KUCHING: The fall in crude oil prices leaves much to be desired for investors and the world populace in general.
Even the Wall Street Journal noted that the sharp decline in oil price has resulted in foreign investors withdrawing around US$2.5 billion from the country last month.
Malaysia’s current account surplus stands at RM7.6 billion in the third quarter of this year compared with RM16 billion for the same period a year ago.
The country’s oil-related revenue amounted to RM63 billion last year equivalent to almost 30 per cent of the total government revenue.
The country’s woes are further compounded due to the decline in the price of rubber and palm oil – two other major exports – to new lows.
According to OPEC’s monthly oil market report for November, the OPEC Reference Bucket (ORB) experienced its largest drop month on month (m-o-m) since June 2012 to settle at its lowest monthly average value in four years on concerns about the pace of global economic growth.
Crude oil’s losing streak continued for the fourth consecutive month in October, with prices tumbling further as another round of monetary stimulus from Japan and a tighter US monetary policy boosted the US dollar and pounded a crude oil market already suffering from robust supply and lackluster demand.
Government revenues
On a general note, the research arm of Maybank Investment Bank Bhd (Maybank IB Research) noted that on the assumption of ceteris peribus, “this will have a significant impact on the Federal Government’s oil-related revenues, which is estimated at 30 per cent of total revenue this year.
“For 2015, the Government projected oil-related revenue of RM62.4 billion, but Petronas recently warned that if crude oil price averaged at the top-end of US$70 to US$75 per bbl range, its payments of taxes, dividend and royalties to the Government next year will fall to RM43 billion, a RM19.4 billion shortfall against Budget 2015 projection.”
After taking into account of the estimated RM11 billion savings in fuel subsidies next year following the decision to ‘manage float’ RON95 and diesel prices starting this month, there is still a shortfall of RM8.4 billion.
“From our estimate, this will result in next year’s budget deficit hitting negative four per cent of GDP instead.”
According to estimates of the Federal Government’s 2015 revenue, the petroleum income tax is calculated based on crude oil price (Tapis) of US$110 per barrel in 2014 and US$105 per barrel in 2015.
“The crude oil price has fallen significantly of late and there is talk that the US$80 per barrel price would be the ‘new normal’”, said Kluang MP, Liew Chin Tong in a media report.
According to an estimate reported by The Edge Financial Weekly, every US$1 per barrel drop in crude oil prices would cost the government about RM650 million in revenue.
It stated that a decline of crude oil price to US$75 per barrel, it would mean a loss of RM19.5 billion while a drop to US$65 per bbl, the loss would be RM26 billion.
“Persistently, soft oil prices and their impact on government revenue, mean that policy-makers would need to cut back on expenditure or increase revenue elsewhere, in order to stay on the fiscal consolidation track,” concurred Morgan Stanley Research.
Petroleum income tax alone constitutes 21 per cent of the federal government’s direct tax revenue. That does not include other forms of revenue contributed by Petronas.
“Malaysia is the only Asian country that really doesn’t benefit from lower oil prices,” said Mitul Kotecha, the Singapore-based head of Asia currency strategy at Barclays Plc.
“Being a net exporter of oil, Malaysia suffers more than others,” he says.
Petronas capex
In a media report, Petronas president & Group chief executive officer Tan Sri Shamsul Azhar Abbas said: “If we are to maintain our dividend contribution or higher, it would significantly impact our growth plans. We would need to channel most of our income into capex. This means we have to be disciplined in our cash management, including our dividend policy. It is prudent for all parties, especially the government, to relook and rebalance the budget policy against this backdrop.
“If the oil price is to remain at the current level, it would mean a much lower revenue contribution (from Petronas) to the government. Lower oil price will affect the amount of tax and royalty to the government.”
Apart from the government revenue, the overall drop has a potential negative impact on Petronas to cut capital expenditure (capex) by 15 to 20 per cent in financial year 2015 (FY15).
Maybank IB Research, the market needs to adjust to the lower oil prices noting that while companies heavily reliant on the domestic market will be more affected by the signal sent out by Petronas, it still sees decent opportunities for them.
“While the sector outlook is fragile, we see values emerging. The situation in 2014 is far from that in 2008,” it said.
It noted that this time around, there is no global financial crisis, credit financing is healthier, there are fewer speculative builds, oil price is above US$40 per barrel (bbl), consumption is higher and companies are less leveraged.
Maybank IB Research added that what has changed is the rapid over-supply situation with the emergence of shale oil and the Organisation of the Petroleum Exporting Countries (OPEC) is non-reluctance to cut production.
