WHILE global markets are still reeling from the spread of the novel coronavirus (Covid-19), the collapse in the oil price was like a kick in the teeth for Malaysia and the world.
Oil prices, which crashed at the start of this week on the anticipation of a price war between Russia and the US, fell further after US President Donald Trump banned travel from Europe to the country.
Brent crude oil was down more than 30% to as low as US$31.2 a barrel this week alone. The international benchmark has been on a decline by 10% since the beginning of the year.
As an oil producing country, Malaysia is relatively reliant on the price of oil to generate the government’s revenue and trade account.
Hence, it is no surprise that Malaysian stocks were among the biggest losers in this week’s global market rout.
According to Malaysian Rating Corp Bhd (MARC), Malaysia’s oil-related products accounted for about 9% of total exports in 2019 and generated about 21% of the government’s revenue annually.
The rating agency noted that the country could experience slower economic growth from the collapse of crude oil price.
“Given the importance of oil-related income to the government’s overall revenue, a sharp decline in crude oil prices will also mean reduced resources to spend on development activities at a time when domestic demand needs support.
“Depending on how long crude oil prices remain below their historical trend and the severity of the Covid-19 outbreak, the final growth outcome in 2020 could be anywhere within or even outside the range that economists are currently projecting, ” MARC says in a report.
With the Covid-19 pandemic spreading, the country would need the government’s stimulus support to its growth.
But the collapse in the price of crude oil will cause the government to lose billions of ringgit in oil revenue. This, in turn, would stretch the government’s fiscal balance as the budget deficit is likely to increase to support the RM20bil stimulus package announced to buffer the economy from the impact of Covid-19 pandemic.
At this point, it looks like the government would need to recalibrate the Budget 2020 and that would mean less money coming into the economy.
According to CGS CIMB Research, crude oil at US$48 per barrel will see Malaysia shave off RM4.5bil from its projected oil revenue.
The US Energy Information Administration cut its 2020 Brent crude price forecast by 29% to US$43.30 per barrel for 2020. The agency expects US crude production of 12.99 million barrels a day this year, down 1.6% from the previous view, and further cut its forecast for 2021 output, down 6.6% at 12.66 million barrels a day.
Moody’s Analytics points out that the price war between Russia and Saudi Arabia is a crisis for oil producers, with Covid-19 already savaging demand for travel and transportation.
“The last thing oil producers needed was a supply shock that would hit their pocketbooks even more, ” it says in a report.
Market observers and analysts have mixed views on their outlook for the industry. Some expect the current shock in oil price is temporary and it shouldn’t have a huge impact on service providers because of the long-term contracts by oil producers.
Meanwhile, some say the low oil price will last for more than one year due to prolonged oversupply of oil and uncertainties brought by the outbreak of Covid-19 to economic growth.
There has been a great imbalance between the amount of crude oil being produced and demand, and prices will react if one part of either supply or demand moves too far from equilibrium. The current supply war would cause that balance to be even more skewed towards downward pressure on prices.
“It will take some time for the dust to settle and some new norms are established. It was never sustainable for the centrally controlled enterprises of the Opec+ alliance to keep making production cuts in order to keep crude oil prices high while the free-market US producers continued to increase production.
“The signs were there. Covid-19 just accelerated the eventual outcome. This is not a knee-jerk reaction, ” Hibiscus Petroleum Bhd managing director Kenneth Pereira tells StarBizWeek.
He notes that the chase for market share is now the priority and the lowest cost producers will prevail.
However, he says the oil price would eventually need to be at least US$55 to US$60 per barrel to ensure mid-to-long term security of crude oil supply.
“Supply cannot continue to remain high without there being an investment. So, unless there is an investment in the services required to keep supply high, supply will eventually fall and oil prices will increase. This is a cycle we have seen repeated many times, ” Pereira says.
Supporting the statement, Astramina Advisory founder and managing director Wong Muh Rong expects the low oil price to stay for more than one year because of the uncertainties in the global growth.
“In view of the global uncertainty and also the Covid-19 outbreak, the decline in the price of oil is expected to continue as the demand and supply curve may take time to stabilise.
“The grace period is more than 12 months for things to stabilise, ” Wong says.
On the contrary, Icon Offshore Bhd managing director Datuk Seri Hadian Hashim reckons that the plunge in oil price is a knee-jerk reaction because of the price war between Russia and Saudi Arabia.
He says the move is partially to pressure the shale oil producers and that the Arab countries wouldn’t be able to stomach the low oil price should the situation prolong.
