Recent politics among OPEC nations, and between OPEC and non-OPEC producers,
have added to the uncertainties in the timing of an oil price recovery
. While the
global industry has reacted to lower oil prices, the local sector is fundamentally
unexciting and still in overcapacity. Maintain MARKET WEIGHT, noting stock
movements have a high correlation (+0.60) with oil price. Brent is trading within the
global industry’s two-year assumption of US$55-70/bbl
■ Malaysia’s position in context to the current environment. Recent events by OPEC
vs the high-cost producers re-iterate a strong focus on market share, dashing hopes of a
quick rebound in oil prices and when the oversupply will truly be narrowed. Petronas,
which maintains its US$55/bbl Brent assumption, incurred a RM12.1b capex in 1Q15 (-
8% yoy; 55% domestic, 45% overseas). Petronas guided for capex to drop 15% yoy in
2015 (2014: RM64b) and a 30% opex reduction. In response, offshore contract flows
have slowed and high-cost upstream projects (RSC, EOR, high-CO2) were
shelved/replanned to be feasible at lower breakeven prices. Contractors are facing the
risk of reduced service rates.
■ Developments. Petronas remains commited to projects such as RAPID in the local
downstream scene. It awarded 28 RAPID infrastructure packages. PETCHEM EPCC
contracts are expected to be awarded by 1Q16. However, the upstream side is less
exciting as contract flows are small and structured as called-out, short-term tenures.
Scomi Energy is re-optimising its Ophir RSC (at a cost of timing delays) to be feasible at
US$55/bbl vs the previous breakeven price of >US$70/bbl. Some OSV contracts were
renewed at a 15-20% discount in charter rates. Rig contracts had been terminated early
or revised with discounts on charter rates.
■ Maintain MARKET WEIGHT - still an oil price play. With lesser contracts, we view
Malaysia’s upstream service players are facing an overcapacity and lagging behind
international peers in terms of opex rationalisation and capacity realignments. The sector
is still unexciting fundamentally and is not yet safe from further earnings downgrades. We
see earnings expectations or contract wins to remain muted and expect the sector to
continue to be dictated by oil price movements within a one-year horizon. We believe the
sector is trading in line with the US$65/bbl Brent range since OPEC’s June decision,
which is within the industry’s 2-year assumption of US$55-70/bbl. We note the sector has
a high positive correlation (+0.60 to +0.87) to Brent movements during the Oct 14-May 15
period (ie correlated to both the downtrend and uptrend of oil prices).
■ Top BUY and SELL. We like Dialog, given: a) its track record as a defensive proposition
to oil price (please see Page 2 on defensive plays), and b) it being a prime beneficiary of
Southeast Asia’s key storage hub with potential for further development of its Pengerang
terminal. SELL MMHE, given: a) orderbook replenishment concerns and low utilisation in
its East Yard, and b) investors will have to bear the delays of large contract awards and a
discount to earnings (even if they secure a large contract) as recognition is backloaded
according to the company’s square accounting method.
■ Defensive plays. Yinson, MISC and Dialog are defensive plays, given their lower or
negative correlation (less than 0.50) to Brent, according to our analysis. Dialog benefits from
rising oil prices due to an oil contango play on its storage terminals and upstream
activities, while enjoying abundant business opportunities from downstream customers
during periods of low oil prices. MISC has a diversified mix of businesses whereby its
petroleum tanker rates and storage business benefit from lower oil prices, despite
suffering from lower LNG earnings as its LNG carriers could see lower utilisation and
lower charter rates on renewed tenure. Yinson’s proven project execution and its status
as a purer proxy to FPSO, which lies in the production capex, render it more defensive
vs Bumi Armada which has a sizeable exposure to OSV and T&I operations.
■ The US$55-60/bbl range could be a psychological barrier to a few Malaysian counters,
a) our channel checks suggest some upstream projects related to Petronas will be
reassessed and replanned to reflect the US$55/bbl breakeven price, and this affects
players with RSC and PSC exposure, and
b) US$60/bbl is the breakeven point for the
upstream production of SapuraKencana, the largest integrated local player.
■ More oil to come. Last week, OPEC made an unsurprising decision to retain its
production quota of 30m b/d, taking into account that the quota had been exceeded by
>1m b/d since Mar 15. Speculation on Iran’s sanction removal could prompt the nation
to pump up production to >3.5m b/d vs 2.8m b/d currently. Iran and Libya are some of
the other OPEC nations that announced their intention to boost production volumes.
These events reiterate a strong focus to defend market share against the higher-cost
producers, dashing hopes of a quick rebound in oil prices and complicating the timing of
when the oversupply will truely be narrowed.
■ Question remains on oversupply. The International Energy Agency (IEA) forecasts oil
demand to surge to >94m b/d by 2H15 to bring oil demand to 93.9m b/d in 2015 (+1.4m
b/d from 2014), with China and the US among the biggest demand drivers. The market
had initially expected the demand surge and a production slowdown to narrow the
oversupply and drive an oil price recovery from the 1Q15 average of US$57/bbl Brent.
We estimate 1Q15 oversupply at 2.0m b/d, based on the IEA’s 1Q15 figures. We are at
the peak of the oversupply now as the IEA estimated Apr 15’s world supply at 95.7m
b/d vs a slightly lower average 2Q15 demand estimate of 92.6m b/d, a difference of
more than 3m b/d.
■ Intensifying fight for market share among producers. The current environment is
shifting the dynamics whereby the more efficient or lower-cost producers continuing
with their production, rather than waiting for better margins from higher oil prices.
According to the market share data based on the IEA’s Apr 15 numbers, Saudi Arabia
recorded higher crude production of 10.0m b/d in April (2014: 9.5m b/d). The combined
production volume of Iran, Iraq and Libya amounted to about 7.2m b/d (2014: 6.6m b/d).
Although OPEC as a whole saw its market share increased to 39.5% (2014: 39.1%),
this was lesser than its historical 60% market share. Also, conventional and tight oil
production in the US remained high at 12.6m b/d in Apr 15 (2014: 11.8m b/d) and
market share remained high at 13.2% (2014: 12.6%). The market share of Russia,
another large oil producer, remained stable at 11.6%.
■ What is the industry’s view? The latest 1Q15 investor guidance of key global major
O&G companies indicated conservative estimates of US$55-70/bbl Brent for capital
budgeting within 2015/16. Prices assumed for longer-term capital budgeting, in order to
be free cash flow-positive, are at US$55-90/bbl. In the new normal of lower oil prices,
many international companies have entered into capital conservation vs expansion
previously, and view the indusry downcycle will be prolonged.
■ The bull camps on oil prices believe:
a) shale production will face a meaningful
decline from late-15, following a 53% yoy drop in the US rig count to 871 rigs (-58%
drop in oil rigs, -30% drop in gas rigs),
b) ongoing restructuring of Saudi Aramco could
revamp Saudi oil policy, and
c) improving demand growth from India and economic
outlook in Europe.
■ The bear camps on oil prices believe:
a) the US shale production may not decline
fast enough despite the rig decline as per Baker Hughes data,
b) over-expectations on
oil demand growth, ie from China’s growth forecast, and the end of the US driving
If Brent falls back to US$40/bbl (-40% decline) and applying a 0.6x correlation
to the decline, we see a 20-25% downside risk to Malaysia’s O&G stock prices
. (Read Report)
Source : UOB KayHian Research
Labels: Oil and Gas sector