As for the research arm of Affin Hwang Investment Bank Bhd (Affin Research), while it was not surprised by Petronas decision to lower its capex, the scope and scale of the cut are worse than expected.
“In particular, the possible cut-backs in Pengerang projects were a surprise as we were earlier expecting Petronas to develop Pengerang at full speed,” it said.
The research arm noted that Petronas did not discuss its capex plan for the enhanced oil recovery (EOR) projects, which is one of its key initiatives to boost production.
“At the current oil price level of US$70 per bbl to US$75 per bbl, we opine that capex cut for the EOR projects seems inevitable, given that the EOR projects are often more complex, higher risks and require higher capital outlay,” it said.
Overall, Affin Research noted that Petronas capex cut would affect the earnings prospects for all oil and gas companies under its coverage.
“The impact will be particularly noticeable on the small and midcaps that mainly depend on the Malaysia oil and gas market,” it said.
These include Malaysia Marine and Heavy Engineering Holdings Bhd (MMHE), Alam Maritim Resources Bhd (Alam), Petra Energy Bhd (Petra Energy) and Perdana Petroleum Bhd (Perdana Petroleum).
Fortunately, the research arm noted that some of these companies (Perdana Petroleum and Petra Energy) have substantial orderbook backlog that will help to mitigate the impact of lower Petronas capex.
Minimal impact on budget deficit
Oil-related industries account for a third of Malaysian state revenue and each 10 per cent decline in crude will worsen the nation’s fiscal shortfall by 0.2 per cent of the GDP, Chua Hak Bin, a Bank of America Merrill Lynch economist in Singapore, wrote in a report.
Warnings on Malaysia’s over-dependence on oil is not new and while the oil price boom has indeed helped revenues, Datuk Seri Abdul Wahid Omar, minister in the Prime Minister’s Department reassured that the impact would be minimal as Malaysia’s dependence on oil related revenue has been declining.
“In 2011, our revenue from petroleum was at 35.8 per cent of total revenue, this was brought down to 33.7 per cent in 2012 and to 31.2 per cent last year.
“It is hoped that the dependency would be reduced to below 30 per cent,” he said.
The government, which has run a budget deficit since 1998, is seeking to trim the gap to three per cent of gross domestic product next year from 3.5 per cent.
With Petronas’s capex expected to drop due to lower earnings, the government will need to manage its budget via adjustments in non-oil revenues and spending. One concern is the Government might be forced to review Budget 2015’s gross development expenditure (GDE) allocation amid flattish operating expenditure allocation. However, the Government has the flexibility on both the non-oil revenue and operating spending sides of its budget equation as well.
Maybank IB Research noted: “ “The Government can review its operating expenses – especially on ‘Supplies & Services’ which has now replaced ‘Subsides’ as the second biggest operating expenditure item at 17.1 per cent of total after ‘Emoluments’, following the reduction in ‘Subsidies’ following recent rounds of fuel and energy subsidy rationalisation.
“In fact, ‘Supplies & Services’ is the largest discretionary items under operating expenses and in Budget 2015 is the main beneficiary of the increase in operating expenditure allocation under Budget. The Government should also optimise outlays on events & functions; travel expenses; embassies/high commissions; Ministries’ agencies like Tourism Malaysia and Matrade,” said the research house.
The research house also advised that the Government must also monitor and tighten up spendings for projects as well as take the necessary remedial and disciplinary actions to prevent costly incidents of wastages, leakages, poor financial management, and non-completion or late deliveries of projects that are repeatedly highlighted in the Auditor General’s Reports.
As it stands, it is unthinkable that the Government will cancel the one to three per cent personal income tax rate cuts announced in Budget 2015 as part of the ‘GST Package’ in exchange for implementing the six per cent therefore, revenue enhancement via tax enforcement should be pursued more aggressively, especially in dealing with tax arrears and evasions; smugglings; illicit trades; as well as under-declarations of incomes from employment and businesses.
The Government could also partially offset the lower dividend payment from Petronas with higher dividend payments from other profitable statutory agencies/bodies and non-financial public enterprises (NPFEs) like Bank Negara Malaysia and Khazanah, whose three largest PLC holdings – Tenaga Nasional, Axiata and IHH – can pay more dividends in FY15 compared to FY14.
Ratings and forecasts
According to recent reports, the World Bank has cut its growth forecast for Malaysia’s economy to 4.7 per cent from an earlier estimate of 4.9 per cent on expectations of slower export growth and investments in the oil and gas industry as well as moderate private consumption next year.
