In this file photo taken on January 8, 2020, US President Donald Trump speaks about the situation with Iran in the Grand Foyer of the White House in Washington, DC. Trump warned Iran on January 12, 2020 against killing protesters who have risen up over the regime’s downing of a civilian airliner as his defense secretary left the door open to talks with Tehran without preconditions.Trump’s salvo came as Iran’s Islamic regime faced a challenge from angry street protests, having come to the brink of war with the US with a series of tit-for-tat confrontations. — AFP photo
KUCHING: The year started unfavourably with the escalation of a crisis which some analysts say was years in the making.
The geo-political development involving the US and Iran has finally escalated to a new level.
US President Donald Trump ordered an attack on an airport in Baghdad, Iraq that killed Iran’s top military commander Qassem Soleimani and a veteran Iraqi military officer Abu Mahdi al-Muhandis in the early hours of Friday, January 3.
The attack followed the death of an American contractor at an Iraqi military base – possibly caused by Iranian-backed militias – as well as strings of political and economic pressure on Iran imposed by the US which began with the US pulling out of the 2015 nuclear deal back in 2018.
Since then, multiple threats of further sanctions on Iran has been uttered by Trump despite his insistence on multiple occasions that he is flexible and willing to negotiate with Iran’s top leader Hassan Rouhani where the latest of such insistence being back in September 2019.
The attack by the US has resulted in Iran vowing retaliation and more than a dozen ballistic missiles raining on two Iraqi military bases (Al-Asad airbase and Erbil) hosting the US soldiers – hours following the funeral of Soleimani.
The US announced that no casualties were reported from the attack and it will not be responding to the attack.
Similarly, Iran has also announced that it will be standing down and has concluded proportionate measures in self-defense.
The impact from this warlike move was felt immediately by global stock markets as investors remain wary of the volatility to come from uncertainties in future political moves.
According to MIDF Amanah Investment Bank Bhd (MIDF Research) head of strategy Kifni Kamaruddin, the equity market sentiment in the US is buoyant hence investors have the tendency to look at the glass half full.
Thus, even in the aftermath of Iran’s ballistic missiles attack on US military bases in Iraq, a conceivably ‘dovish’ statement (such as Iran “appearing to be standing down” after it attacks US bases in Iraq) by US President Donald Trump was enough to appease the market.
“On the Iranian side, its Foreign Minister issued a statement declaring that it had “concluded” its retaliatory, self-defense attacks, and added that “we do not seek escalation or war, but will defend ourselves” against any further aggression.
“At this juncture, we do not expect further escalation to this crisis as both sides seem unwilling,” the head of strategy said. “We reiterate our FBM KLCI 2020 baseline target at 1,680 points.”
Iran has also announced that it will be standing down and has concluded proportionate measures in self-defense. — AFP photo
Earlier this week, MIDF Amanah Investment Bank Bhd (MIDF Research) in its weekly funds flow recap saw that international funds made their way back to Asian markets amidst easing geopolitical tensions in the Middle East.
“Based on the provisional aggregate data for the seven Asian exchanges that we track, investors classified as “foreign” acquired US$590.6 million net last week, compared to US$741.9 million net disposed in the preceding week,” it said in a note on January 13.
Closer to home, Malaysian ministers are keeping a close eye on US-Iran developments and how they impact the country. Finance Minister Lim Guan Eng revealed that geopolitical conflict was discussed during the Cabinet meeting on Wednesday, with concerns more over the effect on global economic growth.
He outlined that the government “could definitely manage the petrol subsidy should prices spike.”
Oil prices surged earlier last week following the US-Iran conflict fed into fears that global oil supplies could be disrupted following the death of an Iranian military leader in a US airstrike on January 3.
Thus, it was crucial to monitor any US-Iran updates to come and how the market reacts:
‘Oily’ implications
Oil and its related assets are commodities with the most at stake. Immediately on January 6 – the first trading day after the attack – Brent crude oil price saw its fifth week of gains after increasing by 0.7 per cent to US$68.60 per barrel the week before.
MIDF Research said the major catalyst for this positive movement was the news that a powerful Iranian military leader had been killed in a strike authorised by the United States – ratcheting up geopolitical tensions in a region that supplies around 25 per cent of the world’s oil and threatening to disrupt global supply.
While the attack did not target any oil production, MIDF Research said it raised fears of a protracted conflict in the region that could involve strategic attacks on oil fields.
“Following that, Brent crude oil price snapped its five-week winning streak after declining by 5.3 per cent to US$64.98 per barrel last week,” it said in its fundsflow report on January 13.
“Monday was the highlight of the week as Brent crude oil price touched the US$70 per barrel mark amidst the heightened tensions in the Middle East.”
