PublicInvest Research

Author: PublicInvest   |   Latest post: Fri, 5 Jun 2020, 9:37 AM


Oil Price - Outlook Amid Twin Shocks

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Current Development

Oil prices have been extremely volatile in the last few months, hit by twin shocks due to the Covid-19 pandemic and the unexpected price war between Saudi Arabia and Russia. Brent is now trading at around USD30 per barrel from as high as USD52 in early March and has now lost about 60% in value since the start of the year. Immediate-term outlook remains challenging as global consumption is expected to contract amid slowing economic activities in large part of the world due to the still evolving Covid-19 pandemic, though there now appears to be some semblance of “calm” with the growth in new cases slowing.

Covid-19 has spread into 200+ countries and territories nonetheless, pushing governments to institute Movement Control Orders (MCO) or worse, total lockdowns to control its spread. This has naturally led to drastic drops in economic activity. Most countries have already rolled-out supportive fiscal and monetary policies to soften the risks from Covid-19 but this may not be enough to trigger a recovery in oil prices as demand may be dampened by a host of challenges including ballooning supply, slowdown in economic activities and uncertainty in economic recovery post-Covid-19 even though oil price is at a 16- year low (Brent).

Fears over widening oil surplus following Saudi Arabia and Russia’s decision to ramp-up production could also derail oil’s immediate-term recovery, though efforts are now underway to strike a new deal. At this time of writing, “commitments” are afoot to cut production by at least 10m barrels per day, though nothing concrete has emerged. Sentiment may also be affected by the prospect of rising oil builds-up amid slowing demand. Over-stretched expectation that Covid-19 pandemic may last until Spring 2021 is also adding to the uncertainty. This challenging outlook is consistent with our lower oil price projection (Brent) which is forecast to average between USD35-USD39 per barrel in 2020 (2019: USD64 per barrel), which is in line with the projection by BNM (USD25 – USD35 per barrel) and EIA’s (USD33 per barrel).

Supply and Demand Analysis: Outlook for 2020

1Q20 will go down in history as the most challenging time for oil prices following the incidence of the Covid-19 pandemic. Demand is expected to be severely affected amid countries’ stepped-up measures to contain its spread. Massive lockdowns especially in major economies (US, Europe, China) are resulting in oil inventories building-up which will not bode well for oil prices.

The biggest annual oil contraction was recorded in 1980 when global daily oil output tumbled by 2.6m barrels (2nd global oil crisis) but this is no match to the current situation amid this unprecedented health crisis that has affected the world over. To add to the strain, Russia and Saudi Arabia are expected to increase their daily oil output following the ending of OPEC+ supply cut agreement in March. Below is the 2020 global oil supply and demand projections (Tables 2 and 3):

1) On a fair-case-scenario, global oil supply is expected to exceed demand by 25.6 mbpd (2020 supply: 105.6 mbpd; 2020 demand: 80 mbpd) compared to a surplus of 500k mbpd in 2019.

2) Daily global oil supply is projected to increase by 4.0% YoY to 105.6 mbpd in 2020 driven by the surge in output by Saudi Arabia (circa +20% YoY) and Russia (+5.3% YoY). The US is not expected to make any change to their daily oil output of 15 mbpd.

3) Daily global oil demand is projected to drop by 21% YoY to 80 mbpd in 2020 consistent with slower GDP growth in China, US, Eurozone and India, the world’s biggest oil users. These countries make up circa 55% of global GDP.

4) Lower global oil demand for 2020 reflects a reduced assumption for global economic growth along with reduced expected travel globally because of the Covid-19 pandemic.

Oil Price Projection: What 2020 Holds

Oil price may endure a heightened period of volatility in the immediate term due to the negative news flow on Covid-19. This will be exacerbated by rising numbers of Covid-19 patients and deaths in advanced economies namely the US, UK and Europe compared to the epicenter of the pandemic, China. This may add to the already fragile sentiment on oil and may cap its rise even when China’s economy is expected to rebound post-Covid-19. Note that China’s March manufacturing PMI surged sharply (52, February: 35.7) which could be a harbinger to the swift economic recovery for the country. Outlook on oil is also affected by the potential delay in OPEC+ new supply cut agreement though this could very well cap the downside risk on oil price.

