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This article first appeared in The Edge Malaysia Weekly on December 31, 2018 - January 6, 2019

THE oil bear was in bull’s clothing for most of 2018, or so it would seem, with Brent crude oil dipping below the US$50 per barrel mark last week. The 42% fall from its US$86 peak on Oct 3 in just 12 weeks wiped out the gains for the whole year and more.

Was it really just three months ago that pundits were forecasting oil prices at US$100 a barrel again?

At the time of writing, a Bloomberg poll indicated oil price climbing to US$70 a barrel again next year. It is worth noting that Petronas’ view on the oil price is US$60 to US$70 a barrel for 2019.

Finance Minister Lim Guan Eng would be spared a Budget 2019 recalibration if indeed Brent crude oil climbed and stayed convincingly above US$60 again. On Dec 23, Lim told reporters that there would be a recalibration only if oil price slipped below US$50 a barrel.

More on what the economists say about this later, given that the significance of oil revenue to Malaysia goes beyond prices at the pump.

A study of Brent’s journey over the past decade reveals three significant dips — in 2008, 2014 and now.

It took Brent three years to climb from just US$28 a barrel in 2016 to a four-year high of US$86 on Oct 5, 2018, and just three months to lose more than a third of its gains. And this is despite news of production cuts and the United Arab Emirates’ hint on Dec 23 that Opec and its allied oil producers may cut more than the 1.2 million barrels per day output reduction agreed upon for the first half of 2019 if necessary — yet another sign that the group’s influence on prices may be waning.

To recap, Brent’s steepest fall was in 2008 when prices nosedived from about US$145 to US$36 levels when the commodity bubble burst. But the rebound came in just five months.

It is worth noting that Brent has been peaking at lower levels since then. Compared with its highest peak of US$146.08 on July 3, 2008, the second peak was about 21% lower at US$115.06 on June 19, 2014. Similarly, the recent US$86.29 peak on Oct 3 was 25% lower than in 2014.

If a 20% discount is the trend, the next peak may be just US$70, back-of-the-envelope calculations show. But that is just a guesstimate at best and prices can be influenced by a confluence of factors — from production and geopolitics to technology or even excess money in the system.

We know that Brent’s plunge from US$110 in October 2014 to below US$30 in 2016 was triggered mainly by Saudi Arabia’s move to stifle competition by oversupplying the market and pushing prices below the level viable for shale oil producers.

The rise of shale — whose break-even level is believed to be around US$45 a barrel — gave birth to the industry’s notion of a “lower for longer” oil price environment.

There is no denying that the oil supply-demand equation is getting increasingly complex. Shale oil and oil sands, previously seen as unconventional and inaccessible, now represent a growing share of global production. In the longer run, advances in green energy and the sharing economy may also play a significant role in suppressing demand for hydrocarbon resources.

 

Impact on Budget 2019

Low crude oil prices is good news for drivers as the weekly pricing mechanism for all fuel products will be reintroduced from Jan 1, 2019.

While the government can save on fuel subsidy when prices are low, every US$1 change in global oil price means a RM300 million difference to government revenue.

Brent near US$50 spells a US$20 difference to the oil price of US$72 a barrel assumed in Budget 2019, which was tabled on Nov 2. This is essentially a RM6 billion revenue shortfall for the government that had estimated oil-related revenue at RM80.1 billion or 30.9% of total federal government revenue estimate of RM261.8 billion.

Oil-related revenue would be 19.5% of government revenue in 2019 if the RM30 billion special dividend from Petronas for excess tax refunds were excluded. Petronas is also paying the government a RM24 billion dividend in 2019.

As the RM54 billion in Petronas dividends for 2019 is certain, only about RM26 billion or 10% of federal government revenue in the year from petroleum income tax and royalties is susceptible to oil price movements.

So, for now at least, a Budget 2019 recalibration is possible but not a certainty.

UOB Bank Malaysia senior economist Julia Goh, for one, reckons that higher government revenue from new tax measures and asset sales mean that “there is room to manoeuvre and prevent a slippage in the fiscal deficit target” of RM52 billion or 3.4% of GDP in 2019.

“The additional revenue gains could be between RM4 billion and RM8 billion while savings from introducing a targeted subsidy scheme could be around RM6 billion,” she says in a Dec 27 note.

To be sure, it does not help that two national budgets — Budget 2015 and Budget 2016 — were revised in the past five years.

The last budget recalibration was in January 2016 when oil price fell below US$35 a barrel and resulted in a revenue shortfall of about RM7.8 billion to RM9.4 billion, given that the oil price assumption was US$48 a barrel back then. The revised Budget 2016 assumed oil prices at US$30 to US$35 and the budget deficit was left unchanged at -3.1% of GDP with expenditure cuts and measures to raise revenue elsewhere.

However, GDP growth for 2016 was revised to 4% to 4.5% from 4% to 5%. Actual growth came in at 4.2% in 2016, down from 5% in 2015.

 

Having an oil kitty

Malaysia can ill afford a cut in sovereign rating, which would make service charges for the more than RM1 trillion debt even more expensive than they already are.

While all three international rating agencies have maintained their outlook for Malaysia so far, they raised concerns about the government’s debts and liabilities as well as budget deficit. They also pointed to the rise in oil-related revenue, owing to the Petronas special dividend.

The national oil company itself has seen its outlook changed to “negative” from “stable” by Moody’s Investors Service, which said the oil company’s financial profile may deteriorate if it continues to pay high dividends, especially should the oil price decline.

Put another way, expectations are high that the government will find new revenue sources that would further reduce the significance of oil revenue to its annual budget, especially with the new Sales and Services Tax raking in less revenue than the axed Goods and Services Tax.

Just like Petronas’ special dividend, the sale of government assets may buy some time but this is unlikely to be convincing over the longer term.

The 2019 Fiscal Outlook report talks about the possibility of setting an oil price threshold for budget formulation to help the government be more prudent in determining the right level of spending while balancing the need to sustain economic growth.

“If oil price breaches the threshold, any additional revenue must be put into a stabiliser fund within the Consolidated Fund. The reserve will provide fiscal space for the government to mitigate the adverse effects of economic crises, including cushioning revenue loss,” the report says.

If executed properly, such a move could eliminate future questions as to whether there is a need to recalibrate the national budget when oil bears roam.

 

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