11/04/2011 (The Star) - Thanks to good foresight, careful planning and precise execution, K.S. Lim, a 60-year-old agriculturist based in Segamat, Johor, has been laughing all the way to the bank.

He sometimes likens his new-found fortune to striking the lottery not in the literal sense, but, Lim says, his strategy of switching from being just a fruit planter to planting agricultural commodities about eight years ago has clearly worked out very well for him and his family.

“It has not been an easy transition due to the apprehension of some of my family members towards venturing into unfamiliar grounds' and the fact that we have to wait for several years before we can reap the harvest' adds more pressure due to the temporary disruption of our family income,” explains Lim. He had then owned a nine-acre fruit farmland which has since been turned into a mixture of rubber and oil palm plantations.

“Well, we are reaping the harvest' now. Not to be mistaken, we're not considered rich by any measure, but my family income has definitely improved significantly over the last few years; not only because our plantations have been bearing good fruits, but also because of the trend of rising commodity prices,” he says.

Some of Lim's peers in the village, who have followed in his footsteps and ventured into plantation of agricultural commodities about a decade ago, have also been experiencing the same fortune. Theirs is a testament that many local planters are indeed benefiting from the rising prices of agricultural commodities.

But the agricultural commodity boom is just part of the larger picture of what's happening in the wider commodities markets, goods of which include the more crucial crude oil, and other mineral resources such as coal and precious metals such as gold and silver, as well as grains such as rice, wheat and soybeans.

Prospects for further gains remain

The prospects of a further rally of the various commodity prices remain high, given the uncertainties surrounding the global economy, partly due to the mounting political crisis in the oil-producing regions of the Middle East and North Africa (MENA), which could lead to further rise in crude oil prices.

“If crude oil prices remain elevated for a prolonged period, it will definitely have implications on the prices of other commodities and the global economy as well,” says Affin Investment Bank chief economist Alan Tan.

At present, many analysts and economists still find it difficult to quantify the impact of the ongoing political unrest in MENA on global crude oil prices. But they have not discounted the possibility of it surpassing its previous record high of US$147 per barrel on fears of supply disruption; and under such scenario, they say, prices of all other commodities would be expected to keep rising as well.

“Commodity prices at present are dictated by rapidly developing events in MENA,” RAM Holdings Bhd economist Jason Fong explains.

While he acknowledges the difficulty in quantifying those events, Fong says he thinks the events in MENA could just be transitory, and when they are resolved, crude oil supply conditions could normalise, and that could help ease the pressure on the prices of other commodities.

Crude oil currently trades within the band of US$105 and US$110 per barrel on the Nymex, up from US$85.88 per barrel a year ago and US$91.55 per barrel in the beginning of 2011.

While the political uprising in MENA is widely viewed as key to the direction of global crude oil prices in the near term, some economists argue that if developed economies were to embark on further quantitative easing, there would be even more pressure on the prices of the commodity to rise further.

For instance, they point out that there is still the possibility of the US Federal Reserve embarking on a third round of quantitative easing (QE3) after its QE2 expires this summer, even though the chances of that happening are still remote at this juncture.

As it is, the earlier rounds of QE measures by developed economies such as the United States and Japan during the onslaught of the global financial crisis have already unleashed a massive amount of money into the system. And a huge chunk of these monies has managed to find its way into global assets and commodity markets, leading to the inflated prices of stocks and various commodities, as we've seen over the past one year.

Undoubtedly, there is also a fundamental factor driving up the prices of commodities that is of supply and demand. Global population growth and the rebound of key economies from the global financial crisis as well as the rapid development of several emerging economies such as China are some of the factors contributing to rising demand for commodities.

Supplies, however, have not been keeping pace. By and large, there is limited scope for capacity expansion due in part to the scarcity of natural resources and land near developed areas such as ports. Supplies have also been perceived to be tight because of seasonal factors, poor weather conditions and natural disasters, which have temporarily disrupted output at some producing countries.

There is generally a strong belief among punters that global commodities demand will continue to outstrip supply over the longer term, and hence drive up their prices.

Such belief is what's drawing investors like Jim Rogers to put their money on commodities. Ever the bull on commodities, especially agricultural produce and precious metals, Rogers is betting on a prolonged boom for the global commodities market.

For Malaysia, a commodity-and-natural resources-rich economy, but one that is still dependent on external demand to drive growth, persistently high commodity prices may present both good and unfavourable news.

Benefits from the rise

Rising global commodity prices will benefit local industries and companies whose businesses deal with commodities such as crude palm oil (CPO) and crude oil. Like agricultural commodity planter Lim, these groups will definitely see a significant improvement in their incomes.

From the macro perspective, Malaysia can expect to see strong earnings coming from its exports of commodities, provided there is no significant drop in volume.

Commodities generally account for around 30% of Malaysia's export earnings each month. Key items include CPO, rubber, crude oil and liquefied natural gas (LNG).

According to data released by the Statistics Department over the week, commodities turned out to be one of the major drivers of export growth in February, and that was partly attributable to their skyrocketing prices. The overall export growth of 10.7% year-on-year (yoy), compared with a growth of 4.6% yoy in the preceding month, beat markets' expectation by quite a wide margin many were expecting to see only a 5% yoy gain.

Earnings from palm oil exports grew 21.9% yoy, despite a decline in volume. This was due to the significant rise of about 48% yoy in the average CPO prices to around RM3,800 per tonne during the month. Earnings from LNG exports and refined petroleum products also rose, by 27% yoy and 65.4% yoy, respectively.

