This article first appeared in The Edge Malaysia Weekly on October 1, 2018 - October 7, 2018

IN recent months, Brent crude prices have been trending upwards, breaching the US$80 per barrel level last week to raise optimism that the triple-digit US$100 threshold is within reach. A big part of the confidence stems from anticipation of US sanctions against Iranian crude exports in November.

The third largest oil producer in the Organization of the Petroleum Exporting Countries (Opec), Iran reportedly exported 2.7 million barrels per day (bpd), or the equivalent of 3% of daily global consumption, at its peak this year.

Should the US proceed as planned, energy market analysts estimate that 500,000 bpd to as much as two million bpd could vanish from the market over the coming months, media reports state.

Going by their recent meeting, Opec and Russia have no immediate plan to increase their combined production levels.

The deterioration in US-Iran bilateral relations has already impacted Iranian crude exports. In August, news reports said the country’s crude sales dropped by 600,000 barrels to 1.68 million bpd in the first half of the month.

“The latest crude oil supply figures suggest that Iran’s crude oil production and export have already started to take a noticeable dip. This implies that the US sanctions against Iran (for starters, banning access to US banknotes and key industries) have started to have a negative impact on Iran’s capability to produce and export crude oil,” comments United Overseas Bank (M) Bhd economist Julia Goh.

“While the drop in Iran’s crude oil production and export is highly anticipated, it appears that Saudi Arabia and Opec are not able to ramp up crude oil production as initially planned. Hence, despite increasing concerns over global growth prospects from the ongoing US-China trade conflict and emerging market volatility, Brent crude prices have managed to rally above US$80 per barrel.”

At the same time, US shale production has seen slower growth in recent times owing to pipeline bottlenecks in the Permian Basin, where most of the activity has taken place. This has also contributed to fears of a supply shortage should oil sanctions be imposed on Iran.

Crude oil prices last hovered above US$100 per barrel levels four years ago, most recently on Sept 8, 2014, when they hit US$100.20, but headed south from thence.

In the first eight months of 2018, Brent crude prices averaged US$71.37 per barrel — a stark contrast to the US$51.21 average for the same period last year.

Socio-Economic Research Centre executive director Lee Heng Guie sees oil prices climbing towards the US$100 mark — albeit for the short term — should the threatened oil sanctions come to pass and other producers keep to current production levels.

“Oil price futures will continue to firm, crossing US$80 per barrel and charging towards US$90 to US$100 per barrel in the next three to six months if the political risks and supply disruptions persist, including the US reinstituting sanctions on Iran in November,” he says, adding that there was “no formal recommendation by Opec and non-Opec members for any additional supply boost to help stabilise prices”.

That said, Lee believes that the current surge in oil prices will end once the geopolitical risk driving it subsides. “A sustained strong rally is unlikely as oil prices that are too strong and the escalation of trade tensions will undermine the global economy and result in moderate demand and prices.”

Goh, however, is not over-bullish about oil prices trading up to the US$100 mark as she believes the upcoming Iran supply disruption could be offset by global growth concerns over the escalating US-China trade war. Nonetheless, she has increased the trading range expectation for Brent crude.

“Overall, we continue to maintain our neutral outlook for Brent crude, but have raised the trading range expectation from US$70 to US$80 per barrel to US$75 to US$85 per barrel for the coming four quarters,” she adds.

Affin Hwang Investment Research chief economist Alan Tan also believes that the trade war could be a bane for higher oil prices. “If the US-China trade war continues, higher oil prices are unlikely to be sustained. At the end of the day, it is all about demand and supply.”

Thicker wallet for the government

Whether or not crude oil prices will revisit their glory days of US$100 or more per barrel, economists observe that even at current levels, they are a boon to the country’s coffers.

Lee says the extra revenue will come in handy at a time when the government’s budget is stretched to meet the shortfall in revenue with the Sales and Services Tax replacing the Goods and Services Tax as well as fund fuel subsidies and other locked-in expenses.

“Every US$1 increase in oil prices will generate about RM300 million in revenue, and [hence] higher contributions from Petronas dividend. This year, Petronas’ dividend was bumped up to RM24 billion from RM16 billion, as budgeted in the 2018 Budget,” he observes.

However, Tan notes that rising crude oil prices will also mean a higher fuel subsidy bill, given the government’s commitment to maintaining RON95 at the current price of RM2.20 per litre.

“While rising oil prices will boost revenue collection, the subsidy bill will increase as well. So, the benefit of higher oil prices may be offset by it. However, the net impact of higher crude prices will still be positive for the country,” he says, adding that quantifying the exact impact of rising oil prices on fuel subsidies is difficult.

Given that Malaysia is often viewed as a country that benefits from higher crude prices, foreign investment sentiment is also likely to improve, Tan says. “There could be more activity among the oil and gas players. It is also a positive for Petronas’ capital expenditure going forward.”

Petronas has targeted capital expenditure of RM50 billion for the year, allocating RM12 billion for upstream activities. This allocation is expected to increase to RM14 billion to RM15 billion next year.

Improved oil prices have lifted oil export earnings, which account for 3.6% of total exports, Lee observes. “However, the overall impact on gross domestic product growth this year will be small and will be offset by the drag from agriculture and lower LNG (liquefied natural gas) production as well as the rationalisation in government spending.”

Although rising crude oil prices are seen as a positive for Putrajaya as they help ease the financial risks and mitigate uncertainties over revenue collection, Goh counsels fiscal consolidation. “We think the government should remain focused on trimming unnecessary spending and stay the course in fiscal consolidation.”

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