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This article first appeared in The Edge Financial Daily on January 2, 2018

KUALA LUMPUR: After more than two years, crude oil prices finally breached the resistance level of US$60 (RM243) per barrel (bbl) in October last year. The gradual uptrend since touching a low of US$45/bbl in mid-June 2017 has put prices at what pundits described as a “fair” level of between US$50 and US$65.

As a net oil exporter, Malaysia has been dubbed by Nomura as among the five “clear-cut winners” of rising crude prices, as seen in the encouraging macro-economic numbers, for instance, the robust GDP growth.

Higher crude prices may not be something that others are looking forward to. Adam Aziz assesses the pros and cons of higher crude oil prices to Malaysians and policymakers.

 

Higher crude prices, stronger ringgit

The currency exchange rate is influenced by a combination of factors. For the ringgit, the movements of crude oil prices are one important variable in the equation, said MIDF Research chief economist Kamaruddin Mohd Nor.

The ringgit slid to the 4.40 level against the US dollar at end-2015. At that time, crude oil was on the way down, sinking under US$40/bbl.

“Historically, the ringgit has been correlated with oil prices,” Kamaruddin told The Edge Financial Daily. The oil price also dictates the direction of equity markets and foreign inflows as well, he said.

Year to date, the Malaysian ringgit has appreciated by 9.8% against the US dollar to 4.0465 as at Dec 29, from 4.4862 against the greenback on Dec 30, 2016, making it one of the best-performing currencies in Asia. In the same period, Brent crude oil appreciated by 16.93% to US$66.44/bbl, from US$56.82 previously.

 

More oil revenue

According to Second Finance Minister Datuk Seri  Johari Abdul Ghani, for every US dollar increase in crude oil prices, the government would earn an additional RM300 million in revenue.

MIDF Research said in a report dated Nov 27: “In the latest Budget 2018, the government’s oil price assumption is US$52/bbl. Currently, the Brent crude oil reference price is hovering above US$60/bbl.

“Assuming that the oil price averages US$60/bbl in 2018, we can expect an additional government revenue of approximately RM2.4 billion,” said the research house.

To recap, the oil slump in 2015 had caused oil revenue for the Malaysian government to shrink to RM42.7 billion, from RM62.5 billion in 2014. The amount declined sharper to RM28.1 billion in 2016.

In that period, the percentage of oil money to government revenue dropped from around 30% to the low teens, which drove the Malaysian government to seek an alternative source of income, such as the goods and services tax (GST) that was introduced in 2015.

 

Oil & gas industry to get out of the woods

Many Malaysian oil & gas (O&G) companies, big and small, have been struggling to keep afloat in this prolonged severe downturn of the past three years as oil majors have halted many exploration and production (E&P) activities and slashed capital expenditures.

The steady recovery in crude oil prices, particularly in the second half of last year, has raised a ray of hope that the worst is over for the O&G sector, although it is far from the heydays.

Should crude prices continue to climb, this will bode well for local O&G companies. Stronger oil prices are likely to prompt oil majors to raise capital expenditure (capex).Hence, there will be more E&P activities which will, in turn, mean more jobs and contracts for local players.

Being an oil producing nation, oil and gas services equipment (OGSE) is an important industry to the country’s economy as it results in, for instance, job creation, private investments and the chain wealth effect.

In his Budget 2018 speech, Prime Minister Datuk Seri Najib Razak named the OGSE sector on the list of “high-impact” sectors alongside aerospace, rail, robotics and other export-oriented industries. This speaks well of the significance of the OGSE industry.

 

Low oil prices, please!

Who doesn’t want low pump petrol prices in the face of rising costs of living?

For the week between Dec 28 and Jan 3, RON95 is at RM2.26 and RON97 at RM2.53. To recap, RON95 was at RM2.30 in November 2014, and RON97 was at RM2.55 when Brent crude was at US$70-US$80/bbl.

It is apparent that petrol prices will rise should crude oil prices climb further. And that will mean higher transportation costs, which will fuel inflationary pressure.

In November 2017, the consumer price index (CPI) increased 3.4% year-on-year to 120.8, with transport indices rising 10.8% — the biggest percentage rise among all indices — to 120.4. The CPI has been at above 3% in 2017, an evidence of rising cost of living.

“Transport costs take up around 15% of the CPI basket,” said MIDF’s Kamaruddin. “Any increase in fuel prices will have a big impact — especially to the lower-income groups, as it represents a bigger percentage of spending compared with those with high income,” he said.

Furthermore, making things difficult is price-stickiness, added Kamaruddin — prices of other goods will go up when fuel prices rise, but it is difficult to see prices go down when fuel prices go down.

 

Weakening purchasing power

In relation to higher crude oil prices, all goods and services are bound to increases in prices when fuel costs go up. This will erode Malaysians’ purchasing power that has already been weakened by the sharp depreciation of the ringgit from RM3.50 against the US dollar in early 2014 to the RM4.05 level currently.

Consumers will tend to tighten their belts further, particularly the B40 group, in order to make ends meet when costs of living creep up. As a result, consumer spending may not be strong enough to be an economic growth locomotive.

Indeed, Malaysians have not been spending generously. The Consumer Sentiment Index (CSI) has been rather flattish in the first three quarters of 2017 (3Q17), according to MIER, with a slight retreat to 3.6 points quarter-on-quarter to 77.1 points in 3Q17 — below the optimism threshold of 100 points.

 

Whopping subsidy bill

To help mitigate the pain of high costs of living, the government has said that it will identify measures if the retail prices of RON95 petrol and diesel soar above RM2.50 per litre for three consecutive months. A subsidy will alleviate people’s burden of high living costs. However, the subsidy will widen the government’s fiscal deficit.

Some quarters opine that the petrol subsidy could be covered by the additional oil revenue. Nonetheless, if other commodity prices are also going up, this will also result in higher prices of food items, like for sugar and cooking oil. Would that mean even more subsidies to be granted by the government?

MIDF’s Kamaruddin noted that an option for the government is to have subsidies only meant for targeted groups to better assist people who are more vulnerable to rising living costs.

“The government has already identified some seven million recipients eligible for the targeted subsidy mechanism,” he said. “Targeted subsidy mechanisms are tricky, but BR1M is a start. The government can use that data to implement fuel subsidies if need be.”

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