The current price war initiated by Russia and Saudi Arabia is also negative for oil price. The International Monetary Fund’s (IMF) view that the world’s economy is expected to endure a recession, likely to be worse than the 2009 Global Financial Crisis is also adding to the negative outlook. All this forms our lower oil price projection for the year (USD35 – USD39 per barrel) derived using regression analysis. The expectation is also largely in line with the forecast by BNM (USD25-USD35 per barrel) and EIA (USD33 per barrel).

Malaysia’s Fiscal Position 2020: Prospects and Challenges

The year started off in a cautious manner due to the still-uncertain outcome of US-China trade negotiations. The negotiations between both parties lasted for almost 18 months causing disruptions in the supply chains that led to a decline in exports (2019: -1.7%) that also hurt imports (2019: -3.4%). Against this backdrop, oil price using Brent as a benchmark, was initially projected to drop only marginally in 2020 (Budget 2020F: USD62 per barrel; 2019: USD64 per barrel), with the government initially expecting to collect about RM40bn from petroleum-related revenue in 2020, a tad lower than the RM42bn estimated for 2019. As a comparison, the government collected RM36bn and RM38bn in petroleum-related revenue in 2017 and 2018 when Brent was at USD54 and USD52 per barrel respectively. Note that the government collected higher petroleum revenue in 2018 against 2017 thanks to the stronger Ringgit (2018: RM4.03 per Dollar; 2017: RM4.30 per Dollar) that offset a YoY weakness in the price of Brent.

This has changed unexpectedly following the emergence of the Covid-19 pandemic that caused a strong sell down in major commodities especially oil. Given the uncertain global outlook especially when Covid-19 is still unfolding in major parts of the world, oil price is projected to average sharply lower (2020F: USD35-39 per barrel) vis-à-vis the previous year (2019: USD64 per barrel). This will be driven by slowdown in economic activities due to the extreme measures to contain Covid-19. Oil will also be pressured by a widening surplus following the price war between Russia, Saudi Arabia and Iran which remains unhindered. Downside risks on oil price may take a toll on the government’s revenue and our overall fiscal position given petroleum’s significant contribution to our economy. Below are our assumptions for our fiscal standing for the year:

1. Fiscal deficit is estimated to reach RM65bn (2019E: RM52.6b) or 4.7% of GDP (2019E: 3.2%) assuming a 0% GDP growth in 2020. The widening of fiscal deficit in 2020 will be contributed by a combination of a drop in revenue and a jump in expenditure, notably the RM22bn fiscal injection under Covid- 19 stimulus package.

2. Direct tax (tax – individuals, companies, PITA) and indirect tax (duties, SST) contributions may decrease due to the slowdown in economic activities as a result of Covid-19. This may be partially offset by higher non-tax revenue that may come in the form of dividends by GLICs, Petronas and BNM.

3. Petroleum revenue may drop to RM30bn in 2020 against RM40bn in 2019 driven by lower oil price (PIVB Brent 2020F: USD35-USD39 per barrel; 2019: USD64 per barrel). Petroleum revenue may gain from a recovery in Ringgit however (PIVB 2020F: RM4.10 per Dollar; 2019: RM4.15 per Dollar)

4. On the expenditure side, the government may refinance existing debt in order to reduce its debt services costs given a low interest rate environment (Budget 2020: RM34.9bn, 2019E: RM33bn).

5. The government could reprioritize economic spending under Development Expenditure (2020F: RM31bn; +7.6% YoY) to be channeled only to high impact and high priority projects. Slower economic activities in 1H provides some space for spending to slow down and save some costs - consistent with BNM’s projection for public investment (BNM 2020F: -7.5%; 2019E: - 10.8%)

6. Further shortfall in fiscal position (if any) is expected to be topped-up by borrowings especially when interest rate is expected to be low in the short term. End of 2019 fiscal debt-to-GDP position of 52.5% (2018: 51.5%) provides some room to raise funds given the statutory threshold of 55%. The government could also under asset liquidation exercises.


This is a testing time not only for Malaysia but also the world as the current health crisis is expected to cause more damage than earlier expected. The economic standstill will hurt especially with the government having to increase its resources to keep the economy intact. Malaysia’s strict fiscal discipline over the years is finally paying off and plans must be devised to restore back the position expeditiously. The pressure on fiscal position is not expected to affect our sovereign debt rating given the one-off nature of Covid-19 but there must be medium-term fiscal consolidation efforts to maintain that.

Source: PublicInvest Research - 10 Apr 2020

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