Investment Highlights

• Aggressive new front in oil price war. Following the failure of the meeting between Opec and its allies on additional production cuts to stabilise oil markets, Saudi Arabia has launched an aggressive oil price war targeting its rivals after Russia refused to participate in the oil cartel. Newspaper sources indicate that Saudi Arabia will produce over 11mil barrels/day next month from 9mil barrels/day currently after the current production quota agreement lapses.

• Unprecedented Saudi price discounts. Saudi Arabia has announced unprecedented discounts of almost 20% in key markets, apparently targeting Russia and the US shale industry as well as other higher cost producers. Saudi Arabia is set to announce that its crude into northwest Europe, a key market for Russian barrels, will be sold at discounts to its reference price of over US$8/barrel compared to that of March 2020. In the US, the country is also set to discount its crude by US$7/barrel in April compared with March. Saudi Arabia also made price cuts of US$4–6/barrel to Asia. This aggressive price war is evident as monthly Saudi price adjustments are usually only by a few cents to US$1.

• Uncertain if Russia will return to negotiating table. While Saudi Arabia could be hoping that the price war would bring Russia back to the negotiating table to discuss cutting output to try to rescue the price, newspapers reported the deterioration in the atmosphere between the Saudi and Russian negotiating teams. Russian President Vladimir Putin had rejected requests from Saudi Arabia’s King Salman for a rapid response to the coronavirus impact on the oil market back in February. Whether this recent action will bring Russia back to the negotiating table remains uncertain given that Russia’s budget oil breakeven price of US$40/barrel is lower than Saudi’s over US$70/barrel.

• Worse than 2014–2017 decimation. In our view, this new price war impact is likely to be worse than the 2014–2017 period when Saudi Arabia waged against US shale oil producers given that: i) US crude oil production has now risen to 13.1mil barrels/day – 3.9mil barrels above 9.2mil barrels which US was producing in 2016 when Brent oil price crashed to US$26/barrel; and 2) speculated China oil demand loss of up to 3mil barrels/day following the impact of the novel coronavirus.

• Lowered 2020 oil price forecast to US$40–45/barrel. Brent spot crude oil price has fallen by 32% since the beginning of the year to US$45/barrel while April futures contract is trading lower at US$35.80/barrel currently. If Saudi Arabia restores its capacity of 12mil barrels/day, we expect crude oil price to easily crash below US$30/barrel.

As such, we have lowered our 2020 crude oil price forecast to US$40–45/barrel and 2021 to US$45–50/barrel from US$60– 65/barrel given the rising excess oil capacity that is likely to flood global markets amid weak demand softened by the novel coronavirus pandemic.

• Oil price crash prelude to service sector curtailment. While US rig count remains robust, rising 12 units YTD to 793 currently amid decent offshore rig utilisation rates of over 70%, we view these as lagging indicators of future demand trajectory. Even though offshore projects have 4–5 years of gestation cycles, a sharp drop in oil prices will raise credit risk premiums while banking institutions tighten lending criteria to the sector, effectively prolonging or even derailing the final investment decisions of oil majors in the near to medium term, as demonstrated by the disruptions in the 2016–2018 period.

Recall that Malaysia’s 2019 contract awards slid 6% YoY to a lower-than-expected RM11.5bil following a lull in 1Q2019 and slower pace in 4Q2019, which registered declines of 35% QoQ and 46% YoY. We view this as the remaining fallout from the 2016–2018 award cycle dislocation.

• Downgrade sector call to UNDERWEIGHT from OVERWEIGHT, with revised calls to SELL for Bumi Armada, Dialog Group, MISC, Sapura Energy, Serba Dinamik and Velesto Energy. Our fair values have changed to P/BV targets based on their lower 5-year valuations (See Exhibit 2 and 3).

As such, the companies which have the most reductions in fair values are Velesto Energy (-64%), Sapura Energy (-62%) and Bumi Armada (-59%). Even though Dialog Group and Serba Dinamik have stable and recurring earnings profile underpinned by operation and maintenance services and their strategically located projects in Pengerang, the current deterioration in sentiment for the sector will still translate to substantive selling pressure. Hence, we have lowered Dialog’s fair value to RM2.81 and Serba Dinamik to RM1.90.

Source: AmInvest Research - 9 Mar 2020