Will rising fuel prices put the brakes on global trade?

fuel prices

The consecutive large increases in the fuel price over the past number of months have left consumers reeling, largely due to the impact such increases have on the cost of most other consumables. 

“However, it’s not just consumers that are feeling the effects of sharply higher fuel prices,” says Bobby Madhav, FNB Head of Trade & Structured Trade and Commodity Finance.

“Trade and industry in South Africa, and globally, is just as vulnerable to energy shocks. However, the effect of increasing fuel costs on trade flows is a lot more difficult to quantify than it is at a consumer level.

“That’s because fuel is just one of many input costs that importers and exporters have to take into account in order to ensure the profitability and sustainability of their businesses.

“So, while there are those who argue that oil price spikes like we’ve seen recently have the ability to put the brakes on global trade, the reality is that it’s just not that simple.”

Madhav adds that while high fuel prices will certainly have some direct influence on trade volumes – particularly trade activities undertaken over vast distances – that direct influence is relatively minor compared to the indirect, knock-on effects of high oil prices and the resulting inflationary pressures on both the supply and demand side of the trade equation.

“For one, it’s very important, when considering the impact of ongoing fuel increases on trade, to look beyond just the activities of importing or exporting goods. Both of these trade activities are ultimately dependent on extensive supply chains, most of which begin way before the trade activity itself, with extraction, harvesting or manufacturing activities.

“The negative effect of high fuel costs is typically felt at every point along these supply chains, and it has a tendency to compound as the number of ‘links’ in the chain increases,” he notes.

“In addition to the supply side, there is also the consumption side of the trade equation to consider, and here too, economic impacts can have a knock-on effect that is far greater than just the cost of fuelling a ship or truck.

“One of the most significant indirect impacts of significant fuel price increases is demand destruction.

“This is effectively the level of inflation at which consumer behaviour changes and becomes notably more conservative. Fuel cost is arguably the most significant direct driver of inflation, whether up or down. And when that influence is upwards, the impacts filter through much of the economy.

“Not only do higher prices at the pump mean consumers have less money to spend, but they also increase the costs of manufacturing and transporting goods; and these costs are invariably passed on to the people who buy them.”

Madhav says while the world may not yet have reached the tipping point at which significant demand destruction takes place, if inflation continues to rise it will likely happen very soon.

“At that point the indirect impact of rising fuel prices on trade volumes will almost certainly be seen as supply is forced to drop to match declining demand.

“The consequences of such demand destruction could be dire. For South Africa, as a developing economy, most production, distribution and trade businesses are already unable to pass through further increases in costs,” he describes.

“And most retailers will soon reach the point where they are not prepared to accept more pass-through costs.

“So, the only alternative is for businesses to absorb them. And the only effective way of doing that is by reducing operating costs in order to maintain margins. In most cases, the first place owners and boards look to cut costs is by reducing staff headcount.

“Unfortunately, lay-offs and retrenchments are only a short-term fix, and they have the further indirect impact of reducing consumption, further stifling economic growth, and ultimately reducing production and trade volumes even further.”

He adds that there’s also a very fine line to be walked here by companies, as reducing employee numbers invariably leads to demands for higher pay from those who remain.

“And when you add that to the already rising costs of labour due to inflation-linked increases, the benefit of reducing operating costs through retrenchments can quickly be eroded. 

“With all this in mind, it’s something of a stretch to say that trade volumes are at the mercy of increasing oil prices. The reality is that we are facing the potential for declining global trade; but there’s far more behind it than just the higher cost of filling up a cargo ship,” Madhav describes.

“And the difficult truth is that, unless a way is found to stabilise fuel prices soon, the negative impact they will have on entire economies and the world’s consumers will massively overshadow those they will exert on global trade volumes.”

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