“It is still a robust and strong growth for an advanced middle-income economy,” Ulrich Zachau, World Bank’s country director for Southeast Asia, said of the revised 2015 GDP growth estimate for Malaysia.
The World Bank report noted that, “ Weaker exports and higher factor payments led the current account to narrow to 2.9 per cent of GDP in the third quarter.
“As natural gas prices decline in tandem with crude oil prices and firms import to rebuild inventories, the current account is likely to narrow further to 3.1 per cent of GDP in 2015 from 4.2 per cent in 2014. Further declines in oil prices would put additional pressure on the current account. Policy makers should avoid delaying productive investments such as the MRT on this account. “
Helped by fuel subsidy cuts, slower growth of personnel expenditures and underspending of the development budget, the government is likely to meet its deficit target of 3.5 per cent of GDP in 2014, taking the debt-to-GDP ratio marginally lower to 53.8 per cent the World Bank added.
The removal of fuel subsidies will help the government save an estimated RM10 billion to RM12 billion in 2015, offsetting losses from lower oil revenues. But further weakness in oil prices could lead to losses outweighing subsidy savings and pressures for lower dividend payments by Petronas, which would put the fiscal targets at risk.
Despite the argument on GST to negate the impact from lower fuel prices, the implementation of the GST in April 2015 is expected to bring in additional revenues of only RM690 million in its first nine months, due to the long list of exemptions and zero-rated items and other offsets.
The World Bank opined that, “Significant upside to other tax revenues is unlikely considering lower oil prices and additional personal and corporate income tax breaks coming online.
“The revenue- to-GDP ratio is in fact projected to decline to 20 per cent in 2015 from 21.6 per cent in 2013. Meeting the deficit target therefore will have to come from expenditure restraint. “
Now on economic growth entering the new year, lower crude oil price is seen as positive for net oil importers by reducing oil import bills, improving trade balance, lowering inflation, boosting disposable incomes and raising discretionary spending.
It is, however, the opposite for net oil exporters like Malaysia. However, being a trade-oriented economy, positive effect of lower crude oil prices on Malaysia’s trading partners that are net oil importers – and global economy in general – will have positive knock-on effects on Malaysia’s exports, on top of the competitiveness impact from Ringgit’s depreciation.
OPEC in its World Oil Outlook 2014 noted, “ There are large uncertainties associated with non-OPEC supply. Scenarios are developed – for both the upside and downside – to explore the extent to which these alternative set of supply drivers could lead to higher or lower non-OPEC supply. “
Forbes believes that at the heart of the recent volatility in crude oil prices is the sharp increase in non-OPEC supplies relative to the overall demand growth.
It looked at the correlation between the annual change in global crude oil demand adjusted for the increase in non-OPEC supply and the change in Brent crude oil prices since 2004 and found out that the two variables were be highly.
This implied that the spread between global demand and non-OPEC supply growth explains around 64 per cent of the overall volatility in crude oil prices.
Despite correlation may not necessarily imply causation, the behavior in oil prices relative to the estimated demand-supply spread does make intuitive sense. Similarly, oil prices increased sharply by almost 29 per cent in 2010 as the growth in demand exceeded non-OPEC supply growth by 1.8 million barrels per day.
To say whether the outlook is positive or negative is too simplistic as there are many varying factors involved including economic growth scenarios, supply scenarios, policy changes, technological changes, investments and so on. But on a general note, OPEC via the World Oil Outlook has noted that in terms of demand, the world will need to find an additional 21 million barrels per day of crude over the next 25 years to meet demand from rising global populations and rapid economic growth in Asia.
The figure might be a slight downward revision from its previous report but it continued to highlights the continued dominant role that oil continues to play in the global energy.
With Asia accounting for 71 per cent of demand growth in the developing world, “It is fossil fuels that will continue to play the leading role in satisfying world energy needs in the future,” said Opec secretary general Abdalla Salem el-Badri.
What’s next for world oil as lower prices extend into 2015?
The oil price decline of 2014 upended the geopolitical chessboard. Worth watching in 2015 will be who can recover and dominate play – OPEC, Vladimir Putin or US shale drillers.
Oil’s international benchmark price dropped as much as 49 per cent in 2014. Those looking for a quick rebound may be disappointed, as world consumption growth slowed to the least since 2009, US companies pumped more than they have since the 1980s and a price war broke out among members of the OPEC.
