Investment Highlights

• Trump tweets, oil prices up... for now. US President Donald Trump tweeted that he expects Saudi Arabia and Russia to cut daily production by 10mil, and potentially up to 15mil barrels after speaking to Russian President Vladimir Putin and Saudi Crown Prince Mohammed bin Salman. Trump also said he had invited American oil executives to the White House to discuss revival measures which would aid the oil industry that is hurt by a demand contraction due to both the novel coronavirus (Covid-19) pandemic and the current price war. This development comes just after a day after the Russian president’s press secretary said that no one has launched any talks about a potential new oil production deal to replace the Opec+ format. While Brent spot oil price has recovered by US$6/barrel to US$30/barrel, we view this as temporary as the two major oil producing countries are unlikely to agree and adhere to such drastic cuts.

• Such cuts will mean 44%–66% of Saudi-Russian production. Currently, Saudi Arabia has ramped up its production from its quota-restricted 10mil barrels daily to nearly 12mil barrels, of which we understand that up to 300K barrels may be from its existing storage facilities being released for exports in its price war with Russia, which has a daily production of 11mil. A daily production cut of 10mil–15mil could mean an improbable 44%–66% reduction for the 2 major oil producers, relegating them to production levels which are only half of the current US output of 13mil barrels. Given that the budget breakeven for the Russia government requires oil prices to be at US$42/barrel and Saudi US$84/barrel, such a drastic cut in production will worsen their fiscal positions.

• Bigger impact from Covid-19 impact than Saudi-Russia price war. We view the ongoing Saudi-Russia oil price war, which catalysed the plunge in crude oil prices following the failure of the meeting between Opec and its allies on additional production cuts, has a lower impact compared with the massive Covid-19-inflicted demand loss, which the IEA and oil trader Vitol both estimated at 20mil barrels/day, with some forecasts reaching 30mil barrels from the growing global lockdown. This accounts for 25%–37% of 2019 global demand. In an unprecedented regime which has never occurred in wars, famine or oversupply conditions, the world has essentially begun to shut down in transportation, in which vehicles account for 40% of global crude oil demand and airlines 10% while petrochemical 30%. As such, Vitol has indicated that global storage facilities are expected to reach maximum utilisation by the end of this month with the duration of Covid-19 remaining uncertain at this stage

• Production capex cutbacks, payment deferrals and contract renegotiations. National oil producers have begun to cut back on production, with Brazil’s Petrobras doubling its daily reduction to 200,000 barrels – 9% of its current output of 2.1mil barrels. We highlight that during the 2015–2017 down cycle when the oil price fell to US$26/barrel, Petrobras did not significantly scale back its production while only slowing down on its exploration and development capex rollout. This major offshore producer has signalled intentions to delay payments and renegotiate contracts with its suppliers to conserve its cash flows, a move which it did not resort to in the past.

• Extensive impact on all. The worst impacted will be those with upstream production sharing contracts such as Sapura Energy and Hibiscus Petroleum, followed by fabricators such as MMHE and offshore support providers Bumi Armada and Velesto Energy. Even though companies such as Dialog Group will benefit from heightened demand for tank terminal storage facilities, we expect project deferrals and cost renegotiations on existing contracts by oil majors to compress margins and volume for specialist/maintenance services as well as engineering, procurement and construction activities. While VLCC petroleum tanker rates have escalated on the rapid increase in floating storage demand, MISC is unlikely to capitalise on it in the near term as its large vessels are on long-term charter; yet its LNG vessels may encounter charter terminations, which had occurred during the previous down cycle.

• Remain UNDERWEIGHT on the sector with the fair values of the stocks under our coverage being pegged to 5-year P/BV lows. Regardless of upstream, midstream or downstream segmentation, we expect the massive global demand destruction from Covid-19 on top of the Saudi-led price wars to continue depressing industry sentiments extensively in the foreseeable horizon. As we continue to view the decimation in oil prices and companies’ earnings to be worse than the previous crisis which led to multiple financial distress to O&G corporations, we have already switched to NTA for stocks such as Sapura Energy. Hence, we retain our SELL calls for Bumi Armada, Dialog Group, Sapura Energy, Serba Dinamik and Velesto Energy.

Source: AmInvest Research - 3 Apr 2020