Investment Highlights

• Oil price rebounds. Oil prices have rebounded over the past 3 weeks with Brent futures now trading above the US$30/barrel threshold at US$32/barrel currently, up 63% from an 18 year-low of US$17/barrel on 21 April this year. For comparison, WTI futures have surged to US$26/barrel, reversing from an abnormal negative US$38/barrel on 20 April. This stemmed from a slower week-on-week increase of 9mil barrels in US oil inventory to 528mil barrels vs an average increase of 16mil barrels over the past 4 days. Compared to the previous week, the 40% reduction in the inventory increase implies that the global curtailment in output together with easing Covid-19 lockdowns have been effective in mitigating US storage constraints. Likewise, the Brent premium over WTI has eased to US$3.71/barrel, 32% below the 3-year average premium of US$5.50/barrel.

• Still too early for optimism. In our view, oil price direction remains precarious as US daily oil production has only decreased by 8% or 1 mil barrels to 12.1mil barrels from 13.1mil barrels in March this year. Given that the previous oil price downturn in 2015-2016 occurred over 2 years with the aftermath still being felt today, the sector has to navigate the multiple financial distress of service operators across the supply chain over the next 12 months. Even if the oil price were to remain at these improved levels, we believe that the lingering risks from the supply cuts mean that it is still too early for a return to optimism.

• OPEC+ cuts by 10mil barrels/day. Recall that Saudi Arabia and Russia have reached an agreement to reduce production with Opec+ reducing output by 10mil barrels beginning this month. Saudi Arabia and Russia will trim production by 5mil barrels/day while the rest of Opec+ by another 5mil barrels/day.

• Necessary given storage constraints. These cuts are necessary given that global storage facilities are rapidly reaching full utilisation due to the massive Covid-19-depressed demand loss, which the oil trader Trafigura has estimated could drop by 30mil barrels/day or by 37%. Given the Opec+ cuts of only 10mil barrels/day compelled by lower offtake, it remains uncertain at this juncture whether oil prices could be sustained at over US$30/barrel.

• Maintain 2020 oil price estimate to US$35–40/barrel. YTD, Brent crude oil prices have averaged US$42/barrel while the current spot price has risen by US$11/barrel over the past month to US$28/barrel. With US crude oil inventories still steadily rising by 23% YTD to 528mil barrels, we maintain our crude oil price forecast at US$35–US$40/barrel for 2020 and US$45– US$50/barrel for 2021. For comparison, the EIA is projecting crude oil price at US$33/barrel for 2020 and US$46/barrel for 2021.

• Catastrophic supply chain impact from oil demand cuts. We view lower oil prices as less of a concern compared with the drastic plunge in demand as national oil producers have cut back on production. Brazil’s Petrobras has cut its daily oil production by 200,000 barrels — 9% of its current output of 2.1mil barrels, which it did not resort to during the 2015–2017 down cycle when oil price fell to US$26/barrel. This major national offshore producer has signalled intentions to delay payments and renegotiate contracts with its suppliers to conserve cash flows. If other major oil producers are forced to employ similar measures, this will have a catastrophic impact on the supply chains which multiple service providers rely on.

• Most service providers will be impacted. We maintain our view that most participants in the sector, except those in storage services, will be adversely impacted. Those with upstream production sharing contracts such as Sapura Energy and Hibiscus Petroleum will suffer from lower prices and offtake, followed by fabricators such as MMHE and offshore support providers Bumi Armada and Velesto Energy. While service providers 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.

• Remain UNDERWEIGHT on the sector as fair values of the stocks under our coverage remain pegged to 5-year P/BV lows. Regardless of upstream, midstream or downstream segmentation, we expect the massive global demand destruction from the uncertain extent and duration of the Covid-19 pandemic 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 retain our SELL calls for Bumi Armada, Dialog Group, Sapura Energy, Serba Dinamik and Velesto Energy.

Source: AmInvest Research - 6 May 2020