Energy question as war ends

THE end of the war in Iran has shaken the ground in the energy markets.

The benchmark Brent futures oil contract has fallen sharply to US$73 a barrel at last view, after hitting a high of US$122 a barrel at the end of April.

The floodgates have also opened as far as traders are concerned, although negotiations are still ongoing between the United States and Iran.

News reports say tankers with millions of barrels of cargo have started sailing freely through the Strait of Hormuz to hungry buyers after months of waiting.

Even unsanctioned Iranian crude is already being offered on the market.

Market talk now is about how quickly energy flows through the strait can achieve normalisation. The bearish price action of the Brent futures contract is signalling a rapid recovery in flows from the region. The consensus is normalisation of physical supplies via the strait will take months and an escalation of tensions could dent those expectations fairly quickly.

Still, most Asian policymakers, refiners and power utilities dependent on Middle East energy imports must be breathing a sigh of relief.

The return of crude oil and liquefied natural gas (LNG) as well as derivatives like fertilisers and petrochemicals from the region could enable factories to ramp up production levels, help avert inflationary pressures, support food production and avert a potential economic slowdown.

The conflict was a rude shock for the Malaysian government and public. Diesel prices shot up to over RM6 a litre at the pump. Putrajaya’s fuel subsidy bill jumped from approximately RM700mil in January to an average of about RM4bil.

National oil company (NOC) Petroliam Nasional Bhd (PETRONAS), however, may have had a good second quarter from higher prices and a lower ringgit if it capitalised on the opportunity the conflict presented.

With general elections on the horizon, an improved economic environment from lower oil prices gives Prime Minister Datuk Seri Anwar Ibrahim one less problem to worry about and maybe even a tailwind to face the public if growth picks up.

That said, the Strait of Hormuz choke point has become a risk governments and companies need to hedge against.

The conflict itself may have triggered a fundamental change in the energy market, which may only become more visible in the months and years ahead in the form of new infrastructure, stake buys or divestments, new regulations, supply deals/contracts, etc.

The demand supply fundamentals of the crude oil markets were already bearish before the conflict started. Now, maybe even more so.

Estimates put world proven reserves in the ground at about 1.57 trillion barrels, equivalent to 47 years of supply at current consumption rates.

Global refining capacity is at about 104 million barrels a day, while demand is about equivalent. Supply availability is rising, but demand is stalling due to megatrends like the electrification of mobility and the economics of renewables. The conflict has only made these more popular for energy security reasons.

Hence, many producers may want to monetise their reserves while demand holds up.

The International Energy Agency estimated a global oil surplus of around 1.9 million barrels per day last year.

If not for the Iran conflict, the surplus could have ballooned to nearly four million barrels as the Organisation of the Petroleum Exporting Countries (Opec) plus its allies wanted to raise its production quotas even as production levels of non-Opec members like the United States, Brazil, Guyana, and Canada are rising to fresh highs.

The question now is how competitive will producers become to defend and build market share, driven by events like the exit of the United Arab Emirates from the Opec cartel?

The big lesson for policymakers from the Iran war is just how sensitive the global economy still is to energy shocks. It exposed the strategic need to diversify sourcing markets to ensure an enhanced level of energy security.

The way China responded is exemplary. Although the largest buyer of crude oil in the market, import-dependent China refused to pay higher prices in the midst of the war and this helped keep a lid on world energy prices when some analysts were predicting oil could touch US$200 a barrel.

This was enabled by its investments in renewable energy sources to reduce reliance on oil imports backed by its ample strategic crude oil reserves to fall back on.

In Malaysia’s case, the investments into renewables are ongoing while domestic carbon resources provide a buffer.

The country’s exports of its premium Tapis crude oil and LNG from Bintulu help offset imports of sour crudes from the Middle East for refining locally into products like petrol, diesel, naphtha and much more. It imports refined products from Singapore as well, and LNG from Australia, as the Bintulu LNG capacity is committed to foreign buyers. More LNG imports will be needed soon.

The regasification terminal projects in the country plan to welcome LNG cargo from around the world to meet the demand for power to run data centres and factories and complement domestic production of natural gas from offshore Peninsular Malaysia.

Efforts like raising the biodiesel mandate to the B15 blend in June with a B30 blend rate targeted by the end of the decade will help. So will the solar policy and plants.

PETRONAS’ integrated business model will be key to helping lower risks with secured supplies. Although margins are narrowing and fields getting smaller locally, the NOC remains committed to raising domestic production levels.

Its investments in Canada, Turkmenistan, Australia and Indonesia help secure supplies and trade, but the portfolio is gas heavy. In a low price environment, the company could benefit from more investment to build its hydrocarbon reserves, but that would mean a cut in paying dividends to the government.

Storage of strategic reserves is another option to consider.

The government has announced it’s studying the plan. A quicker option is to encourage private sector investments into storage facilities to have supply flexibility to absorb future shocks just as producer dynamics turn more competitive.