Sunday, November 9, 2014

Sustained low crude oil prices - Impact on Malaysian Economy


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Crude palm oil (CPO) futures prices on Bursa Malaysia Derivatives closed lower yesterday dampened by weakness in crude oil prices and expectation of higher palm oil inventory for October. Phillip Futures Sdn Bhd Derivative Product Specialist David Ng said traders remained cautious ahead of the Malaysian Palm Oil Board’s data to be released next week on the stock level for October.
At close, November 2014 fell RM27 to RM2,192 a tonne, December 2014 lost RM27 to RM2,201 a tonne, January 2015 was down RM26 to RM2,196 a tonne and February 2015 declined RM22 to RM2,206 a tonne. Volume rose to 59,182 lots from Thursday's 53,064 lots while open interest widened to 289,165 contracts from 278,651 contracts yesterday. On the physical market, November South eased RM30 to RM2,230 a tonne.
The traditional oil and gas producing countries are riding on the hope that the shale oil and gas phenomenon is only temporary, that the United States will not be able to sustain its production of oil and gas as the price declines and hence a floor price will be discovered sooner than people think. This is based on the notion that the cost of producing shale oil and gas – through horizontal drilling and hydraulic fracturing – is more expensive than the cost of extracting conventional oil found in the Middle East and resource-rich Russia.
But latest reports indicate that the cost of producing shale oil and gas in the United States has dropped to an average of US$57 per barrel from US$70 per barrel in the middle of last year. And the cost could likely go down further as more shale oil and gas activities pick up because the producers tend to enjoy economies of scale and become more familiar with the production process. This year alone some 18,000 horizontal wells are to be drilled, according to a report.
Considering the circumstances, Malaysia needs to re-think its subsidy rationalisation programme for petrol and diesel.The Government is looking at ways on how to better administer the subsidy that is given to consumers. At the moment the subsidy is about 12 sen per litre, as of October this year. This is based on the price of RON95 at RM2.30 per litre. In a reply in parliament last week, Deputy Finance Minister Datuk Ahmad Maslan said that if the global crude oil price was between US$75 and US$80 per barrel, there would no longer be any subsidy on petrol. Effectively, the trigger for petrol at the pump without subsidy is when crude oil trades at between US$75 and US$80 per barrel. This is not far from where the global prices are today.
In the next few months, indications are that the US dollar is expected to rise gradually, indicating further pressure on commodities, including crude oil.In fact, the US dollar is already appreciating against all major currencies. In the last one month, it has gone up by more than 2.6% against the ringgit. The rise of the US dollar is helped by expectations of the interest rates there rising, due to the end of the quantitative easing programme last month.
A sustained drop in crude oil prices could have an adverse impact on the Malaysian economy, as Malaysia was still a net exporter of oil, sustained low prices may likely pose adverse impacts on the overall economy. The net effect of a sustained fall in crude oil prices would likely be more disadvantageous to the revenue front rather than fuel subsidy savings, given that the oil and gas (O&G) sector revenue contribution to GDP ratio was 6.6% versus the fuel subsidy to GDP ratio of 2.6% in 2013. Currently, Budget 2015’s projection is hinged at an average price of US$100 per barrel for 2015. However, crude oil prices averaged at a low of US$88 per barrel in October, after hitting a 4-year low of US$83 per barrel on 15 October. Every sustained US$10 per barrel drop in crude oil prices would shave off up to RM4 billion of budget revenue and savings of RM2 billion from fuel subsidy expenditure. If prices were to average at US$90 per barrel for the next 12-month period, this would push the fiscal deficit to 3.2% in 2015 versus the targeted level of 3%. While inflation in the short term is likely to be muted as fuel prices are administered through government fuel subsidy provision, a sustained fall in crude oil prices poses downside risk to potential GDP growth in 2015.

Everything points to a period of lower oil prices. The low crude oil price could have negative impacts on businesses and consumers which the subsidiaries might be potentially removed by the government if the crude oil price continue to fall down from the expectation of government budget. 

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