Easwaran Kanason

Co - founder of NrgEdge
Last Updated: March 28, 2021
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Business Trends

Malaysia is, literally, a country of two halves. In the west, there is Peninsular Malaysia, where most of the population lives and the heart of economic activity. Across a huge stretch of the South China Sea is East Malaysia, the resource-rich states of Sabah and Sarawak. This divide has coloured much of the economic development of Malaysia, since its formation in 1963 to the present day. And the clearest depiction of this is in the energy industry.

This is particularly crucial for natural gas. The huge distance between the two halves (which also run through the world’s busiest shipping lanes) means that natural gas produced in Sabah and Sarawak cannot be viably piped westward. Instead, it has to be transported as LNG. And because a lot of the LNG produced in East Malaysia is already tied up in long-term sales-and-purchase agreements with East Asian clients, there isn’t simply enough domestic production to satisfy consumption. Leading to the slightly odd situation where Malaysia is simultaneously a major exporter of LNG, as well as an increasing importer of the supercooled fuel.

This is something that Petronas, as the state oil firm that (until recently) held a monopoly over national gas supplies, can manage. Having invested in a portfolio of national and international gas resources, Petronas has distribute supplies as efficiently as it can. On the export side, there is the LNG Complex in Bintulu, Sarawak, with nine trains and total capacity for 29.3 million tons per annum. Two floating liquefaction plants (PFLNG Satu and PFLNG Dua) added to export capacity in 2017 and 2020. On the other side of the sea, the first LNG import terminal started up in Malacca in 2013, joined by a second terminal in Pengerang, Johor in 2017. These terminals were necessary, since piped natural gas supply from East Coast fields (as well as imports from Indonesia’s Natuna Block B, the Malaysia-Thailand JDA and the Malaysia-Vietnam PM3 CAA) were dwindling. The Malacca and Johor terminals take some LNG from Sarawak, but were mainly supplied by Australia and Brunei.

The situation will continue to persist. Within the first quarter of 2021 alone, two major natural gas discoveries were made in East Malaysia – PTTEP’s Lang Lebah-2 and Petronas’ Dokong-1, both in Sarawak. The PTTEP find itself is the largest the Thai company has ever found, confirming that vast unexplored flows are still to be found in East Malaysia – a discovery that Petronas is trying to accelerate by offering up 13 offshore blocks in its 2021 licensing round.

But all the new gas may not be able to make it to Peninsular Malaysia, since the subsidised nature of domestic gas prices and rocketing demand across Asia-Pacific makes it tempting to turn to lucrative exports. This has had led to an increasing reliance on coal as a power generation tool for Malaysian industries and households, which would negate Malaysia’s own pledges to reduce carbon emissions by at least 35% by 2030. So the question for Petronas – and Malaysia itself – is: should new gas been used to fulfil the nation’s own demand and its pledged move to cleaner fuels, or should it chase international profits in an arena where competition from the UAE, Australia and especially the USA is heating up tremendously?

Meanwhile, the domestic market is opening up. In January 2021, domestic player Petrolife Aero was cleared to begin importing LNG cargoes into Peninsular Malaysia. The two-year contract is the first time a third-party will gain access to the country’s LNG import and gas transmission networks under the amended Gas Supply Act 2016. Petrolife has been granted six LNG import slots per year into Petronas’ 3.8 million tpa Sungai Udang regasification terminal in Malacca, and has already locked in several contracts from existing gas consumers, liberalising the market by offering discounts on the regulated gas prices. But Petronas won’t be completely shut out; it still has full control over the 2,623km pipeline network that delivers regasified LNG across Peninsular Malaysia, earning a toll fee in the process.

As this development of two halves continues, rising supplies in East Malaysia that cannot fully satisfy rising demand in Peninsular Malaysia – one thing is clear. At some point, Malaysia will no longer be a net exporter of LNG. It has already fallen from the world’s second largest LNG exporter to the fifth (though largely because it has been overtaken by other larger countries). This is inevitable, given growing consumption and the inevitable decline of current fields that cannot be fully offset by new discoveries. How soon that switch comes will depend on how Petronas and the Malaysian government choose to direct the industry.

Market Outlook:

  • Crude price trading range: Brent – US$63-65/b, WTI – US$60-62/b
  • A resurgence of Covid-19 infections across Europe that are prompting renewed lockdowns knocked crude prices from their recent peak, with the IEA forecasting that fuels consumption will not return to pre-pandemic levels until 2023 and growth will remain subdued after
  • Against that backdrop is chatter regarding OPEC+’s next move in its supply agreement, which is due early April and could trigger another recalibration in global crude prices
  • Propping up the market, however, is the supply risk factor, with Yemeni rebels making a third attack on Saudi oil infrastructure in a month; the Saudi navy has now begun naval exercises in its portion of the Persian Gulf to foil future terrorist attacks on its vital installations and fields that is key to the Kingdom’s ability to act as swing producer

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High Oil Prices and Indonesia’s Ban on Oil Palm Exports

Supply chains are currently in crisis. They have been for a long time now, ever since the start of the Covid-19 pandemic reshaped the way the world works. Stressed shipping networks and operational blockages – coupled with China’s insistence on a Covid-zero policy – means that cargo tanker rates are at an all-time high and that there just aren’t enough of them. McDonalds and KFCs in Asia are running out of French fries to sell, not because there aren’t enough potatoes in Idaho, but because there aren’t enough ships to deliver them to Japan or to Singapore from Los Angeles. The war in Ukraine has placed a particular emphasis on food supply chains by disrupting global wheat and sunflower oil supply chains and kicking off distressingly high levels of food price inflation across North Africa, the Middle East and Asia. It was against this backdrop that Indonesia announced a complete ban on palm oil exports. That nuclear option shocked the markets, set off a potential new supply chain crisis and has particular implications on future of crude oil pricing and biofuels in Asia.  

