Double-edged sword effect of oil rally
Stephanie Jacob 
Malaysia’s power generation depends largely on burning fossil fuels whereby higher input prices would in turn affect business overheads, says Gan

THE capital market has rejoiced over the ringgit’s recent rally to 4.17 per US dollar on Nov 16 in tandem with the recent spike in crude oil prices. But while there are reasons to cheer for the economy, spiralling oil prices can be a double-edged sword to certain economic segments.

While an uptick in oil prices and the positive spillover effects it has on trade, confidence and fiscal standing are key ingredients for a stronger ringgit going forward, rising inflationary pressures also tend to be inevitable when oil prices appreciate.

For a start, higher oil prices do not only affect petrol pump prices – no thanks to the absolute lifting of the country’s petrol subsidy effective December 2014 – its impact essentially cascades down into the rest of the economy.

On Nov 16, the petrol price rose to RM2.38 for RON95, the highest since the weekly float was introduced on March 30.


Likewise, prices of essential day-to-day commodities such as food and electricity as well as business overheads and wages are also bound to head north.

“To-date, Malaysia’s power generation depends largely on burning fossil fuels [oil, coal and natural gas] in which higher input prices would in turn affect business overheads,” OCBC Bank’s economist Barnabas Gan tells FocusM.

“Additionally, the positive correlation crude oil prices have with palm oil stems from the latter’s contribution to the nation’s biofuel industry which in turn affects costs of prepared food both at home and away.”

Brent crude has been climbing steadily beyond the US$60 (RM250.80) per barrel level since Oct 27 to settle at a high of US$64.27 on Nov 6 – its highest level since June 2015.

Although the ringgit has posted steady gains against the greenback by 6.51% year-on-year (yoy) as of Nov 14 compared with 4.32% contraction in the previous year, TA Securities Research expects the local currency to be volatile against the US dollar moving forward on the back of potential interest rate hikes in the United States.

“We maintained our average [the median between year-high and year-low] ringgit forecast for 2017 to 4.29 against the US dollar,” the research house noted in its November edition of trader’sCompass.


More good than bad

Inflationary pressures aside, Gan believes that Malaysia’s reliance on crude oil as one of its key exports will give the economy the necessary lift should oil prices continue to rise.

With trade to be a key beneficiary when oil prices rise, positive spillover effects into energy-related industries, equities, and foreign investment will likely to be felt as well. Moreover, oil revenue also accounts for a sizable portion of government receipts, suggesting that fiscal standing will be strengthened as well.

The only concern, however, lies in higher domestic prices when oil appreciates: Malaysia remains to be a price-taker where energy prices are concerned.

“Crude oil is a key input for energy generation and correlates with palm oil given its biofuel status,” he cautions. “As for now, inflation remains tame as we speak, though policymakers may likely need to contend with higher domestic prices should prices surprise higher into 2018.”

With the government’s average crude oil price assumption of US$52/barrel for 2018 (Budget 2017: US$45/barrel; revised Budget 2016: US$30-35/barrel) – deemed conservative considering the cyclical upturn in the global economy – Maybank IB Research has projected petroleum income tax (10% of income tax and 5% total revenue) to rise further by 4.6% to RM11.4 bil next year after the estimated 29.9% surge this year to RM10.9 bil (2016: -27.1% to RM8.4 bil).

This is on top of improvements in other oil-related revenue, ie Petronas dividends (2018E: +18.1% to RM19 bil; 2017E: maintained at RM16 bil; 2016: -38.5% to RM16 bil); and petroleum royalties (2018E: +6.6% to RM4.1 bil; 2017E: +4.1% to RM3.8 bil; 2016: -28.8% to RM3.7 bil).

Crude oil export duties (2018E: +18.8% to RM1.1 bil; 2017E: +33.7% to RM900 mil; 2016: -32% to RM700 mil) and income from oil & gas explorations in Malaysia-Thailand Joint Authority or MTJA (2018E: +10.6% to RM2.2 bil; 2017E: -10.3% to RM2 bil; 2016: +3.6% to RM2.2 bil) are also expected to be better.

Despite the bullish assessment, whether the momentum is sustainable remains a concern. The US Energy Information Administration in its recent short-term energy outlook has forecasted Brent prices to ease somewhat in the coming months and to average US$56/barrel next year.

This is given it expects global oil supply growth to outpace global oil demand growth next year, contributing to global oil inventories rising by a forecasted 300,000 barrels per day compared with an estimated 200,000 barrels per day this year.