Earnings from exports of electrical and electronic (E&E) products, which generally account for 40% of the country's total exports, grew 7.5% yoy.

MIDF Research chief economist Anthony Dass, in his report, says the continually high commodity prices, especially that of CPO and crude oil, suggest that Malaysia's export earnings from the category in March would continue to show robust performance.

This could possibly help sustain the healthy trade surpluses that Malaysia has been enjoying all this while, especially in anticipation of weakness in the exports of E&E products in the months to come. This is due mainly to the aftermath of the earthquake and tsunami that hit Japan last month.

Malaysia registered its 160th consecutive month of trade surpluses in February, with net earnings from trade growing 8.3% yoy to RM12.6bil. Net earnings from trade are an important source of growth for Malaysia's economy, contributing around 10% to 15% to the country's gross domestic product (GDP) each year.

Income booster?

The soaring prices of crude oil commodity will usually boost the total revenue of the Government. This is because the Government earns around 40% of its total revenue from petroleum resources, mainly through direct taxes and royalties from national oil company Petroliam Nasional Bhd (Petronas).

At current price levels, the oil and gas industry is already buzzing with activities. More projects are expected to be in the pipeline, and this will definitely create more job opportunities for individuals in the process, and the Government will likely be able to extract more income from the sector.

But the actual amount the Government could derive from this source depends on the sector's earnings.

Petronas paid RM30bil in dividends to the Government last year. That is the legacy amount the national oil company has been paying the Government in recent years.

But last month, Petronas chief Datuk Shamsul Azhar Abbas said the company had intentions to revise lower its annual dividends to the Government, stating that it could not afford to maintain such a high payout ratio for long.

This is because the company had plans to increase its capital expenditure substantially to replace ageing plant and machinery and to search for new oil reserves in the coming years. In fact, an allocation of RM280bil over the next five years has already been earmarked for that purpose. That amount works out to about RM55bil annually, which is substantially higher than the RM40bil capex for its fiscal year ended March 2011.

Party will not last

Given the fact that Malaysia is a heavily subsidised economy, any increase in oil revenue for the Government will likely be offset by higher spending on subsidies that it currently provides for various goods, especially fuel and foodstuff.

“The nation's subsidy bill is highly correlated to global crude oil prices. This is largely because food prices, the other major component related to subsidies, follow a similar trend with global energy prices,” RAM's Fong says.

The Government may have a rationalisation scheme in place to reduce its spending on subsidies as part of its fiscal consolidation plan. But with inflationary pressure rapidly rising, the Government would likely pause the measure to minimise the effects of rising prices on local consumers.

Under the Budget 2011, the Government has allocated RM10.3bil as subsidies for fuel based on the assumption that crude oil prices would average at US$85 per barrel. But current crude oil prices are already much higher by now.

According to RAM, without any drastic subsidy-reduction, oil prices at US$110 to US$120 per barrel would result in a total subsidy expenditure of around RM34.3bil, or 4% of GDP, in 2011. The baseline scenario envisages a deficit impact of around RM6.7bil, which implies a fiscal deterioration of 0.8-percentage points to 6.2% of GDP, compared with the targeted 5.4% under Budget 2011.

Economists like Wan Suhaimi Saidi Kenanga Investment Research concur that it could be difficult for the Government to keep to its targeted fiscal-reduction programme this year unless drastic actions are taken.

“The Government's revenue may increase as a result of the rising crude oil prices, but the benefit it could derive from the sector has to be net of its expenditure on subsidies, and we also have to take into consideration the fact that Petronas has already signalled its intention to reduce dividend payout to the Government,” he explains.

Last year, the Government's fiscal deficit stood at RM43.3bil or 5.6% of GDP. It was an improvement from the 2009's fiscal deficit of RM47.4bil or 7% of GDP, thanks in part to its subsidy rationalisation programme.

Under the 10th Malaysia Plan, the target is to reduce the Government's fiscal deficit to 3%-4% of GDP by 2015.

“The Government should now look even more seriously into other drastic ways to reduce its deficit plug the leakages (corruption) and cut down on unnecessary spending,” an economist says.

“Subsidy scheme still has to be reformed as the present blanket' system is not necessarily a sensible approach. Any form of assistance meant for the people has to be more targeted at helping the poor and vulnerable household, especially at current times of high inflation,” he says.

A roadblock to growth?

Concerns are already growing over the impact of high commodity prices, especially that of crude oil, on the recovery process of several key economies, most of which are also major trading partners of Malaysia.

Rising commodity prices are already pushing global inflation higher, and many of these economies, including the United States and the Eurozone, are not spared. With a still-fragile recovery, prolonged high commodity prices could dampen consumer spending in those regions, and hence, their economic growth, and this could ultimately reduce their demand for Malaysia's products.

“Malaysia is an open economy; any slowdown in the economies of its major trading partners would affect its growth through external demand,” Affin's Tan explains.

According to RAM's estimate, the recovery of major advanced economies is inversely related to energy prices, such that industrial activity would probably face a form of production stagnation if crude oil prices become “sticky” at above the US$140 per barrel level.

The impact on Malaysia's growth will therefore depend on how well advanced economies navigate their recovery process amid high energy prices, Fong says.

Earlier reports by CIMB Research said that a US$10 rise in crude oil prices could dampen Malaysia's GDP growth by 0.5 percentage point through both direct and indirect channels because of the vulnerability of its major trading partners to high crude oil prices.

That's another downside of persistently high commodity prices to Malaysia's economy. It seems economic management will likely become an even more complicated affair in the days ahead; hence it is crucial that policymakers continue to keep their focus right, economists say.