Ukraine-Russia conflict should have minimal direct repercussions to Malaysia as both nations only accounted for 0.4-0.5% of total trade. However, resulting higher oil prices is (ironically) a net negative for Malaysia’s fiscal position as incremental government revenue is more than offset by additional subsidy cost given the fuel price ceiling. While the conflict has hit markets, the local bourse included, we see trading opportunities in stocks with O&G upstream exposure (DNeX is our pick) from higher oil prices, and plantation (OVERWEIGHT) as supply disruption for sunflower oil could be a boon to palm oil.

Escalating conflict. The Ukraine-Russia conflict has escalated significantly since the start of 2022. At time of writing, Russian missiles and airstrikes have hit Ukraine’s capital, Kyiv, alongside over a dozen cities across the country. Prior to that, earlier this week, President Putin formally recognised two pro-Russian separatist areas in Ukraine’s Donbas region – the so called Donetsk and Luhansk People's Republics – and initiated military operations there. Following Russia’s military offensive yesterday, President Biden said more “severe sanctions” would be imposed, on top of the first barrage enacted a few days ago by US, EU and UK (mostly financial in nature).

Soaring oil price. Brent oil price has surged past USD100/brl, an increase of c.50% since Dec 2021 – when the conflict started to build up. Russia is the third largest oil producer in the world at 10.5m bpd or 11.2% of global output in 2020. As such, if sanctions eventually encompass Russian oil, this could send prices ascending further. There is also the issue of natural gas whereby Europe buys 38% of its consumption from Russian state-owned Gazprom – three out of seven pipelines that supply gas from Russia to Europe pass thru Ukraine. Consequently, gas price in Europe have risen 66% since mid-Feb.

Small trading partners, indirect impact via higher oil price. Both Ukraine and Russia are small trading partners of Malaysia, collectively accounting for only 0.4-0.5% of total trade over the past five years. Naturally, we expect minimal direct repercussion to Malaysia from their ongoing conflict but there will be an indirect impact via higher oil prices. We estimate fiscal revenue to gain RM300m for every USD1/brl increase in Brent oil price vs MOF’s benchmark assumption of USD66/brl for 2022. However, with the retail price of petrol capped (RON95: RM2.05/litre, diesel: RM2.15/litre) we calculate that the government will have to incur additional fuel subsidy cost of c.RM653m for every USD1/brl increase. Assuming Brent oil price averages USD100/brl for the year (YTD: USD89/brl) and exchange rate of USD-MYR 4.19, this could lead to a net deterioration in Malaysia’s fiscal balance by RM12bn or 0.7% of GDP – MOF’s targeted fiscal deficit is 6.0% for 2022 (2021p: 6.4%).

Market thoughts. Global markets have been hit following the conflict between the two former Soviet nations as risk of higher energy prices and shortages may exacerbate the ongoing supply chain disruption, further fuelling cost push inflation and making a case for even faster monetary tightening. The local bourse too, has not been spared with its bellwether index down -1.9% from its YTD high of 1,605 just a week ago. Still, there are pockets of trading opportunities from this. Higher oil prices would benefit those with upstream exposure – Hibiscus (non-rated), DNeX (our conviction BUY, TP: RM1.64) via its 90% stake in Ping Petroleum and Sapura (HOLD, TP: RM0.05). The plantation sector (which we are OVERWEIGHT on) is another likely winner as sunflower oil supply disruption (76% comes from the Black Sea region where Ukraine is located) would cause buyers to seek alternative vege oils, palm oil included. While higher global energy prices may eventually reach Tenaga (BUY, TP: RM13.60), we find solace in the IBR and ICPT mechanisms – which were honoured during last month’s tariff review.

Source: Hong Leong Investment Bank Research - 25 Feb 2022