International Business Review


Oil’s Not So Well
As crude prices plunge, International Business Review Malaysia examines the fallout and why

by IBR Malaysia
29 October 2015

US$60 per barrel... US$60 per barrel.” That is the refrain which is being uttered in the trading community, with oil prices dropping to levels not seen since 2009. As at time of writing, global oil price benchmark Brent is hovering below the psychological 50-dollar point, and has stayed there since the beginning of 2015. What’s astonishing is that the ones orchestrating the price plunge, are the ones who may be the most negatively affected by low the prices.

Hail to the Shale

There was a time when falling oil prices reflected fundamental problems with the global economy, as it marked a decline in demand owing to an industrial slowdown. Such was the case when oil prices were at their previous lowest, right in the middle of the subprime-driven financial crisis of 2008/09.

This time, however, the situation is not so clear cut. There is indeed a drop in demand – most significantly from China and Europe. The United States, however, has posted a 5% Q3 growth rate – its highest in over a decade, and a sign that economic activity is on the rise in the world’s largest economy.

So given that the slowdown in Europe and China, and Japan slipping into recession has affected oil demand, the extra activity in the United States should have at least lessened the impact on oil prices. But it hasn’t, and the reason for that is the new oil extraction technique known as hydraulic fracturing or fracking.

Fracking, which involves using hydraulic drilling to release oil trapped in shale rock underground, has revolutionised the US oil industry. In fact, the United States has been forecast to overtake Saudi Arabia as the world’s largest oil producer by 2015. While the US still imports some crude oil, its intake has dropped by 15% over the last two years.

OPEC Rethinks Its Strategy

OPEC (The Organization of Petroleum Exporting Countries) – the international group which produces 40% of global crude oil and accounts for 60% of exports – has therefore been facing a dilemma. In the past, the standard response to falling prices has been to slash production in order to force a spike in the value of crude oil.

Slashing production won’t work this time. For one thing, alternatives are there – in the form of shale oil from the United States, oil sands from Canada and also Russian oil. All of which are ready to take up the slack should OPEC production figures drop.

This is where the new OPEC strategy has come in. Led by Saudi Arabia and the UAE – the two largest oil producers in the group – a decision was taken during a meeting on the 27th of November 2014 to maintain oil production levels. Needless to say, prices quickly went south.

As self-defeating as such a move may seem, it is part of a long-term strategy to price shale oil out of the market. That is where OPEC, or rather Saudi Arabia, has aimed its cross-hairs and this was borne out of a Reuters’ report that Saudi Oil Minister Ali al-Niami has been the most vocal advocate in OPEC for maintaining production levels.

However, not everyone in OPEC is pleased. For the cartel’s less wealthy members such as Venezuela and Iran, lower crude prices mean a cut in their foreign reserves and their ability to pay off debts and other obligations has been impaired.

A Bumpy Ride Ahead

Countries like the UAE, Kuwait, and Saudi Arabia are better geared towards resisting the downward pressure of falling crude prices. The last mentioned for instance, has foreign exchange reserves totalling US$750b, which is the third largest in the world. To its credit, Riyadh saved up a remarkable amount from the oil price boom of the past when one barrel cost more than US$100. It is now prepared to eat into that reserve as it faces down shale.

Boon and Bane in Malaysia

For non-OPEC oil-producing countries, lower oil prices may be proving to be more a pain than a pleasure. In Malaysia for example, petrol prices have gone down, and consequently the consumer price index (CPI) is expected to drop as well.

However, other things have also dropped. For example, the ringgit stood at RM3.198 to US$1 on the 31st of July. As at time of writing, it was RM3.496 to US$1 on the 31st of December. This comes as no surprise. After all, the standard investment trick is to put money in commodities (such as oil and gold) when the greenback is weak, and to invest in US dollars when gold and oil are weak, as they are now.

A weaker ringgit may be good for exports, but it is definitely not good for the country’s ability to meet its debt obligations. It is also not good for national reserves, considering that crude oil and gas account for 40% of Malaysia’s GDP. And last but not least, it is not good for the palm oil sector, which has experienced reduced demand as cheaper petrol means that there is less need for palm oil biodiesel.

Two energy giants facing off against each other... That is the situation now between Saudi Arabia and the United States. As much as it affects Malaysia, there is precious little it can do about it, except to hope that whoever wins, the fallout will not be too harsh. Of course there is one more option, and that is to start moving towards an economic policy which will reduce our dependence on oil money. After all, when 40% of your GDP is derived from a commodity – the prices of which you do not have any control over – it is time to really think about long-term economic security.

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