OPEC+ Alliance Partners Failed to Reach a Deal on Oil Production Cuts

Oil prices have fallen sharply recently, with Brent crude oil (the international benchmark) trading at US$33 per barrel as of 13 March 2020, a 50% drop since early 2020. The last time the benchmark traded at this price level was in February 2016. The sharp drop in oil prices was triggered by Russia’s refusal to participate in the production cuts, which also likely led to OPEC abandoning its cuts altogether (earlier OPEC meeting recommended a further adjustment of a production cut of 1.5mn bpd). The existing deal limiting production by 1.7mb/d (2.1mb/d taking into account Saudi’s voluntary cut) is set to expire at the end of this month. Depending on the outcome between OPEC and Russia on their renewed negotiations, Saudi Arabia has planned to ramp up oil production by 2mn bpd to 11-12mn bpd by April 2020.

With excess global crude oil supplies, the outlook for global oil prices depends on the early containment of the Covid-19 outbreak and the impact on global oil demand and economic growth, especially in China. The International Energy Agency (IEA) stated that China accounted more than 80% of global oil demand in 2019. The outbreak has also led to major disruptions in tourism, travel and trade across the world. The Energy Information Administration (EIA), in its ShortTerm Energy Outlook (STEO) published in March, guided lower Brent crude oil prices, with a forecast of an average of US$43/bbl, compared to its previous forecast of US$64/bbl.

Is There a Need to Recalibrate the 2020 Budget?

So far, the Perikatan Nasional (PN) Government acknowledged, but has not given a tentative date or timeline, that the 2020 Budget revenue and expenditure proposals need to be recalibrated to reflect the sharp fall in global oil prices. The 2020 Budget was formulated based on the assumption of an average global oil price of US$62 per barrel.

However, in view of the current excess global crude oil supplies as well as recognising that the drop in oil prices will take some time to stabilise and recover, we believe the newly setup Economic Action Council (EAC) will likely recommend the government to recalibrate the 2020 Budget proposals. We believe the forecast for its average baseline price of Brent crude oil will likely be revised lower to around US$50 per barrel for 2020, from its earlier projection of US$62 per barrel, which will also be in tandem with Petronas’ earlier estimate of US$50 per barrel for this year.

Based on these assumptions, without any fiscal measures (i.e., cut in operating and development expenditures and other fiscal measures), we believe the country’s budget deficit target will likely increase to -3.8% of GDP for 2020. This has also taken into some consideration a possible shortfall in the government’s total revenue (especially from direct taxation) from the slowing domestic economy, based on the tax buoyancy measure, by factoring in the change of Malaysia’s tax revenue from changes in the levels of GDP.

However, there have been some concerns raised about how foreign credit rating agencies will view the country’s deteriorating economic fundamentals due to lower global oil prices, especially if it leads to a larger fiscal deficit position. Given these concerns, in an effort to show a commitment towards fiscal discipline and consolidation, if there is a Budget recalibration, we believe the government will likely raise its fiscal deficit target to only slightly higher than the current -3.4% of GDP. This can be achieved if the government takes some initiatives to reduce its operating and development expenditures. According to the estimate by the authority, for every US$1 per barrel drop in the price of crude oil, the Federal Government’s revenue will likely translate into a loss of about RM300m. Therefore, a revision from US$62 to around US$50 will result in a government revenue loss of slightly above RM3.0bn.

Based on our own estimate on the expenditure composition, we believe that if the government’s operating expenditure were to be cut by roughly RM2bn (i.e., reduction in supplies and services), as well as trimming slightly its development expenditure (i.e., delaying some non-priority projects), the shortfall from oilrelated revenue can be covered. This assumes that global oil prices recover in 2H20.

Source: Affin Hwang Research - 16 Mar 2020