“It’s a turning point in the way people perceive OPEC, that this so-called cartel is not really driving prices,” said Jeff Colgan, a professor at Brown University’s Watson Institute for International Studies who researches the geopolitics of energy. “The real story is going to be about the fracking industry. How much pain can North American producers take?”
Here are five concerns about oil markets for 2015:
1. Will OPEC hold together?
The group that controls about 40 per cent of the market has showed signs of fraying.
Since January 2012, members have exceeded the daily production ceiling of 30 million barrels by an average of 886,000 barrels, according to data compiled by Bloomberg. Following OPEC’s decision not to trim output at its November meeting in Vienna, some countries have even less incentive to comply. OPEC’s own demand forecast is the lowest in 12 years and more than one million barrels a day below its current production target.
Prices are lower than what all OPEC members except Kuwait and Qatar need to balance their budgets, according to data compiled by Bloomberg. Still, Saudi Arabia, the group’s largest member, has led the opposition to reducing output and continues to question the need. The kingdom has enough reserves to win a price war, but at great cost to itself and other OPEC members, according to Citigroup Inc.
“OPEC has a very hard time maintaining the cartel,” Jeffrey Rosenberg, chief investment strategist for BlackRock Advisors Inc., said in a Nov 21 interview on Bloomberg Television. “Everybody has an incentive to boost up their quantity to maintain their revenue.”
2. Will the shale boom suffer?
Traders and analysts interpreted Saudi Arabia’s decision to let prices fall as a challenge to higher-cost US shale producers. At least a dozen “tight oil” companies have cut spending plans, executives said on conference calls.
The US Energy Information Administration reduced its production forecast. Genscape Inc expects a more severe impact, with output slipping from its three-decade high.
Energy companies have led losses among US equities and bonds, with some investors raising concerns that the damage could spread. Others are preparing to take advantage of distress and consolidation.
“We’re all fascinated to see what the real economics of tight oil are as prices go down,” said Paul Horsnell, head of commodities research at Standard Chartered Plc in London.
3. Will global demand recover?
Sagging demand from weak economic growth in Europe and Asia helped push oil into a bear market. Lower prices could help stimulate the market, according to Citigroup and Goldman Sachs Group Inc.
The International Energy Agency expects oil consumption to rise by 900,000 barrels a day in 2015, up from a 700,000-barrel-a-day increase in 2014. Still, gasoline demand is flat in the US, where cars are getting more fuel-efficient and young urbanites are riding public transportation.
“Efficiencies are permanent demand reductions that are not going to come back because prices are lower,” said Tamar Essner, an energy analyst at Nasdaq. “The big driver of demand-related headlines has been Chinese growth and Europe slowing, all of which is true, but I don’t foresee enough of an uptick to alter the price dynamic.”
4. Will the US allow more exports?
Lower prices are fueling the debate over the 40-year-old ban on most exports of unrefined US oil. Producers want access to higher overseas prices, while refiners want to keep their cost advantage.
Those shipments that are permitted are already surging, and the US would probably export as much as 1.5 million barrels a day if the law changed, EIA Administrator Adam Sieminski told a House subcommittee on December 11. The issue could gain prominence in the new Republican-led Congress, especially as Senator Lisa Murkowski of Alaska, the ban’s most outspoken opponent, takes over the upper chamber’s natural resources committee.
5. Will political instability disrupt supply?
In June, with violence spreading in Ukraine and Islamic State warriors threatening Baghdad, analysts were wondering how much higher the international benchmark price would rise past US$114 a barrel.
Let’s just say those people have adjusted their thinking. Now the question is how much US$60 a barrel will strain already unstable countries.
Venezuela, struggling with inflation and capital flight, faces soaring borrowing costs as investors weigh the risk of default.
Libyan output almost quadrupled between April and October as fighting eased, only to drop 32 per cent in November.
Iraq’s production is close to a 13-year high as the country struck a deal with its semi-autonomous Kurdish region to sell more oil as they wage war against Islamic State insurgents.
If Iran agrees to restrain its nuclear program in exchange for relief from Western sanctions, the Persian Gulf country said it aims to almost double output to 4.8 million barrels a day, an oil ministry official said December 9. In Russia, the combined force of U.S. and European sanctions over the annexation of Crimea and the plunging value of its biggest export have triggered a recession, a currency crisis and runaway inflation.
“Geopolitical risk is definitely one of the downsides of low oil prices,” said Brian Youngberg, an energy analyst at Edward D Jones & Co in St Louis. — Bloomberg