This article first appeared in The Edge Malaysia Weekly, on February 1 - 7, 2016.
We have done it before. Insya Allah, we can do it again,” Prime Minister Datuk Seri Najib Razak pronounced confidently when presenting the revised Budget 2016 at the Putrajaya International Convention Centre last week.
Recalling the 1997 Asian financial crisis and the 2008 US subprime mortgage crisis, Najib reminded his audience that Malaysia had trudged through worse. Moreover, the high oil prices seen in 2008 and again in 2011 were more the exception rather than the norm. Oil traded at under US$30 a barrel for all of the 1990s until 2003.
So, Najib’s assurance that Malaysia is well placed to weather another year of “external headwinds” — now that he has recalibrated Budget 2016 to cater for the current economic environment and make up for any difference in state earnings from the shortfall of oil revenue — is timely. Oil prices, he said, even at US$30 a barrel, which was substantially below the assumption of US$48 in the original budget, will pose no threat to the country’s finances or growth.
That may be generally true but a close look at the history of oil shocks and the wild swings in oil prices that brought global economies to their knees proves unsettling. After all, weren’t low oil prices stemming from excessive demand the chief cause of the Great Depression in the US?
In the 1930s, the world was already flooded with oil, but major oil discoveries in the US, most notably the massive East Texas field, aggravated the situation to send oil prices tumbling. Large oil companies attempted to force smaller independent players to stop drilling by increasing their own production. The world soon went into deflation.
Then there was the 1973 oil crisis, which historians called “the first oil shock”. In response to American involvement in the Yom Kippur War between the Arab states and Israel, the Organization of the Petroleum Exporting Countries (Opec) raised posted prices and announced production cuts in October that year. Later, the Organization of Arab Petroleum Exporting Countries (Oapec) imposed an oil embargo on Canada, Japan, the Netherlands, the UK and the US. Crude oil prices quadrupled to US$12. The embargo was only lifted in March 1974.
Before that, though, the US struggled with price controls and rationing. Christmas lights were discouraged while some states called for a stop to commercial lighting altogether. Odd-even petrol rationing — where vehicles with licence plates ending with an odd number were allowed to fill up their tanks on odd-numbered days, and vice versa — was implemented.
oil-price_chart_02_tem_1095_MM59The embargo period coincided with the 1973/74 global stock market crash. The Dow Jones Industrial Average lost over 45% of its value during the two years. The US economy slowed from a real gross domestic product (GDP) of 7.2% in 1972 to -2.1% in 1974. Meanwhile, the London Stock Exchange lost 73% of its value as the UK sank into recession, with GDP falling 1.1%.
That’s how crude oil prices can affect the world economy.
Crude oil prices hit a record high of over US$147 a barrel in July 2008 before diving to just US$40 a barrel, a prelude the subprime mortgage crisis.
Not all financial crises are directly comparable because production and consumption patterns have changed vastly since the 1970s. Yet, there is a sense of déjà vu as the market struggles with volatile oil prices today. The US Energy Information Administration reported last week that US commercial crude oil stocks have hit their highest levels since the Great Depression in 1931. Opec’s response to low prices — staunchly refusing to cut back on production — has pushed prices below multi-year lows. Brent crude reached a low of US$27.88 in January, forcing many oil-producing governments, including Malaysia, to relook state spending to squeeze out more savings.
Things could easily get worse. Iran, which has seen trade sanctions against it lifted, will join the party soon, pumping an additional 500,000 barrels of oil into the market each day.
Or, things could get better, as developments last week showed. Oil prices rose for three consecutive days to trade as high as US$35.84 when Russian Energy Minister Alexander Novak said Saudi Arabia had proposed to cut oil production by up to 5%. However, no agreement on that has been made.Forecasting the direction of oil prices is now guesswork. The Malaysian government has put oil price within what it calls a “conservative” band of US$30 to US$35. Economists approached by The Edge are of the view that this year, it will average higher than the current levels.
“Currently, our oil and gas analyst keeps his oil price forecast at US$40 per barrel, with a downside potential of US$32 per barrel by using our econometrics model. From our estimate, Saudi Arabia may have been expecting an average oil price of between US$32 and US$38 per barrel for its 2016 budget. We are expecting a rebound in oil price in the second half of this year, albeit marginal, that is, around US$40 to US$50 per barrel,” says a MIDF Research economist.
Standard Chartered is so bearish that it is warning that the price of oil could slump to US$10 a barrel. Royal Bank of Scotland has put the number at US$16 while Goldman Sachs and Morgan Stanley are in the US$20 club.
Wherever oil prices are headed, Malaysians are hoping that Najib’s confidence is rooted in sound policymaking and prudent economic planning.
http://www.theedgemarkets.com/my/article/cover-story-getting-through-oil-price-pains
