Malaysia should assume worst case for oil, says analyst

Malaysia should assume worst case for oil, says analyst

Kuala Lumpur - AS Teheran re-enters the oil market, pushing prices to below US$28 (S$40) a barrel and a 12-year low, an analyst has suggested that it may be necessary for Malaysia to pencil in an ultra-conservative average of US$10 oil in its revised Budget, given the rapid pace of decline of oil prices.

Whether the assumption is provocative or overly bearish, independent interest rate and foreign exchange strategist Suresh Ramanathan maintains that the oil-exporting country needs to "be pragmatic", and that Putrajaya ought to base its oil inference on the worst-case scenario, rather than go with the crowd.

"It should go below consensus and if the numbers turn out better, they can be revised as Putrajaya will be ahead of the curve rather than behind it," he said.

On Jan 28, Prime Minister Najib Razak is to announce a revised Budget to better reflect the current climate, which includes further oil price weakness, a slowing Chinese economy and depreciation of the yuan, as well as the lifting of economic sanctions on Iran, which will let loose its oil supply into an already over-saturated market.

Only 10 days earlier, with oil prices at the US$32-33 range, Mr Najib, who is also finance minister, declared that the Budget, tabled last October, would have to be "recalibrated", because it was based on oil costing US$48 a barrel.

With prices now lower in anticipation of Iran's supplies, Malaysia's oil revenues could be reduced by more than RM30 billion (S$9.8 billion).

The RM30 billion figure was based on oil being priced in the low US$30s. Every drop of a dollar in the per-barrel price adds up to a RM300 million loss in oil revenue for the country.

Last week, Petronas president and chief executive Wan Zulkiflee Wan Ariffin said that oil prices could average US$30 barrel this year, down from the US$48 price assumed only two to three months ago; he warned that the rough patch could last two to three years.

While radical, Mr Ramanathan's suggestion of US$10 oil doesn't seem too far-fetched. Standard Chartered has said that prices could go as low as that, though economists at the Royal Bank of Scotland have put it at a more moderate US$16.

But even if prices were to plummet to those levels, chances are it would not last long.

In a report last week, Bank of America Merrill Lynch (BOAML) observed that many companies would not be able to cover their operating costs if oil prices dip into the US$20s, "marking a possible inflection point for oil".

While it believes it is too early to pick a bottom - given the current global environment including the growing animosity between Saudi Arabia and Iran - it said that conditions for a floor in crude oil prices are coming together, as a result of the following factors: spot crude prices are nearing cash costs, a bumper US driving season is approaching, the Chinese yuan is finally starting to move towards fair value, shale production is falling and the West Texas Intermediate (WTI) grade of crude oil has now matched Brent.

BOAML expects global oil demand to expand at a brisk pace on lower oil prices as Iran's oil hits the market. It also expects oil prices to bottom out in the first half, with a recovery into the summer months, and has projected Brent to average US$46 (from US$50) and WTI at US$45 (US$48).

If oil prices trade close to the bank's average, Putrajaya is likely to have more breathing space in the second half to tinker with a leaner Budget, especially if its oil assumptions are more conservative.

Given that the economy is slowing noticeably, Mr Ramanathan said, the focus of the Budget should be on growth, which he believes is paramount. "Instead of being fixated on debt, they should concentrate on growth."

Fiscal deficit concerns should be put on the back-burner, he said, because "a ratings downgrade is inevitable especially if oil revenue continues to drop".

This article was first published on January 19, 2016.
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