What low oil prices mean for us


  • Business
  • Saturday, 25 Oct 2014

IT is beginning to sink in that falling crude oil prices could well be the pin that will burst the growing asset bubble in emerging markets.

Fuelled by an addiction to debt, stock markets and property prices have been at an all-time high since March this year, something that seasoned investors feared. The volatility index or better known as the fear index was at an all-time low two months ago. Something had to give in. Increasingly, most economists see the falling oil prices as the factor that will force market valuations to come to its senses.

Nobody had expected that crude oil, a commodity that has seen phenomenal demand in the last 10 years, could see a dramatic collapse in prices. Since July this year, the price had declined by more than 20% from a high of US$115 per barrel.

The reasons for the drop are well rehearsed. The conventional logic is when there is a crisis, especially in the Middle East, oil prices will shoot up. But that has been disproven with crude oil price stabilising at levels of less than US$85 per barrel despite the rise of the Islamic State of Iraq and Levant (ISIS) in the Middle East and the tension between Russia with the United States and Europe.

Apart from the shift from the norm, the more fundamental reasons for the drop in crude prices are that the global economy is seeing a slowdown and the US is now a major producer of oil and gas with the advent of shale oil and gas. Its output is up by 80% since 2009, making it second to only Saudi Arabia, in the list of the largest oil and gas producers. Suddenly, the US has become the kingmaker in determining the global oil prices.

Next year, the experts are predicting oil prices to average US$85 and for 2016 the forecast is for crude to average at US$80. This is based on the assumptions that Organisation of Petroleum Exporting Countries (Opec) do not cut down on their production and the independent oil producers in North America continue with their production of shale oil and gas.

There are some reports pointing to crude oil averaging US$70 per barrel next year. That is based on a prolonged slowdown in Europe and China failing to put its house in order by the first half of next year. For now, both that scenarios are unlikely to pan out. China has been on the mend since early this year while its only be a matter of time before the European Central Bank implements its own version of monetary easing policies to add more liquidity to the system with the hope it will fuel lending and eventually economic growth.

The losers from the lower oil prices are ISIS, which to a large extent depend on oil money to fund its war and Russia, which is a major exporter of oil and gas. Both the ISIS and Russia are thorns in Obama’s reign as president which comes to an end in January 2017. So there really is no incentive for the Obama administration to see that the price of oil rises. Who knows, a continued prolonged spell of crude oil at less than US$90 per barrel could weaken both the ISIS and Russia.

Cornerstones

For Malaysia, the lower oil price will bode well for the government’s subsidy rationalisation programme – one of the cornerstones of Prime Minister’s Datuk Seri Najib Tun Razak’s economic programme. He wants to see Malaysia have a balanced budget by 2020 and towards this end sees the reduction in subsidies as the way out to achieve the goals. At the moment, the direct and indirect subsidy for oil and gas forms the biggest component of Malaysia’s subsidy bill.

When crude oil hits US$80 per barrel, there no longer is any subsidy for petrol and diesel at the pumps. However, the subsidy for cooking gas and supply of cheap gas to the electricity generation sector by Petronas continues. The net effect to the consumer from the lower crude oil price is that they will not likely see increases in the price of petrol and diesel at the pump.

The biggest losers will be the oil and gas service providers. There are about 40 oil and gas companies listed on Bursa Malaysia and many more that are unlisted. Some have been cautious in their expansion but a large number have taken up gearing to build up their assets with expectations that Petronas will continue to be generous with charter rates.

But Petronas cannot be faulted if it is less generous on the rates. The national oil corporation had already warned oil and gas players in March this year of a coming storm. Then many had not envisaged oil prices to trade below US$90 per barrel. It’s happening now. With lower crude prices, there would be less exploration activities, hence more oil and gas assets will lie idle. Everything points to lower charter rates.

Petronas itself will have to re-balance its portfolio and funding activities. It cannot keep on spending when oil prices are trending down. Petronas is already re-looking its gas investments in Canada. It will be only a matter of time before it reviews its local investments. That will have a negative impact on local oil and gas companies.

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Business , oil , economy , markets

   

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