Ukraine tensions and Putrajaya's oil revenue

Crude oil prices currently hovering at US$95 per barrel is surging to US$100 per barrel, it's highest since 2014.

By ZAIDI ISMAIL

17 Feb 2022 03:17pm

Surge in fuel prices will also increase government revenues.

Crude oil prices which is currently hovering at US$95 per barrel is surging right now and is eyeing the US$100 per barrel, it's highest since 2014.

The fledgling oil and gas sector which has been pressured by low oil prices at US$20 per barrel is set to benefit.

So too will the government which is expected to reap higher oil royalty from Petronas.

But will this uptrend persist? Can oil prices hold at current levels, dip or climb even higher?

Russia-Ukraine tensions causing oil prices jittery

AIMST University vice-chancellor Professor Datuk Dr. John Antony Xavier said one reason why oil prices are skyrocketing is the impending invasion of Ukraine by Russia.

Xavier said Russia will use oil as a weapon to fight back when US and the West impose punitive sanctions on Russia.

"The Western sanctions will disrupt oil prices in an already tight market.

This is because Russia is one of the world's top oil producers and supplies to the rest of the world could be cut off if tensions escalate to the point of an invasion.

"Furthermore, Russia controls the Nordstream 2 pipeline that will send gas straight to Germany and the West.

Should Russia turn off the Nordstream 2 pipeline, then oil prices will shoot through the roof as Russian oil is very much in demand to heat up homes and offices in the West," Xavier told Sinar Harian.

The world has factored in the fact that there will be a war in Ukraine although no one knows when.

If the attack on Ukraine happens, then oil prices can be expected to shoot beyond US$115 per barrel by the middle of this year.

The Organisation of Petroleum Exporting Countries or Opec has not been able to ramp up production to meet disruptions caused by the impending invasion.

It has struggled to deliver on its monthly pledges to increase output by 400,000 barrels per day (bpd) until March.

The Russian invasion of Ukraine would almost surely trigger economic sanctions from the US and the European Union.

That would lead to oil and gas shortages around the world and therefore result in higher energy prices.

Russia provides up to 40 percent of Europe's oil, gas and coal requirements.

And Russia's fuel exports supply 4 percent to 5 percent of the world's energy.

So if supply from Russia is disrupted, oil prices are sure to shoot up.

On the 14th February, Ukraine hinted that it will give concessions to Russia and so tensions eased a notch down and so did black gold.

But the situation is so unpredictable as Omicron surges.

"With the easing of restrictions in the movement control order, the pent-up consumption demand is unleashed creating a spike in the production of goods and services," said Xavier.

Manufacturing of this magnitude would require energy and hence an increase in oil prices.

Similarly, the opening of borders have created a huge demand for tourism and travel and this has also spiked the prices of oil.

In Nov 2021, the US and other nations announced that they would release oil from their strategic petroleum reserves.

Prices fell in anticipation of the announcement.

However, the stockpile release was not enough to prevent the upward trajectory in oil prices.

Natural gas prices too have propelled upwards due to the demand from the opening up of economies.

"As a result, power hungry companies especially in the West started to burn oil to generate electricity instead of using expensive natural gas.

This consumed more oil thereby contributing to the price surge.

Also, the oil market is sensitive to any news of potential supply disruptions as oil inventories are low and oil producers' spare capacity is expected to fall further.

A nuclear deal with Iran may also flood the oil market with oil supplies but it is unlikely to stop the robust oil prices although the rise may be slower than otherwise.

Impact of oil price increase

Xavier said inflation in the economy will shoot up in tandem with rising oil prices.

This is because fluctuating oil prices directly affect goods prices and it can also depress the supply of other goods because of the increased costs in producing them.

Transport costs will also significantly increase given the spike in oil prices.

This may result in the government providing more fuel subsidies to keep the cost of manufacturing and general inflation down which adds operational cost to the government.

To stanch the spike in inflation, Bank Negara Malaysia will have to increase the benchmark interest rate – the rate at which banks lend to one another.

But all this will reduce economic growth because there will be lesser consumption demand due to the skyrocketing price increase of goods.

"Businesses will not be able to produce more due to reduced demand.

"Additionally, as interest rates rise, investments will be curtailed as it will be more expensive to borrow funds for business expansion," said Xavier.

He added it will also become costlier for the government to borrow money for economic expansion.

Government to receive higher royalty from Petronas

As we are an oil producing economy, government revenues will also increase.

So there is some benefit from the oil price increase after all and the bulk of this royalty will come from Petronas.

It is estimated that for a one US dollar rise in oil prices, the government will earn US$ 300 million.

"So there is some benefit from the oil price increase after all and with increased income from oil revenues the government will be able to subsidise petroleum prices more.

Meanwhile, Malaysia University of Science and Technology economist Professor Geoffrey Williams said higher oil prices add to headline inflation which is a concern at the moment but in a sense this effect has passed.

"The big increase was from April 2020 when oil was around US$20 per barrel until today at around US$95 per barrel. In other words the big surge is behind us.

"A US$1 increase in oil prices adds about 0.03 percent to headline inflation according to recent AMRO (Asean +3 Macro Economic Research Office in Singapore) estimates and we saw this effect last year in April 2021 when headline inflation was 4.7 percent but since then it fell to 3.2 percent in December.

Williams said without this effect, inflation is very stable and not a high risk at the moment.

On the positive side, AMRO estimate that every US$1 increase in oil prices adds RM646 million to the Malaysian gross domestic product and RM339 million to government revenue.

"So the US$75 increase from April 2020 until today may have added RM48.5 billion to the GDP and RM25.4 billion to government revenue in 22 months.

"Oil prices could breach the US$100 due to tensions in Ukraine but I don't see it will hold at that level unless there is fighting, which I do not foresee," Williams told Sinar Daily.

This will obviously impact the government positively at an average of around RM1 billion per month in extra revenue since April 2020.

"But this is being used for subsidies and eaten away by Covid-19 costs. So we are not seeing too much benefit from this."

Fortunately, Malaysia has this buffer because without oil royalties, the impact on the government would very bad.

Higher oil prices will affect headline inflation but since we are near peak levels, this effect will not be a repeat of the high inflation seen in 2021 which was an inflation not caused by oil prices.

Core inflation will be low and stable in 2022.

Williams said petrol prices at the fuel pumps will be pretty stable especially RON95 because of the subsidies.

Businesses or transportation using diesel however will be affected more.