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What falling oil prices mean for Malaysians

Updated 19 Oct 2018 – By Loanstreet

It's a well-known fact that oil prices fluctuate based on the laws of demand and supply, which applies to every other commodity, stock or bond out there. Sometimes, you’re not sure how to feel about the fluctuations, which can be a pretty wild ride. What was USD110 per barrel of oil in June 2014 could now be trading under USD50 per barrel. On one hand, "Yay! Cheaper gas! Cheaper flights! Lower inflation!"

What’s not to like about it? But on the macro side, you’ve also heard some pretty scary things about Malaysia’s future. Like how falling oil prices could bankrupt us, or lead to a recession. This can all be so difficult to understand. Are we or are we not supposed to be happy about falling oil prices?

If you’re feeling uncertain, fret not. We’ve come up with a layman’s explanation of what will likely happen to Malaysia if oil prices continue to stay low. Admittedly, it’s not the easiest thing to understand. But by the time you’ve finished reading this, you would have gotten a good grasp on subjects spanning economics, federal budgets, and Malaysia’s role in the global oil trade that you can use to impress your friends with.

Malaysia – A net oil exporter / importer?

Net oil exporting countries stand to gain whenever oil prices are high. Conversely, low oil prices hurt them. The common wisdom heard is that Malaysia is a net oil exporter. If you put two and two together, we can understand why you’re worried.

But the truth about Malaysia’s situation as a net oil exporter is more complicated than that. Beginning 2011, Malaysia’s crude oil consumption actually outstripped our own production. Simply put, we consume more oil than we produce. So how is it that so many people still think of Malaysia as net oil exporters?

Malaysia oil production vs consumption

Fact of the matter is, Malaysia’s oil exports are made up of two main components:

  1. Crude oil
  2. Liquefied Natural Gas (LNG)

While we have already become net importers of crude oil since 2011, we continue to be net exporters of LNG products. Only when taken together with LNG can we say Malaysia is a net exporter of oil and gas.

But how important is oil and gas to Malaysia anyway?

The Importance of Oil & Gas to Malaysia

To understand this, we must look at its share of contributions in relation to other sectors. The table below shows its contribution to our nation.

the importance of oil and gas to Malaysia  

  1. Petroleum income tax
  2. Crude oil export duty
  3. Petroleum royalty
  4. Petroleum dividend

From 2010 to 2013, total oil related revenues to our government grew from RM55.313bil to RM64.923bil. But weirdly, its share of contributions to government revenues shrank from 34.65% to 30.26%. Even the oil sector’s share of GDP has shrunk from 10.8% to 9.9%. How can this be?

The explanation is simple. Revenues from other economic sectors have been growing faster than the oil sector. In effect, government revenue streams have gradually been diversifying away from oil. 

But 30% of revenue and 10% of GDP is still a significant amount no matter how you look at it. Are these now at risk?

Loser – The economy

The short answer is: Yes. It’s only natural that a shrinking oil and gas sector will negatively impact the overall size of Malaysia’s economy. But the effects will not be felt equally. The brunt of the loss would be absorbed by the oil and gas sector itself. If we are being honest, it’s not the end of the world for them. It just means that years of extra-normal profits returns to being more... normal.

For the rest of the economy, the negative effect transfer would come muted and delayed. These secondary effects will manifest in things such as lower government spending, and everyone (the economy) generally having less money to fling around.

How does this transfer happen?

Loser – Government revenue

Since our government taxes oil producers, when oil prices are low, government revenues will undoubtedly take a hit. But thankfully, the price drop does not result in a direct 1-to-1 transfer to government revenues.

Firstly, LNG prices while also weaker, have not dropped as drastically as crude oil prices. Secondly, sales of oil and gas products from Malaysia are slightly cushioned by the USD strengthening against the Ringgit. (We’ve touched on how this works in a previous article).

Additionally, there is further cushioning in the form of expenditure saved by the removal of fuel subsidies. This alone will save the government at least RM21bil in expenditure, which makes up about a third of our oil revenues anyway.

Possible Winner – Malaysia’s trade balance

One of the things to understand is that the country does not equal the government, and the government does not equal the country. Even though government revenues suffer when oil prices are low, as a net oil importer, the balance of trade actually moves in Malaysia’s favour.

Confused? Stay with us.

Government oil revenues come mainly from taxes and duties on the extraction and sale of oil plus dividends from Petronas. Whether or not the oil is sold within the country or exported, the government stands to make the same amount of money (with the exception of export duties).

But don’t forget that Malaysia is now a net importer of crude oil. We buy more than we sell! So it makes sense that we as a country (the collective of people and entities that make Malaysia) stand to save more money than the amount we will forego with lower crude oil prices anyway! How awesome is that?

As net gas exporters, so long as the prices of LNG do not fall too drastically (it could), the balance of trade should remain in our favour.

Winner – consumers

So what does it mean for you and me?

When input costs (cost price) are low, savings should cascade down into the rest of the economy in the form of cheaper prices. Overall, with oil prices low, inflation should be kept in check. In fact, we are already seeing the direct effects of cheaper gas at our petrol pumps. Yay!

But wait some say. Not good enough. The last time oil prices increased, so did the price of many other consumer goods. So shouldn’t we expect to see a similar drop in consumer good prices across the board too?

Unfortunately, many consumer goods prices are sticky upwards. Meaning that once they go up, it takes a whole lot more for it to come down. Naturally, someone in the value chain of goods would be taking this opportunity to pad profit margins. But before you get all hot and righteous about it, did you know most of us are also guilty of the same thing? 

Think about it. Labour is part of the input costs of producing goods and services. And since salaries are generally adjusted according to the inflation rates, when was the last time you accepted a salary adjustment downwards when oil prices came down? You’d probably throw a fit.

That said, there’s still much to be happy about. Generally, we can expect inflation to slow down or even pause entirely for a while. But unless we enter into something as major as a recession, we should not see prices coming down except for select goods like petrol and airfares.

To conclude

If you've read all the way to this point, CONGRATULATIONS! Go forth and impress your friends with your newfound knowledge.

But don’t just let your quest for knowledge stop here. Read on to learn about what caused the current drop in oil prices in the first place.

Continue reading...

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