What Falling Oil Prices Mean For Malaysian Economy, Petronnas & O&G Players ?

The OPEC decision on 27 Nov 2014 to maintain the crude oil production ceiling at 30 million barrels a day, implies that oil prices would stay low for a while. OPEC will meet again in June.

For The Malaysian Economy …

If crude oil prices remain at current levels (Nov 2014) in 2015, the upside to inflation from the introduction of GST could be contained.

The implementation of GST is expected to cause a one off inflation hike to about 4% in 2015. However the managed float mechanism would introduce more volatility to the transport component of the CPI, hence indirectly impacting inflation calculations, as fluctuations in crude oil prices will affect fuel prices.

For The Malaysian Government Coffers …

The managed float mechanism would help Malaysia achieve its fiscal deficit target of 3% of GDP for 2015 via the savings it makes on petrol subsidies. It was reported that the saving could be between rm10 billion and rm15 billion in subsidies under a managed float mechanism at Nov 2014 crude oil prices.

It should also be highlighted that Malaysia derives about 30% of its revenue from oil related sources. This means that the government revenue would see a reduction from June 2014.

The last time crude oil fell below USD70 per barrel was in Oct 2008. At the time, it was trading at USD69.60 a barrel. It fell to USD38.37 a barrel in late Dec of that year. After that it took about six months until June 2009 for it to recover to USD68.34 a barrel.

It is believed that under duress, the government would rather slash development spending than other subsidies. The government could also trim those projects that are not a priority.

For Petronas …
Malaysia is best known for its thriving oil and gas industry that is supported by Petronas that spends an average RM60bil per year on capital expenditure. But the spending will be cut by up to 20% from 2015 onwards until the international price of Brent crude has settled down at more than US$80.

Petronas’ contribution to Government coffers in the form of dividends, taxes and oil royalty for next year will dive by 37% to RM43bil, assuming the Brent crude settles at US$75 per barrel;

Petronas will not proceed with contracts to award new marginal oil fields unless oil settles at levels above US$80 per barrel;

Projects in Pengerang that have yet to receive the final investment decision (FID) will be affected by the cut-backs. Projects worth US$27bil that have received FID will not be affected, but Petronas does not have 100% equity in all the projects approved;

The capex crunch is expected to send chills down the spine of the already fragile O&G sector, nearly all depend on Petronas for jobs.

Petronas is also reviewing the feasibility of some of its projects and could shelve projects that are no longer viable and for which Petronas has yet to make its FID.

It also has to review its capex plans for 2015 onwards and have to assess the feasibility of projects. At current oil price levels (Nov 2014), marginal oil fields are no longer feasible for Petronas to get involved in.

Meanwhile, Petronas still needs to keep investing in new technology, in overseas projects and increasing its oil reserves in order to maintain its growth, considering that current production levels decline by some 10% every year, naturally.

At present (Nov 2014), Petronas produces some two million barrels of oil equivalent per day. In five years, if it does not replenish its production, its production will be down to half of what it is now (Nov 2014).

For Marginal Oil Fields Players …

Petronas will not proceed with the awarding of new marginal oil fields unless the price of Brent crude settles above US$80 per barrel.

Although the breakeven for marginal oil fields is US$65 per barrel, they will not look into any such proposals until the global price situation stabilises. It would be comfortable to embark on marginal oil fields only when the price settles down at more than US$80 per barrel.

Marginal oil fields were once a hot topic for the investment community. In fact, these projects were touted as a re-rating catalyst for some listed oil and gas players seeking to venture into the upstream segment.

These oil fields are essentially small and old oil fields belonging to Petronas, for which the oil giant sought to partner with international players together with a local partner, to enter into ‘risk service contracts’ (RSC) that would expose the local players into the world of oil exploration. Under the terms, the joint venture between the local and foreign oil and gas companies are responsible for producing the oil.

For meeting the production targets, the joint venture gets paid. However the RSC contractror does not enjoy any upside from the oil prices nor carry any risk should there be a slide in oil prices.

So far among the companies awarded RSC contracts to develop marginal oil fields are SapuraKencana Petroleum Bhd, Dialog Group Bhd and Petra Energy Bhd.

Petronas had in the past identified more than 100 marginal oil fields to pursue RSCs. It was a strategy to grow its reserves. That was when oil prices were much higher. These contracts were awarded when oil prices were above US$100 per barrel. In today’s (Nov 2014) environment of plunging oil prices, RSCs are hardly viable.

The breakeven production for marginal oil fields is US$65 per barrel. If Brent crude is below this level, it is left to be seen if the operations of the existing fields will continue.

Going forward …the Malaysian O&G industry is going through a consolidation.

The contractors and service providers will have to realign themselves to cope with lower oil prices.

Malaysia is best known for its thriving oil and gas industry that is supported by Petronas that spends an average RM60bil per year on capital expenditure. But the spending will be cut by up to 20% from 2015 onwards until the international price of Brent crude has settled down at more than US$80.

A shrinking pie implies that weaker players might be weeded out.

Also lower valuations present attractive entry for some investments especially if there are synergistic propositions. The biggest hurdle, however, is the issue of ownership and corporate structure.

It makes sense for companies to acquire other O&G companies that have synergies.