External environment which impacts our ability to create value
Weak economic growth and volatile currencies
Global growth slowed to average 3,1% in calendar 2016, from 3,4% in 2015. The US grew by 1,6%. China and India expanded 6,7% and 7% respectively, while recessionary conditions persisted in Russia and Brazil. South Africa grew 0,3%, before contracting in first quarter calendar 2017 following the downgrade of its sovereign credit rating to sub-investment grade. The rand/US dollar exchange rate remained volatile and much stronger in relation to other currencies. Mozambique’s growth slowed to 3,4% in calendar 2016 from 6,6%, following IMF actions on the discovery of previously undisclosed loans to state firms, leading to a sharp fall in the currency.
How we responded
On-going weak demand conditions and the strong rand/US dollar exchange rate limited gains in our revenue, margins and earnings. South Africa’s downgrade resulted in a corresponding downgrade of Sasol’s credit rating. However, we remained focused on delivering on our Response Plan (RP) objectives, and prudently managed our balance sheet and cash flows and increased our hedging activities to create headroom on our balance sheet. For financial year 2018 we have hedged 70% of our currency exposure which equates to US$4 billion. In Mozambique, the fiscal crisis led to reduced government spending and increased fuel, electricity and food prices. The government increasingly enforced regulation to generate revenue. Sasol and other companies were impacted by this in the areas of work permits, customs and business visas.
We expect global GDP growth to be stronger in calendar 2017 and 2018, however there are a number of uncertainties. These include the implementation of the Trump administration’s policy agenda and risks around the timing, pace, extent and spill-over effects on the rest of the world, the evolution of the ‘Brexit’ process, geopolitical tensions and the sustainability of China’s growth. South Africa’s growth prospects are challenging and exchange rate volatility will continue. We estimate that a 10-cent change in the annual average rand/US dollar exchange rate will impact our operating profit by approximately R710 million in 2018.
Changing digital landscape
All industries in which Sasol participates are increasingly impacted to some extent by the adoption of digital solutions. Digital technologies are transforming how we work and we aspire to deliver even more superior returns by accelerating our digital journey at Sasol.
How we responded
We embarked on a journey to formally define our digital roadmap.
To improve our efficiencies and maintain our competitiveness we will embrace more digital solutions in our upstream, exploration and manufacturing operations, supply chain activities and in our strategic business units to meet our customer needs.
Structural shifts in global commodity prices
Commodity prices showed a slight recovery. Oil prices benefited from agreements between OPEC and non-OPEC countries to cut production, but high global inventory levels constrained gains. Brent averaged US$49,77/bbl in the 2017 financial year. Warmer US weather in the second half of the 2017 financial year and high inventory levels led to lower natural gas prices. With a significant amount of rejected ethane in the US system, the price of ethane remained just above the energy floor. Prices for the main commodity chemicals were moderately stronger.
How we responded
As crude oil prices fell and the rand strengthened, the selling prices of fuel marketed by our Energy business decreased, reducing our profitability. Our chemicals businesses however benefited from the moderately stronger commodity chemical prices and wider performance chemical margins in the US. Our continuous improvement drive to add value and protect our competitive advantage and our various RP and hedging initiatives helped mitigate the impact of commodity price volatility.
Crude oil price volatility is expected to continue in the short term. Longer term, oil prices are at risk of staying much lower for longer and may impact on our business’s profitability. For every US$1/bbl change in the annual average crude oil price, operating profit will be impacted by approximately R850 million in 2018. US natural gas production is slowing and fundamentals are tightening. More rigs and greater infrastructure build point to higher production in 2018. Increasing demand for US natural gas for LNG purposes could provide support to prices in the medium to longer term. Demand for US ethane is expected to rise in the next few years. In the foreseeable future, prices for oil and commodity chemicals will be driven by supply, demand, inventory fundamentals and industry improvements. Longer term, commodity chemicals will be driven mainly by oil prices.
Increasing environmental regulatory requirements and labour market unrest
The 2016 United Nations Paris Agreement set a path towards a lower-carbon global economy and is a defining milestone for the climate change challenge. Changing regulations continue to reflect the worldwide trend to the more efficient use of resources and reducing environmental impacts. In South Africa, where multiple environmental laws have been promulgated over the same period of time concurrently and where further law reform is anticipated, it is important that an integrated and co-ordinated compliance and environmental management approach is adopted. This will enable aligned and optimised outcomes, and reduce misalignments and duplications across air, water, waste and future climate change requirements. For our Mining operations, we also experienced prolonged labour action which is reflective of the current economic and political climate in South Africa.
How we responded
The implications for resource-intensive businesses like Sasol’s are numerous. Recognising the role we have to play in addressing the global sustainability challenge, we continued to focus on sustainable growth and efficiency improvements, while ensuring we meet our regulatory requirements.
To respond to the strike at Mining, we increased external coal purchases to maintain the uninterrupted supply to other Sasol businesses. We have developed a risk-based approach to minimise labour volatility challenges.
This required a review of our broader employee relations strategy and the adoption of a more integrated approach across all affected stakeholder groups to ensure business continuity.
With our global reach and greater bias towards chemicals and gas, we are now better positioned to respond to evolving regulations. Notwithstanding our reliance on coal, we continue to optimise the use of lower-carbon natural gas-derived feedstock in our energy mix. However, our options to respond to new regulations may require significant capital and other resources which we are actively investigating. More research and development is needed, particularly for our South African operations, in terms of studies and commercial testing of various options. We will continue to prioritise strengthening our relationships with employees and recognised trade unions to reintegrate teams disrupted by strike action in 2017.
Link to material matters:
Delivering value-based growth
Human capital management