Tough road ahead
With the oil price continuing on its drop, since June 2014, with lowest price of USD 25 in early 2016. it is expected that the global oil price will remain low for several years if Iranian production and OPEC could not come into any decision to cut the oil supply.
Moody’s projected that the oil prices would be around USD33 per barrel in 2016, probably raised to USD38 a barrel in the next year and to USD43 in 2018.
The oil industry is crucial for Malaysia as it has direct contribution towards the nation in terms of tax. For Petronas, the Petroleum Income Tax is taxed at 38%, which indicates that for every RM1 earned, the government gets RM0.38. On top of that, Petronas also pay a dividend to the government which varies depending on their profit.
Despite the tough situation Petronas have to pay RM16 billion dividend last year to the Ministry Of Finance.
Petronas is granted with the entire ownership, rights, privileges and benefits in relation to explore and produce oil and gas, offshore and onshore in Malaysia.
Petronas is also the responsible authority for licensing any third party contractors wishing to participate in upstream petroleum activities and licensing goods and service providers operating in the upstream sector, including providers of rigs and drilling services and supply of general goods and services related to upstream operations.
In short, Petronas owns everything in relation to oil and gas and companies such as Esso and Shell has to go through Petronas to co-develop or at the very least lease areas from Petronas to look for oil. This is mostly done through the Production Sharing Contract between Petronas and other companies such as Shell, Exxon and Murphy.
As a result of the drop in oil price, in January this year (2016), the company has announced an expenditure cut of RM50 billion over the next four years, starting with RM15 billion to RM20 billion this year alone. Therefore, as much as RM6 billion could be slashed from its exploration and production arm, in order to meet the capex reduction numbers.
The company also decided to reduce its staff count by 2% out of 51,000 people. It is believe that, this decision has affected the overall performance of the industry players as more lay-off and revenue reduction effects are seen among the operators and third party contractors as less upstream contracts are offered for them to explore.
The trickle-down effect on the industry is higher than the initial effect on Petronas. Given the high cost, low price of oil and less offshore projects this has make it tougher among the local upstream oil and gas players to survive. Given the volatility in oil price, it has somehow impacted the value of ringgit as Malaysia is an oil exporting country.
The above graph explains the relationship between oil price and the value of ringgit. As the price of oil increase, the value of ringgit will appreciate and vice versa (data derived from Bloomberg).
These indicate a strong relationship between oil and ringgit. Hence, the volatility in Ringgit is influence by oil and impacted the commodities trading market and the import depending businesses. In August 17, 2016, the Ringgit was valued at RM4.02/USD.
The value of Ringgit has continues to be very volatile given the oil price phenomenon added with the interest rate cut. With the world expecting the Fed to increase its interest rate this does not move in favor of the Ringgit.
In the first quarter, companies such as Amway (M) Holdings Bhd, Cahya Mata Sarawak Bhd, MSM Malaysia Holdings Bhd, Petroliam Nasional Bhd (Petronas) and Tan Chong Motor Holdings Bhd attributed their drop in earnings to the impact of weakening ringgit.
When Ringgit depreciates, firms that rely more on import products will face more significant impact on their profit margin, especially among tendered contractors.
The manufacturing industry appears to be most affected. Higher sales tax and import tax cost because of the fall in value of Ringgit led to greater cost burden.
Besides that, depreciation of Ringgit could also contribute towards higher cost of imported components utilised by domestic producers.
This could also contribute to lower purchasing power of the companies for imported product. However, given the drop in local material price, depreciation of ringgit should able to boost the domestic spending and local market should be seen as an alternative for lower cost strategy.
The global economy is currently facing a tough time due to the changes in the oil industry. It is important for related businesses to accept that the current oil price level could be the new normal in the market. It is predicted that the oil industry will continue facing challenges.
Article written by Sharifah Azzahra