Thursday 28 Mar 2024
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BEFORE the recent tumble in global oil prices, it was said that the growing popularity of shale oil would herald a structural shift in the world’s oil supply, which experts said could augur less volatile prices going forward.

This was premised on an increasing level playing field between the Middle Eastern and the Western producers, with rapid advancements in fracking technology making North American shale increasingly cheaper and faster to produce.

But before that could be achieved, the Organization of the Petroleum Exporting Countries (Opec), appearing to fear such a structural change, initiated a price war by refusing to pull back production to shore up falling oil prices.

That caused oil prices to nosedive 45% from US$115 per barrel on June 19 to a fresh low of US$63 last Friday, sparking even greater volatility in the global market.

Market observers say the Saudi Arabia-led Opec is banking on low oil price levels to hinder the growth of shale oil. The logic is simple, as shale oil still costs much more to produce than Opec’s, a lower oil price environment would hurt shale oil producers more. For Saudi Arabia, a lot is at stake as it provides some 40% of global oil supply.

“It is becoming a matter of power. Opec does not want to lose that to the US, so keeping oil prices low would make its oil more competitive against shale,” says an industry player in the exploration and production (E&P) business.

“Previously, the US had to rely a lot on imports of oil from Opec nations. But now, it has shale oil and gas and Opec is losing its hold over the nation,” he explains.

In 2013, the US imported 9.9 million barrels per day (mbpd) of petroleum, 3.72 mbpd or 38% of which came from Opec countries, according to the US Energy Information Administration (EIA). However, it is envisaged that further growth in US’ shale oil production would drastically cut its demand for imported oil in the future.

The question now is how low oil prices will have to sink before costs become too much for some shale producers and force them out of the market. This balancing point is just what Opec is now seeking, some quarters say.

According to US-based consultancy IHS Inc, over the last year, the cost of shale production has fallen to US$57 per barrel from US$70 per barrel. For conventional oil, the cost of production, especially for Opec countries, is still much lower. For instance, the production breakeven costs for Saudi Arabia, Iraq, Iran and the UAE were below US$20 per barrel in 2011, according to news reports.

Opec is concerned that there may be a power shift towards the US as the latter’s shale producers’ spare capacity now exceeds that of Saudi Arabia. The US has 5 million mbpd in spare capacity — the amount of crude oil a country is able to produce in 30 days — while Saudi Arabia has only 1.5 mbpd.

According to the EIA, the US’ total crude oil production averaged some 9 mbpd last month and is projected to average 9.3 mbpd in 2015. Its current production is just short of Saudi Arabia’s 9.6 mbpd in November, according to Opec’s latest monthly oil market report.

“In November, Opec’s crude oil production averaged 30.05 mbpd, according to secondary sources, a drop of 0.39 mbpd over the previous month,” it said.

It remains to be seen how long Opec will keep its top position. For the more affluent members such as Saudi Arabia, the UAE and Kuwait, a squeeze in margins in order to retain market share is a sacrifice they can afford to make.

For countries such as Algeria and Venezuela, however, oil prices are crucial in balancing their budgets, an economist points out.

But Opec’s measures to protect its market share may be short term because as fracking technology develops further, there will be an increased supply of shale oil at lower prices.

This could mean that oil prices have entered a new cycle in which it will trend lower, from US$80 to US$60 per barrel as the new norm. Many industry experts and analysts are acknowledging that this is a possibility.

“Prices will probably move back up sometime next year, but I don’t think we will return to the previous levels of US$100 and above,” says one industry official.

What does this mean for Malaysia?

The falling crude oil prices has been a hot topic for Malaysians since the decline first started in October.

And this is not surprising given that the bulk of the government’s revenue comes from oil. In 2013, the commodity contributed 31% to the government’s revenue of RM220.4 billion.

RHB Research estimates that every US$1 per barrel decline in oil prices will result in some RM650 million loss in revenue, not accounting for fuel subsidy savings.

Considering that the government budget is based on oil prices of roughly US$100 per barrel, this implies a RM24 billion gap in actual budgeted oil revenue at present prices.

In a note last Thursday, Morgan Stanley Research said that if oil prices were to fall to US$66 per barrel, Malaysia’s fiscal deficit would widen by at least 0.3% in 2015. “In Malaysia, unwinding fuel subsidies and falling oil prices have a negative impact on the fiscal balance of at least 0.3% of gross domestic product. Every US$10 fall from hereon would further weaken the fiscal balance by 0.6%,” Morgan Stanley said. Oil prices on the West Texas Intermediate have since fallen below US$60.

Malaysia targets to bring down its fiscal deficit to 3.5% this year and 3% in 2015, from 3.9% last year. “To continue fiscal consolidation, the policymakers would need to cut expenditure or raise revenue elsewhere,” the research house said.

The national oil company, Petroliam Nasional Bhd (Petronas), which is often viewed as the government’s cash cow, is now caught between paying the government sufficient dividends and making business sense.

Petronas has felt the pressure, with Finance Minister II Datuk Seri Ahmad Husni Hanadzlah saying that the company did not have the authority to decide how much contribution it would pay the government. That authority lay with its owner, the government, he added.

However, the Institute for Democracy and Economic Affairs (IDEAS) has come out to say that Petronas should not be forced to carry this burden. “Petronas should not be forced to pay for the government’s inability to balance the country’s budget,” IDEAS CEO Wan Saiful Wan Jan said in a statement. He added that there was an urgent need to re-examine the government’s hold on Petronas’ finances.

Petronas is also reviewing all its businesses in an effort to cut costs amid the sluggish outlook and has said that next year, it will cut capital expenditure by 15% to 20%. It had originally allocated RM300 billion to be spent between 2011 and 2015, but this was based on an oil price of US$80 per barrel.

This will put pressure on oil and gas companies hoping to bag E&P contracts from the oil giant as well as downstream players.

This article first appeared in The Edge Malaysia Weekly, on December 15 - 21, 2014.

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