Story of the year: New supply equation for O&G

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THE world had lived with crude oil prices at above US$90 per barrel for the past four years, partly because geopolitical tensions in oil-producing countries had shut down some oilfields. However, something that few have noticed is that the world’s big energy consumer, the US, has become a major oil producer with an ample supply of shale oil — the unconventional fuel.

As the geopolitical tensions ease, the world’s oil production rises. As a result, there is an oversupply of crude oil, sending its prices on a downward spiral as demand grows at a slower pace. The price of international benchmark Brent crude has halved since June, when it reached a peak of US$115 a barrel. Last Tuesday, it fell to US$58.50, the lowest level since May 2009.

Low crude oil prices should come as a welcome relief for the world economy as cheaper energy costs will prevent inflation from rearing its ugly head. But not for countries that are dependent on petroleum revenue; the slump in oil prices will shrink government coffers.

The currencies of most oil-producing nations, including the ringgit, have depreciated sharply against the US dollar due to the heavy outflow of foreign investment funds.

Russia, where half of the government’s revenue is derived from oil and gas (O&G) sales, is an example. Its currency, rouble, depreciated 45% against the US dollar this year, even after the central bank raised the interest rate to 17% from 10.5%. Russia is expected to be headed for an economic crisis.

Recently, some oil majors hinted at cutting exploration expenditure. Canada’s Chevron has announced that it is putting its Arctic drilling plan on hold “indefinitely”.

On the home front, concerns about a possible twin deficit are growing following the fall in oil prices and the depreciation of the ringgit as Petroliam Nasional Bhd (Petronas) would not be able to pay generous dividends as it did in the past few years.

Already the national oil company has advised the federal government to “tighten its belt”. Its president and CEO Tan Sri Shamsul Azhar Abbas reportedly said Petronas’ payments to the government could be 37% lower at RM43 billion next year if oil prices are around US$75 a barrel.

Brent crude is now hovering around US$60 per barrel, so Petronas’ dividend payments may even be lower than expected. The US Energy Information Administration (EIA), in its December Short-Term Energy Outlook, forecasts the Brent crude price to average US$68 per barrel in 2015.

Petronas has also signalled to local O&G companies that it will cut its capital expenditure by 15% to 20% next year, which will result in slower roll-outs of contracts and jobs.

The party in the O&G industry has ended abruptly. The nerve-racking plunge in oil prices has sent investors fleeing from O&G-related counters. A 40% to 50% drop in share prices is seen in most O&G stocks on Bursa Malaysia. Billions ringgit in market capitalisation has evaporated.

SapuraKencana Petroleum Bhd has suffered a RM14.9 billion decline in market capitalisation; Bumi Armada Bhd, RM8 billion; and Perisai Petroleum Bhd, RM1.4 billion.

Things just seem to have turned gloomy in a span of three months.

Last week, the World Bank trimmed Malaysia’s 2015 gross domestic product (GDP) forecast to 4.7% on the ground that weak oil prices will slow down the country’s economic growth.

Malaysia’s GDP can only grow 3% to 4% next year, says Manokaran Mottain, an economist at AllianceDBS Research.

He opines that the risk of a trade deficit is highly likely in the first half of 2015, warning that Malaysia’s “sovereign rating” may be downgraded amid expectation that the government’s efforts to narrow the country’s budget deficit could be derailed.

Meanwhile, the International Monetary Fund (IMF) has cut its global economic growth forecasts for 2014 and 2015 for the third time this year. In its World Economic Outlook report released in October, global GDP growth forecasts have been reduced to 3.3% for 2014 and 3.8% for 2015, led by revisions for Europe, China, Brazil and Russia.

The EIA expects global liquid fuel supply to average 92.8 million barrels per day in 2015, which is higher than the anticipated average global demand of 92.3 million barrels per day.

Considering the unexciting global economic outlook going forward, the demand for oil is not expected to increase soon to ease the oil glut.

Recall that in 2008, Brent crude plunged from a peak of US$144 in May to US$38 in December at the onset of the global credit crunch caused by the US subprime loans.

However, by June 2009, it had rebounded to above US$70. From there, it headed higher to above US$120, and had hovered between US$100 and US$120 most of the time since 2010.

Using that as a guide, the current oil price slump is unlikely to be a permanent situation.

However, some quarters may disagree as the US was not part of the supply equation back then. Furthermore, the Organization of the Petroleum Exporting Countries (Opec) has no intention of cutting production.

Still, realistically, will the Americans and Opec members keep pumping oil into the market if the prices are not as attractive as before, especially for the unconventional energy projects, where the production costs are substantially higher?

This article first appeared in The Edge Malaysia Weekly, on 22 - 28 December 2014.