“Many contracts are on a long-term basis, which would not impact the oil and gas (O&G) players but it is still a concern for the short and medium-term contracts.
“I believe sensibility will prevail but it may take two to three months and hopefully Covid-19 will also recede by then, ” Hadian says.
Icon Offshore provides offshore service vessels to the O&G industry.
The local O&G service providers’ stocks are being hammered. Their share prices fell as much as 50%-60% in less than one week, triggering margin calls.
This was despite the announcement made by national oil company Petroliam Nasional Bhd (Petronas) to maintain its planned capital expenditure for this year.
Activity level should remain stable
On Wednesday, Petronas said it plans to continue with its domestic capital expenditure (capex) programme of RM26bil to RM28bil this year, although oil price has plunged almost half of its forecast.
The oil producer had informed the market the kind of projects and contract that it will be dishing out in Malaysia over the next three years through its Petronas Activity Outlook (PAO).
According to the latest PAO 2020-2012, local O&G service providers could expect steady job flows in segments such as pipelines and pipe-laying, offshore fabrication, maintenance, construction and modification, offshore support vessels (OSV), as well as decommissioning.
Petronas is targeting 26 drilling rigs in 2020 compared to 24 rigs last year.
However, Petronas warns it will continue to reassess its plans and budget to cushion the short, medium and long-term impact on its business.
It says that with the ongoing geopolitical uncertainties and prolonged trade tensions, the volatility of prices has worsened due to the impact of the Covid-19 outbreak and the recent failure of the Opec+ talks.
With Petronas expected to maintain its capex, local O&G activities should remain vibrant, especially with no new assets and players coming into the market due to depress oil prices over the last five years.
So, why are the O&G stocks badly hit when Petronas is maintaining its capex? (see sidebar)
Deja vu all over again?
CGS CIMB warns that if the oil price continues to decline, the situation will be the same as in 2014 to 2016 when Petronas cut its operating costs at the expense of its suppliers and contractors.
“Velesto was hit badly as its long-term rig charters were prematurely ended by Petronas, ” it says.
For financial year 2020, it says Velesto has four rigs chartered to Petronas that are due for renewal and these may not be renewed at its assumed higher rate of US$75,000 per day versus US$70,000 currently.
In September 2014, oil prices went into free fall, trading from above US$100 per barrel to as low as US$30 per barrel.
At that time, the oil market was hit by supply shock because prices had sustained at US$100 per barrel for three years, leading to an increase in production of oil globally, including the boom in the production of shale oil industry in the US.
Supply was disrupted when Opec flooded the market with oil to protect its market share as US shale oil producers expanded. This was followed by a price war that led to oil prices hitting as low as US$30 per barrel.
Today, the oil market is hit from two sides, demand shock and supply shock. The demand shock is because of Covid-19 and its impact on cautious spending and contraction in economic activity, which lower the demand for oil and energy.
Meanwhile, the supply shock is because of Russia and Saudi Arabia want to flood the market with oil.
Drowning in oil
Moody Analytics says the world is now drowning in a glut of crude oil that is likely to persist for months. It was already bad in the third quarter of last year when global demand for crude oil was 1.1 million barrels per day compared with a supply of 1.8 million barrels per day.
The agency says three conditions are necessary to restore oil prices.
Firstly, global fears about a Covid-19 pandemic must ease, as apprehension is weighing significantly on global economic activity, especially on the travel and tourism sectors.
Secondly, oil exploration and production must fall “significantly, ” specifically the highest-cost producers in the world with the quickest turnarounds must stop looking for oil.
Thirdly, the geopolitical rift between Saudi Arabia and Russia must be healed.
“Their cooperation has put a floor under oil prices in recent years. But without that alliance, the oil market becomes a wild, wild West where only producers with the strongest means of production can profit, ” Moody’s Analytics says.
In the past, when oil prices tumbled, consumers gained as it would curb inflation growth and increase disposable income as they spent less money on transportation and electricity.
But that is different now. Consumer spending is about to slow dramatically and that every economic assumption that seemed valid a month ago will be evaluated and there is no sign it is being revised upward.
“Normally, low energy prices would jump-start economic activity but with the Covid-19 cases still on the rise, it will take some time before the overall demand for oil increases, ” Pereira says.
The market is expected to continue to be in a turmoil as long as the economy has yet to conclude the actual impact of Covid-19 and the lingering tension in the oil market remain.
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