The latest round of load-shedding has focused attention on the cost of running generators during power outages, in particular mitigating the effects of volatile diesel prices.
Mention fuel prices and most of us think only in terms of what it costs us every time we fill our tanks at the garage. However, the reality is that changes in fuel prices affect us in other ways too. Fuel prices affect the cost of transporting goods to retailers, costs that are either passed on to consumers or absorbed by the retailer.
Now with load-shedding a reality for South Africans, fuel costs are having another impact on the cost of doing business, in the form of running generators to ensure business continuity.
In today’s ‘always on’ business environment, sitting out outages and waiting until the power comes back on is not an option. For shopping malls, hospitals, office blocks and other key services, lengthy power outages mean a breakdown in services to clients, loss of income (and sometimes jobs) or even a health risk. Many businesses and other organisations have had to invest in generators and have found themselves having to cover a new cost, the cost of diesel.
Volatility and business planning
The cost of diesel would be enough of a challenge for businesses if it were steady and predictable. Unfortunately, diesel prices are highly volatile, which makes planning and costing difficult.
The price of diesel is set by government, as part of what is known as the basic fuel price. A number of factors go into the setting of the basic fuel price (such as fuel levies), but the two key variables are the US dollar price of oil and the Rand/US dollar exchange rate, both of which are usually volatile. Much of that volatility stems from factors outside of the control of South Africans, such as global confidence in emerging markets and global oil supply dynamics.
Combined, these two variables (exchange rate and oil price) make up 65% of what determines the basic fuel price. However, they account for 98% of the changes in the basic fuel price – which accounts for the volatility of the basic fuel price.
In short, businesses have to deal with an important and volatile cost item on their income statements. They can absorb the cost of rising rand diesel prices (which affects cash flows and profitability) or pass it on to customers and clients (again affecting profitability and cash flow if customers withdraw their business).
Mitigating costs by using derivatives
Fortunately, businesses need…
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Read the full article by Quentin Allison, Head of Commodities Trading & Structuring and Itumeleng Merafe, Head of Interest Rate Structuring, Investec Specialist Bank, as well as a host of other topical management articles written by professionals, consultants and academics in the February/March 2020 edition of BusinessBrief.
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