Iran threatened the US with retaliation and pulling back from the international nuclear accord while the US warned on new massive economic sanctions and major retribution.
However, Brent crude oil retreated below US$70 per barrel, as low as US$65 per barrel as Tehran and Washington issued statements that appread to back away from war-footing.
The team at Hong Leong Investment Bank Bhd (HLIB Research) anticipate lower 2020 average Brent forecast to US$60 per barrel. In 2020, we still expect crude prices to remain volatile, with downside price risk capped in the near term due to geopolitical tensions and OPEC+ maintaining output cuts.
This follows OPEC+’s Short Term Energy Outlook (STEO) report released in November, the EIA forecasts Brent spot prices will average US$60 per barrel in 2020.
“EIA expects average crude oil prices will be sightly lower on in 2020 vs 2019 because of forecasted rising global oil inventories, particularly in the first half of 2020 (1H20) against a backdrop of sluggish global economic growth.
“We concur with EIA’s views on the back of greater output growth from non-Opec players such as Norway and Brazil; and shale players increasing output by 0.9mbd against an un-resolved China versus US trade dispute.
“Thus we are of the view that Brent crude oil price could average USD60 per barrel in 2020 in the absence of a supply shock.”
Volatility in oil prices will continue to be heightened in the near term due to recent developments between US and Iran. Any further escalation will have serious ramifications to global oil prices.
“Whilst Iran does not have the capacity to retaliate against the USA directly, it has the means to do so against the US allies in the middle-east, particularly Saudi Arabia – the worlds swing producer and OPEC supremo.
“We do not discount the possibility of another attack of similar nature to Aramco’s fields and facilities such as the one experienced on September 14, 2019, which resulted in oil prices jumping 20 per cent at the open (Brent) on fears of a supply shock.”
Possibility of attack on US-related assets
MIDF Research analyst Noor Athila Mohd Razali in another report said further escalation will potentially result in attack on US-related assets.
“While both the US and Iran seemed to have come to a stand-off following the US drone attack in Iraq and counter-attack by Iran; many are unconvinced that the crisis will end there,” she highlighted.
“This is following multiple contradicting media statements released by both the US and Iran on the state of the crisis.
“This signals that while the contradicting statements may ease the escalating tensions between the two countries in the near term; the situation could immediately turn south for both very quickly.
“While we do not believe that at this juncture further escalation will take place, we opine that should any escalation resulting from the attacks or rise in internal pressure happens; it will potentially result in a target placed on US-related assets and oil-related assets,” the analyst added.
“This, in return could lead to a temporary disruption in oil supply and rise in oil price.”
MIDF Research believed there will be a temporary knee-jerk reaction towards the oil price – should there be an escalation of attack.
“It will be similar to that of the recent attack on Saudi Aramco’s oil facilities – the Abqaiq and Khurais oil facilities, back in September 2019 which wiped out 5.7 million barrels per day (mbpd) of crude supply from the market,” it said.
The attack is also followed by a series of explosions and sabotage attempts against ships in the Persian Gulf of which the US has blamed Iran for.
“Following the drone attack, we saw the oil price rising by 14 per cent to US$69 from US$60 before the attack.”
De-escalation to stabilise oil price
On the other hand, should the current stand-off between the US and Iran remain, the analyst opined that it will lead to a more sustainable oil price movement and a more stable outlook for the oil and gas industry. Some 20 per cent of the world’s oil supply originates from the Middle East.
“Therefore, any tensions surrounding the region and Strait of Hormuz will disrupt world trade and oil supply,” she highlighted.
Members of the Organization of Petroleum Exporting Countries (OPEC) in recent interviews with various news agencies stated that they are vulnerable to regional conflicts and unable to cope should there be an attack by Iran on their oil facilities.
As recent experience has shown; the drone attack on two of Saudi Arabia’s oil facilities effectively wiped out half of the Kingdom’s oil production.
“Due to this, we reiterate our view that the situation is unlikely to escalate further at this juncture and we expect oil price to trade between the USD60-65pb range and to average at USD65pb in 2020.
“Furthermore, various measures have been taken by fellow OPEC countries to reduce the impact of the regional tensions some of the measures include the re-routing
oil tankers away from the Strait of Hormuz; adding armed security guards on oil tankers; reviewing evacuation plans and; orchestrating orderly shutdowns of offshore facilities should the need come.
“Additionally, the deeper production cuts – from 1.2mbpd to 1.7mbpd, agreed in the recent OPEC meeting on December 6, 2019 will assist in mitigating the volatility of the oil price going price.”
Corporate O&G to put a drag on oil prices
Back in the states, the impending US oil and gas companies’ debt maturity is a key factor which investors believe will continue pressuring oil price downward with optimisation of existing drilling wells.
