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Light At The End Of The Oily Tunnel

World is keeping an eye on plummeting crude oil prices

Saudi-oil-rig

The world is currently facing a scenario where supply is outstripping demand for oil, and this has caused uncertainty not just in the oil markets but the world economy, which will eventually have an impact on the national economy and the property market.

According to oil and gas consulting service firm Rystad Energy head of analysis Per Magnus Nysveen, the largest oil supply shock in history was seen from 2011 to 2014. The United States’ shale oil production was adding more than one million barrels per day every year, or more than the growth of global demand for oil.

The Organization of Petroleum Exporting Countries (OPEC) faced a risk of critical reduction in market share. An expected initial cut of two million barrels per day from the collective quota during 2014 and 2015 would be needed to keep oil prices at the 2011-2013 level of US$110/barrel.

However, such cuts would support a continuous growth of US shale oil production, as less than 5% of shale oil recoverable resources are extracted to date, based on Rystad Energy’s estimate.

The pain limit for US shale drillers was reached when US oil prices dropped below US$50/barrel. In the first week of 2015, with fresh and downsized budgets, oil companies reduced horizontal drilling for oil for the first time in core plays (group of oil fields or prospects in the same region) of Bakken, Eagle Ford, and Permian Basin, where rig count went down from 700 rigs to 675 rigs. A minimum of 500 rigs drilling horizontal oil wells on these plays is needed to keep production flat on the plays.

The country that is worth watching in the midst of this unsettling situation is Saudi Arabia, which plays a leading role in oil production and exports as the world’s largest exporter of crude oil. Looking at the global liquid supply cost curve graph, it is clear that onshore Middle East average break-even cost is the lowest among other oil producers, at US$25/barrel, followed by offshore shelf average break-even at US$40/barrel.

Global-liquid-supply-cost-curve

With average break-even cost having been estimated for different types of oil production methods and locations, this implies that oil producers that have the lowest average break-even costs, assuming all else is constant, are more likely to survive a scenario of lower oil prices when compared with oil producers with higher average break-even costs.

According to media reports, oil minister Ali al-Naimi of Saudi Arabia had stated in Dec 2014, “It is not in the interest of OPEC producers to cut their production, whatever the price is.”

He added that Saudi Arabia will be able to withstand a period of prolonged low prices because its production costs stand at just US$4-5/barrel.

Further supporting this stand were comments by Mohammad al-Sabban, a former advisor to the Saudi Arabia minister for petroleum, to the media recently, “Saudi Arabia can sustain these low oil prices for at least eight years. First, we have huge financial reserves of about three trillion Saudi riyals. Second, Saudi Arabia is embarking now on rationalising its expenditure, trying to take all the fat out of the budget.”

Given this position by Saudi Arabia, the stabilisation of oil prices is dependent on demand and supply of oil reaching an equilibrium state.

However, there is a silver lining in this scenario of low oil prices. OPEC’s secretary-general Abdulla al-Badri recently commented, “Now the prices are around US$45-55, and I think maybe they [have] reached the bottom and we [will] see some rebound very soon.”

In spite of the fact that US drillers have pulled their rigs off fields for several weeks in response to the decline of the fall in oil prices, US oil production and stockpiles continued to rise. As of end-February 2015, US crude inventories had expanded by 10.3 million barrels to 444.4 million, the biggest weekly gain in 14 years, according to Energy Information Administration data.

The questions worth posing are when and how are oil markets expected to stabilise. Given that oil prices have an impact on national economies, property investors should be watchful on developments in the oil sector, as this will bring opportunities and challenges in the property market.

RESILIENCE THROUGH DIVERSIFICATION

In the case of Malaysia, low oil prices are having a limited impact on the national economy, as the national economy is already diversified in various economic sectors.

According to Treasury secretary-general Tan Sri Dr Mohd Irwan Serigar Abdullah, the drop in oil prices may not necessarily have a negative impact on the fiscal deficit, as the country’s economy was diversified and did not primarily rely on commodities like petroleum and palm oil.

Irwan recently shared with the media, “Our growth is based on the services, manufacturing, agriculture, and construction sectors coupled with high consumption and private investments. Therefore, we do not completely rely on oil and gas.”

Although Petronas had made a loss of RM7.3 bill for the last quarter of 2014, it will be making its RM26 bill payment to the Government in tranches, according to media reports.

Fluctuations in crude oil prices also impacts Malaysia as an international producer of palm oil. Media reports had recently indicated that palm oil is expected to climb to RM2,500 per tonne in May, due to lower production and reduced stocks outlook.

However, the improved sentiment in crude palm oil prices in the first half of 2015 could be short lived, according to international palm oil expert Dorab Mistry, and could reverse back to trend lower in the second half of the year on bearish fundamentals.

LMC International Ltd chairman Dr James Fry recently commented, “The palm oil industry must learn to accept the reality of the lower global crude oil prices. The world responded to the demand for biodiesel but until now, many still do not realise how much the high crude oil prices have underpinned the palm sector.”

Given that the national economy is diversified, low crude oil and palm oil prices should not have much adverse effect on the economy, and their impact on the property market should be limited.

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