the sharp drop in the oil price since mid-2014 will not necessarily lead to a significant drop in the overall basket price of food and beverages in South Africa and abroad, notes consulting firm Frost & Sullivan.

Engineering News reported last month that collapsing oil prices had resulted in a decline in the cost of domestic fuel by about 30% from last year, according to economic consultancy Econometrix.

“However, industry participants should not assume that a drop in the price of crude oil will lead to a direct cut in overall prices, even though food and beverage manufacturers and suppliers benefit from a reduction in fuel and logistics costs, which often account for a significant portion of a com- pany’s operational costs,” warns Frost & Sullivan chemicals, materials and food senior industry analyst Anthony Lawrence.

He explains that food and beverage manufacturers and suppliers do not necessarily reduce the cost of their produce when production costs decrease.

“However, these companies try to absorb increased operational costs as much as possible when energy costs increase to subdue the overall costs that consumers have to face for a basket of goods.”

He adds that there often tends to be a delayed drop in transportation costs when fuel prices drop, as logistics for food products is often contracted to large supply chain companies. These contracts are often negotiated in advance and extend over a long period, which means logistics companies will benefit in the short term, he says.

“Only when contracts are renegotiated can consumers expect to see a potential drop in food and beverage prices as a consequence of transportation cost reductions,” notes Lawrence, pointing out that the length of a supply chain also determines the length of delay in a cost drop.

Consumer Shift
Lawrence suggests that the more interesting aspect about the effect of a fuel price reduction is the increase in consumers’ overall disposable income.

He highlights that the world’s poorest consumers are inclined to spend close to 60% of their income on food, which is extreme when compared with consumers in developed countries, who spend less than 40% of their income, on average, on food.

However, with a decrease in the global oil price and a subsequent reduction in fuel prices, consumers can increase their disposable income and allocate some income to other needs, which Lawrence believes includes food and beverages.

Further, there is a positive distributional effect when the petrol price decreases, as those who fall within a lower income bracket will benefit more.

Meanwhile, media company The Economist Intelligence Unit’s (EIU’s) latest Global Food Security Index’s (GFSI’s) quarterly price adjustment update released in January, states that “food affordability improved in nearly 75% of countries from September to November 2014, largely owing to a 2.8% decline in global food prices, which are forecast to fall further still”.

“While [the] prioritisation [of essential food items is the general rule, and] might be determined by the market or consumer strategy, the food and beverage industry has seen a shift in the mindset of consumers, who are buying necessities, not luxuries,” Lawrence suggests.

However, he believes that a decrease in the oil price will have a more severe and contrasting effect on oil-dominant producing nations.

“If the oil price takes a long time to recover, do you think we can expect to see decreased spending at food retail outlets in Nigeria, for example?” questions Lawrence.

He notes that the Nigerian economy will suffer from the decreased oil price and will, consequently, face job losses. As a result, Lawrence expects retail store sales in oil-producing countries to shift away from the sale of luxury goods to the sale of necessities.

“Many countries, such as South Africa, export large volumes of fast-moving consumer goods – products that are sold quickly and at a relatively low cost – to countries such as Nigeria. Therefore, the South African food export market will be negatively affected by the declining oil price,” he notes.

Price Prospects
Lawrence highlights that the drop in the crude oil price is not a one-off phenomenon. “While this is a common issue, the debate should also be focused on how long the price drop will be endured. History has taught us that crude oil prices do not simply go back to normal overnight and is unlikely to do so in a year.”

Nevertheless, the crude oil price already showed signs of an increase in January. As at February 18, the price for a barrel of oil was about $60 to $62. “The increase was not significant, but was rather ‘tip-toeing’ around a 3% growth point. It is further anticipated that the shift back to the $60/bl to $70/bl range will not be easy and will not be soon,” Lawrence concludes.

Edited by Samantha Herbst
Creamer Media Deputy Editor

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