According to Moody’s Investor Service, an estimated US$200 billion worth of debt raked up by the North American oil and gas companies since 2015 is expected to mature within the next four years.
The first tranche of debt worth US$40 billion is due in 2020.
Average daily crude production has risen 34 per cent since November 2014 as US companies continued to drill new wells reaching about 12.5mbpd in September 2019.
“The specter of debt maturities will prompt companies to reduce drilling of new wells,” MIDF Research’s Nor Athila opined. “Evidently, the number of rigs currently in the US went down by 25 per cent at the end of 2019 to 805 from 2018.
“Furthermore, the US Energy Information Administration (EIA) expects the US crude oil production to reach 13.2mbpd in 2020, an increase of 0.9mbpd from its 2019 level.”
Though the growth in 2020 is expected to be lower when compared against the 2019 growth of 1.3mbpd and 2018 growth of 1.6mbpd which mainly attributable to the decline in number of rigs operating in US; the EIA forecasts production will continue to grow as rig efficiency and well-level productivity level rises as companies chase the deadline of their respective debt maturity.
This is evident by the increase in net exports of US crude petroleum recorded back in September 2019.
Thus, the research firm believed that a stable and sustainable oil price is the way forward.
“While in general a higher crude oil price is favourable to encourage the continued spending of oil and gas exploration and production (E&P) producers, we opine that a stable and sustainable oil price will be even more favourable to the oil and gas companies in the current operating climate.
“It is to enable a proper planning for future capital expenditure (CAPEX) to be conducted using predictable parameters rather than projecting numbers in an extreme environment.
“That said, we understand that most exploration and production (E&P) producers are comfortable at the current US$60 to US$70 per barrel oil price level as current production costs ranges from US$30 to US$40 per barrel for offshore production whilst for onshore productions; the cost is even lower which will ensure the current upbeat offshore and onshore activities momentum will be sustained.”
Minimal impact on tourism
Geopolitical instability in the Middle East to have minimal impact on passenger traffic in Malaysia. Following the recent geopolitical turmoil between the US and Iran, airlines such as Germany’s Lufthansa, Air France, Singapore Airlines and Malaysia Airlines have rerouted flights to avoid airspace over Iran and Iraq.
The rerouting of flight will lead to longer flight durations and higher operating costs in terms of jet fuel consumed.
However, it is important to note that the percentage of Malaysia’s international passengers travelling to and from Europe and the Middle East – only including Amman, Baghdad, Basra and Tehran – is very minimal at around 2.5 per cent of total international passenger traffic based on 2018 statistics.
“Therefore, we do not foresee any major disruption in passenger traffic if travelling demand from the said areas was to decline as demand from North East Asia and South Asia is expected to pick up further this year due to oneyear visa exemption for tourists from China and India in tandem with Visit Malaysia Year 2020,” said MIDF Research.
“Moreover, load factors in Asia Pacific have been on an upward trend in the past few years.”
As for low cost carriers such as AirAsia Group Bhd and AirAsia X, the analytical team saw no issue at all as these airlines do not have routes requiring their aircraft to fly over the Iraqi and Iranian airspace.
On the low cost carriers,MIDF Research analyst Adam Mohamed Rahim affirmed that having hedging policies in place was necessary to shield them from oil price volatility.
“We opine that there might be an increase in the amount of jet fuel consumed this year by AirAsia Group as we do not discount the possibility that it will be adding more capacity and routes in conjunction with the Visit Malaysia Year 2020,” he added in a special report.
“Nevertheless, AirAsia Group’s prudent hedging strategy means it could weather the expected rise in oil prices. In FY20, AirAsia Group is hedging 72.8 per cent of Brent crude oil price at US$60.22 per barrel.
“Assuming if the geopolitical tensions between the Middle East and the US prolong, pushing the Brent crude oil price up to around US$75 to US$80 per barrel, we estimate that the unhedged portion of fuel costs could decrease by one per cent year-on-year (y-o-y) or RM3 million in FY20.”
Meanwhile, it expect AirAsia’s total fuel cost to be 13.8 per cent y-o-y higher in FY20, which does not vary much from the percentage increase in expected jet fuel consumed of 9.5 per cent y-o-y during the same year.
“Under a situation where none of AirAsia Group’s fuel requirements were hedged, we estimated that the total fuel cost could increase as much as 25.7 per cent y-o-y, assuming that Brent crude price were to hit US$75per barrel.
“In contrast, a 100 per cent hedge on its oil requirements would result in only a 9.4 per cent y-o-y rise in AirAsia’s total fuel cost in FY20. Nevertheless, it would be important to have a buffer in a situation where Brent crude oil price could go below the hedged amount.
“Hence, we reiterate that AirAsia’s current hedging strategy serves as a tool to prevent fuel costs from inching higher.”