“However, global economic developments, geopolitical events, and crude oil production dynamics in the US and in other major producers in the coming months have the potential to push oil prices higher or lower than the current short-term energy outlook price forecast,” highlighted EIA.

Some analysts are already arguing that bulls are getting ahead of themselves by underestimating how quickly US shale producers will respond to the rise in prices. While also overestimating how effective efforts by major oil producers to curb production will be in taming a global oil glut.


Inflationary concerns

Nomura Global Markets Research has named Malaysia as one of its five “clear-cut winners” from the recent Brent crude surge from US$44/barrel in June to the current US$63/barrel level although this still pales in comparison to the drastic drop from US$115 to US$45 from June 2014 to January 2015.

The other four “clear-cut winners” are Colombia, Nigeria, Russia and Saudi Arabia while Brazil and Venezuela are defined as mere “winners”. The “clear-cut losers” are India, the Philippines and Turkey with Argentina, Chile, China, Egypt, Indonesia, Peru, South Africa and Thailand categorised as “losers”.

“With Malaysia being a net exporter of oil (0.3% of gross domestic product [GDP]) but an even larger exporter of liquefied natural gas (2.6%) – the price of which is closely linked to oil but with a few months lag – the benefit from higher oil prices is amplified,” Nomura’s (Asia ex-Japan) chief economist Rob Subbaraman pointed out in a recent report entitled Oil Price Moves: A Big EM Differentiator.

By Nomura’s estimates, every US$10 increase in the oil price would widen Malaysia’s trade surplus by about 0.4% of GDP and keep the current account which now stands at around 2.3% of GDP in a comfortable surplus.

“The government has removed fuel subsidies yet still collects oil revenues (14.8% of 2018 budgeted revenue),” noted Subbaraman. “Consumer price index inflation is therefore more sensitive to oil prices; our estimates show it would rise by about 0.8 percentage points on a US$10 rise in oil price.”

Against the backdrop of what is perceived to be confidence in the strength of the global and domestic growth seen this year being sustained into next year, Bank Negara Malaysia at its Nov 9 Monetary Policy Committee (MPC) meeting has stated that it “may consider reviewing the current degree of monetary accommodation.”

The central bank’s latest monetary policy statement signals an upside bias in the overnight policy rate (OPR) next year, according to Maybank IB Research’s chief economist Suhaimi Ilias.

“This is in line with our view of post-election +25 basis points hike in OPR next year,” he noted in a recent report. “Our eyes are on the MPC meeting in May 2018 as the earliest possible timing of the move to raise the OPR.”

The MPC will meet in late January for its first meeting of the year. However, Maybank IB believes they will hold off any hikes till after the 14th General Election which must be held by August next year.

“We maintain our view that BNM’s OPR hike will be a post-election event,” says Suhaimi. “With our view that the 14th General Election happening sometime in between February and April 2018, our eyes are on the MPC meeting in May 2018 as the earliest possible timing of the move to raise OPR.” 

Higher crude oil prices translate into better overall economy

THE country’s overall trade will benefit from higher oil prices, with recent OCBC Bank findings suggesting that rising crude oil prices is supportive of Malaysia’s growth prospects going into next year.

Higher oil prices is expected to benefit the balance of payments accounts, which usually translates into widening trade surpluses and stronger investor appetite. This then cascades down to benefiting energy-related industries and its equities, government revenue receipts, and eventually wages in related fields.

Speaking to FocusM, OCBC’s economist Barnabas Gan highlights that crude oil and related mineral fuel trade accounted for the second largest export group in Malaysia with a value of RM123.3 bil (or 13.6% of total exports) over the past 12 months since September.

Moreover, the manufacturing of petroleum and its related mining activities accounted for over 18% of gross domestic product back in 2011 before fading to around 15% in recent quarters given lower oil prices.

As such, in the light of higher oil prices to-date, Malaysia’s total trade surplus has grown by a strong 16.4% in the first nine months of this year versus the same period last year.

“In the same vein, stronger consumer and investor confidence will likely follow suit when Malaysia’s growth prospects brightens, which in turn benefits capital flows and energy-related equities,” Gan adds.

To-date, the FBM KLCI has rallied by as much as 4.7% in the first 10 months against the same period last year. Similarly, net portfolio inflows made by foreign institutional and retail investors printed a strong US$2.2 bil in the first 10 months, up from a mere US$491.8 mil in the same period last year.

“The uncanny resemblance crude oil prices have with foreign portfolio flows strongly suggests that higher crude oil prices have supported Malaysia’s equity market as well,” adds Gan.


This article first appeared in Focus Malaysia Issue 259.