OPEC Members to Extend Production Cut for 9 Months Until March 2018

Malaysia’s headline inflation, as measured by Consumer Price Index (CPI), increased sharply from 1.3% yoy in 3Q16 to 1.7% in 4Q16 and 4.3% in 1Q17, the highest quarterly yoy level since 4Q08. While inflation moderated slightly from a high of 5.1% yoy in March to 4.4% in April, there is concern being raised of rising inflationary pressure in the country. However, we concurred with Bank Negara Malaysia (BNM), where in the latest Quarterly Bulletin report, noted that the country’s recent sharp rise in inflation rate was driven mainly by cost factors, attributed mainly to higher cost of transports, reflecting rising petrol prices, especially in RON95 petrol.

The retail price of more commonly used domestic RON95 petrol, which has a significant weightage of 7.8% in the CPI basket, rose to an average of RM2.23 per litre in 1Q17, significantly higher than RM1.73 per litre in 1Q16. As a result, growth in the transport component, which accounted for 13.7% of total CPI basket, rose sharply by 16.2% yoy in 1Q17, as compared to -2.6% in 4Q16, due to the base effects. The higher price of RON95 since early 2017 reflected the increase in global crude oil prices, particularly when the Organization of Petroleum Exporting Countries (OPEC) members reached an agreement to cut production by 1.2 million barrels a day in September 2016, where a number of non-OPEC countries also joined the production cut by a cumulative 0.6 million barrels per day.

Extension by OPEC on Production Cut Failed to Lift Global Oil Prices

There were renewed concerns earlier of further pressure on Malaysia’s headline inflation rate before the OPEC scheduled meeting on 25 May 2017, that the decision by its member to extend output cut may lead to higher global oil prices, therefore putting upward risks on domestic price of RON95 petrol. Furthermore, in Malaysia, the change to a weekly fuel pricing mechanism since April 2017, also indicates that the up and down in domestic retail petrol prices are more sensitive to the directions of global oil prices.

However, following the latest OPEC meeting on 25 May 2017, despite the agreement by its members to extend their production cut by 1.2 million barrels a day by nine months until March 2018, the direction of global oil prices remained relative flat, with downside bias, alleviating some concerns of further rise in Malaysia’s headline inflation rate from higher transport costs.

Nevertheless, the OPEC agreement gave a sense of comfort to the market, as the International Energy Agency (IEA) has previously mentioned that with such an action (i.e. production ceiling), the global oil market could “move from surplus to deficit very quickly in 2017," hence supporting the crude oil price to remain above USD50 level. The extension is being supported by Russia and other non OPEC countries, which has also agreed to continue to cut their own production by 558,000 barrels per day. In total, the production cut will maintain at approximately 1.8 million barrels per day level.

There was some improvement in the supply glut, in which the production surplus has declined from an average 0.77 million barrels per day in 4Q16 to 0.31 million barrels in 1Q17. While early to gauge the impact of OPEC’s extension in production cut, we believe that the decision may be enough to sustain the global oil price at around USD50-55 per barrel for Brent. However, any upside surprises to global oil prices through the end of 2017, will be limited somewhat by higher shale production growth (from US oil producers).

US Oil Production Put Pressure and Limit the Rise in Global Oil Price

Based on our own estimate, a continuation of the production cut at the current level will not be enough to significantly reduce the oil inventory level to five-year average of 2.7 billion barrels – a self-imposed target of the OPEC. This is due to the expected higher production by the US, in which we estimate will likely achieve its previous high. US oil rigs had a sharp rebound since mid-May 2016, when the oil price began to signal signs of stabilisation around USD45-50 level.

According to a Rystad Energy analysis, since 2013, the average wellhead breakeven price (BEP) for key shale players has dropped from US$80 per barrel to US$35 per barrel. Currently, we believe that the US oil production will continue to increase until it is close to the previous high at 9.6 million barrels per day, on the assumption that the companies will operate all of their existing wells and rigs, but at the same time remain cautious for new exploration.

Note that the US Energy Information Administration (EIA) forecast for the Brent price to average USD53 per barrel in 2017 and USD57 per barrel in 2018.

Retail Petrol Prices (RON95) Likely to Average RM2.08/litre in 2H17

With the Brent oil price hovering around USD50-55 range, barring any upside surprises, based on our own estimate, assuming that the average price of MOPS95 is roughly at USD66 per barrel level and Ringgit continues to appreciate around RM4.20/USD, the domestic retail petrol RON95 prices will average about RM2.08-2.12/litre for 2H17 (RM2.10/litre currently).

Moving forward, with our expectation that retail price of RON95 averaging around RM2.08-2.12/litre for 2H17 (having average at around RM1.81/litre in 2H16), the increase in year-on-year change of the retail pump price will be approximately 14.9%. As a comparison, the average yearly difference of retail price of RON95 for Jan-May 2017 was at 28%. As such, the magnitude of increase in cost of transport in the CPI basket will be less significant in 2H17 comparative to 1H17.

Maintaining Our Inflation Forecast at 3.5% for 2017 and 2.2% for 2018

As a result, we are currently maintaining our inflation forecast at 3.5% for 2017, at the mid-point of the official forecast of between 3-4%. As the country’s inflationary pressure from rising transport cost is likely to stay contained in 2H17, we believe the secondary pass-through impact of global oil prices will be manageable. We believe the headline inflation has already hit its highest yoy level and peaked at 5.1% yoy in March. Malaysia’s producer price index, which measures inflation at the producer/manufacturer level, has also slowed from 10.8% yoy in February to 9% in March and 7.5% in April, attributed to some easing in global commodity and energy prices. We are also projecting that the country’s 2018 headline inflation rate to average around an estimated 2.2%, as the low base effect of the retail pump price (RON95) diminishes.

With manageable headline inflation, and core inflation remaining low and stable, we expect the stance of the country’s monetary policy to be accommodative and supportive of domestic demand. BNM will likely maintain its overnight policy rate (OPR) unchanged at 3.0% possibly throughout 2017.

Source: Affin Hwang Research - 1 Jun 2017