A brief recap. Like most of Asia, Indonesia has been grappling with food price inflation as consequence of Covid-19. Like most of Asia, Indonesia has been attempting to control this through a combination of shielding its most vulnerable citizens through continued subsidies while attempting to optimise supply chains. Like most of Asia, Indonesia hasn’t been to control the market at all, because uncoordinated attempts across a wide spectrum of countries to achieve a similar level of individual protectionism is self-defeating.

Cooking oil is a major product of sensitive importance in Indonesia, and one that it is self-sufficient in as a result of its status as the world’s largest palm oil producer. So large is Indonesia in that regard that its excess palm oil production has been directed to increasingly higher biodiesel mandates, with a B40 mandate – diesel containing 40% of palm material – originally schedule for full implementation this year. But as palm oil prices started rising to all-time highs at the beginning of January, cooking oil started becoming scarcer in Indonesia. The government blamed hoarding and – wary of the Ramadan period and domestic unrest – implemented a Domestic Market Obligation on palm oil refineries, directing them to devote 20% of projected exports for domestic use. Increasingly stricter terms for the DMO continued over February and March, only for an abrupt U-turn in mid-March that removed the DMO completely. But as the war in Ukraine drove prices even further, Indonesia shocked the market by announcing an total ban on palm oil exports in late April. Chaotically, the ban was first clarified to be palm olein only (straight refining cooking oil), but then flip-flopped into a total ban of crude palm oil as well. Markets went haywire, prices jumped to historical highs and Indonesia’s trading partners reacted with alarm.

Joko Widodo has said that the ban will be indefinite until domestic cooking oil prices ‘moderate’. With the global situation as it is, ‘moderate’ is unlikely to be achieved until the end of 2022 at least, if ‘moderate’ is taken to be the previous level of palm oil prices – roughly half of current pricing. Logistically, Indonesia cannot hold out on the ban for more than two months. Only a third of Indonesia’s monthly palm oil production is consumed domestically; the rest is exported. An indefinite ban means that not only fill storage tanks up beyond capacity and estates forced to let fruit rot, but Indonesia will be missing out on crucial revenue from its crude palm oil export tax. Which is used to fund its biodiesel subsidies.

And that’s where the implications on oil come in. Indonesia’s ham-fisted attempt at protectionism has dire implications on biofuels policies in Asia. Palm oil prices within Indonesia might sink as long as surplus volumes can’t make it beyond the borders, but international palm oil prices will remain high as consuming countries pivot to producers like Malaysia, Thailand, Papua New Guinea, West Africa and Latin America. That in turn, threatens the biodiesel mandates in Thailand and Malaysia. The Thai government has already expressed concern over palm-led food price inflation and associated pressure on its (subsidised) biodiesel programme, launching efforts to mitigate the worst effects. Malaysia – which has a more direct approach to subsidised fuels – is also feeling the pinch. Thailand’s move to B10 and Malaysia’s move to B20 is now in jeopardy; in fact, Thailand has regressed its national mandate from B7 to B5. And the reason is that the differential between the bio- and the diesel portion of the biodiesel is now so disparate that subsidy regimes break down. It would be far cheaper – for the government, the tax-payers and consumers – to use straight diesel instead of biodiesel, as evidenced by Thailand’s reversal in mandates.

That, in turn, has implications on crude pricing. While OPEC+ is stubbornly sticking to its gentle approach to managing global crude supply, the stunning rebound in Asian demand has already kept the consumption side tight to match that supply. Crude prices above US$100/b are a recipe for demand destruction, and Asian economies have been preparing for this by looking at alternatives; biofuels for example. In the past four years, Indonesia has converted some of its oil refineries into biodiesel plants; in China, stricter crude import quotas are paving the way for China to clamp down on its status of a fuels exporter in favour of self-sustainability. But what happens when crude prices are high, but the prices of alternatives are higher? That is the case for palm oil now, where the gasoil-palm spread is now triple the previous average.

Part of this situation is due to market dynamics. Part of it is due to geopolitical effects. But part of it is also due to Indonesia’s knee-jerk reaction. Supply disruption at the level of a blanket ban is always seismic and kicks off a chain of unintended consequences; see the OPEC oil shocks of the 70s. Indonesia’s palm oil export ban is almost at that level. ‘Indefinite’ is a vague term and offers no consolation to markets looking for direction. Damage will be done, even if the ban lasts a month. But the longer it lasts – Indonesian general elections are due in February 2024 – the more serious the consequences could be. And the more the oil and refining industry in Asia will have to think about their preconceived notions of the future of oil in the region.

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Market Outlook:

  • Crude price trading range: Brent – US$110-1113/b, WTI – US$105-110/b
  • As the war in Ukraine becomes increasingly entrenched, the pressure on global crude prices as Russian energy exports remain curtailed; OPEC+ is offering little hope to consumers of displaced Russian crude, with no indication that it is ready to drastically increase supply beyond its current gentle approach
  • In the US, the so-called NOPEC bill is moving ahead, paving the way for the US to sue the OPEC+ group under antitrust rules for market manipulation, setting up a tense next few months as international geopolitics and trade relations are re-evaluated

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