There is huge uncertainty in the oil industry with the prices crashing below the zero mark when trading on Monday.
West Texas Intermediate, the US benchmark, traded as low as -$40.32 a barrel in a day of chaos in oil markets.
Oil demand has dropped so rapidly that the world is running out of room to store barrels.
Plainly speaking, it all happens due to the coronavirus pandemic. Russia and Saudi Arabia flooded the world with excess oil supply.
On Tuesday, the price of US oil clawed back above zero after plunging into negative territory for the first time.
West Texas Intermediate, the US oil benchmark, was fetching $1.67 a barrel in early Asia trading after starting the session at -$14.
This means the producers were paying buyers to take oil off their hands given limited access to storage in the US.
To look at how the Oil and Gas Service (OGSE) companies will be affected with a volatility of oil price, One Malaya decided to take dive into the woes faced by them.
Putting it plainly, OGSE companies are the contractors or vendors that provide the support to PETRONAS and all its operations as well as to other Oil Companies operating in Malaysia known as Petroleum Arrangement Contractors (PAC) such as other big industry players like Shell, ExxonMobil, and many more.
The OGSE companies in Malaysia are represented by large multi-nationals, public-listed companies, and SMEs.
More interestingly, SMEs represent more than 60% of the OGSE companies in Malaysia.
Low Oil Price Impact
Sharing her thoughts with One Malaya, Linda Zain, Director of Cendana Energie Sdn Bhd said that “as oil price is being pressured, this will directly impact the OGSE industry.
“Following the 2015 to 2017 oil price crash, OGSE companies are still struggling; some have not even recovered from the 2015 downturn.
“The cost-cutting measures that were implemented during downturn has caused a lot of OGSE companies operating at a low margin.”
Indirectly, the weakening of Malaysian Ringgit has a big impact on Oil and Gas business as import costs increases and huge losses taken into consideration on exchange rate capacity.
Non-anticipating, any further impact such as exchange rate loss will further hit the OGSE ecosystem and companies, Linda highlighted.
Margins overshadowed by exchange rate
Linda continued to illustrate that there is a small margin of 2 to 3 per cent which normally earned is now been given away to further negotiate the price with the supplier due to higher USD against Malaysian Ringgit.
While writing, we noticed that the 1USD equals to 4.39MYR.
She suggested that certain companies have different margins.
“Some companies can earn between 8 to 10%. Others may vary to 5%, depending on OGSE management strategy to win the contract.
“When late delivery penalties are imposed by the client or contract to vendors which can cause to lose another additional 1% to 2% margin.”
Bracing the volatility of exchange rate
At the moment, it is understood when they deal with foreign companies and vendors, they need to pay in USD or other forms of currency.
“If more OGSE companies pay using foreign currencies, then there is a tendency for local companies had to be entangled with potential exchange rate loss that might eat up their profits to run business.”
As an example, Cendana will pay the manufacturer in Europe. The manufacturer in Europe will issue an invoice quoting in Euro.
Example, the exchange rate at the time of invoice issued is MYR 4.6 against 1 Euro, so they are forced to convert the invoice into Malaysian Ringgit.
Today’s Euro rate is 4.76, Cendana will have to pay the manufacturer based on today’s exchange rate at 4.76.
However, some vendors are kind enough to follow the old rate as per the invoice date. But not always we get lucky and escape with this sort of situation, said Linda.
“In this industry, many raw materials and equipment are being procured from other countries such as Italy, German, China, Korea and the United States.”
Hoping for some grace assistance
Contingency plans are crucial for any business sustainability. To overcome the economic challenges, Cendana Director Linda has shared her views to weather the business crunch facing them.
“In our case, generally raw materials and equipment are long lead items, minimum 24 weeks from engineering to delivery.
“It is quite challenging because price was negotiated months ago and due to price war to secure the tender, manufacturers were squeezed, hence very little room for further reduction.
“Sometimes, due to LD (Late Delivery) clause in the contract, manufacturers are not willing to reduce their costs/price.”
Some of her suggestions to the government are to look into withdrawing the requirement for local companies to pay in Malaysian Ringgit rather than converting from US dollar or other foreign currency based on exchange rates.
Another possibility will be to look into pegging Malaysian ringgit against US Dollar.
“On the other hand, banks can help SMEs and our industry players to waive bank guarantee requirements or at least reduce from standard 10% to less than 5%.
“We must realize that not many SMEs are eligible to obtain Bank Guarantee facility.
“Banks are imposing stringent terms and mostly require Fixed Deposit as security. This affects SMEs cashflow where the cash can be used for operational expenses.”
Also, it is made to understand that OGSE due to its high-risk nature is not favorable in getting new banking facilities.
It will be good if banks revisit and revise downwards interest rates on existing and new loans.
“Also banks should be more flexible in offering Bank Guarantee to SMEs. It is instrumental to secure new business as most of our vendors do ask Bank Guarantee as a proof document to do business.”
Does economic stimulus package helps
According to Linda, the moratorium helps to ease cashflow, however, they don’t really know how is the impact on bank interest after 6 months.
“The payment from SOCSO for staff below RM4000 salary helps to ease Company’s burden in maintaining their employment” she added.