Investment Highlight

• Divergent equity trends vs. oil price. The volatility in crude oil prices following the Russia-Ukraine conflict has triggered divergent equity trends for the stocks under our coverage. Crude oil prices surged 41% to US$138/barrel from US$98/barrel on 25 February this year just before the Ukraine invasion and has subsequently fallen by 18% to US$113/barrel currently. However, equity prices of oil & gas stocks have not moved in tandem given the unexciting rollout of fabrication jobs by oil majors amid pandemic-inflicted logistics disruptions.
  The rising sanctions against Russia have further catalysed elevated commodity prices and consequently, triggering stagflation worries that could dampen global oil demand. This was exacerbated by fresh Covid-19 lockdowns in several cities, especially Shenzhen, Shandong, Guangdong and Jilin, in China, prompting fears of another round of supply disruptions.

• Only Hibiscus Petroleum kept pace. Since the beginning the year, Brent oil price has risen by 46% and only Hibiscus Petroleum, which has direct exploration and production exposure, has kept pace with a jump of 41% while service provider Dialog Group rose by only 6% and Petronas Chemicals Group 5% (Exhibit 6).
  MISC was flat given that petroleum tanker rates remained subdued from the persistently low shipping volumes as OPEC struggled to meet its own production quotas. However, the share price of Bumi Armada, which bears an extended balance sheet, fell 11%. The worst performance came from Yinson, currently undertaking a rights issue.

• Coming global supply shortfalls. Even so, we believe the correlation between equity and oil prices will improve given our unchanged optimistic outlook on the sector as the impending supply crunch will sustain elevated oil prices, eventually catalysing increased spending by oil majors as highlighted in our thematic report on 25 June last year.
  Further underpinning our outlook, the International Energy Agency’s (IEA) March report estimated that the global oil market could lose 3mil barrels per day (bpd) of supply from Russia starting in April, as sanctions on banks and buyers’ reluctance to purchase Russian oil could result in the biggest oil supply crisis in decades.

• Inadequate supply even with slower demand growth expectations. Although the IEA cut its global oil demand forecast by 1.3mil bpd to 99.7mil bpd in 2022 (+2.1mil bpd YoY), the supply-demand balance remains in a deficit from the loss of Russian supply if the shunning of Russian oil accelerates and continues throughout the year.
  Recall that since Russia invaded Ukraine at the end of February, the US has banned imports of Russian energy while the UK is working to phase out its Russian supply by the end of the year. Even though Europe has not sanctioned Russian oil and gas, a growing number of European buyers are joining the wave of condemnation of Russia’s war and have pledged not to buy its oil. Currently, 66% of Russian seaborne spot cargoes are struggling to find a buyer.
  Production needs time to gather momentum given the time lag of up to 12 months between drilling and first oil for onshore shale producers and 3–4 years for offshore developments. This is also compounded by years of underinvestment, capital discipline, discouraging federal policies toward the oil industry, manpower shortages and supply chain bottlenecks.

• Slow 4Q2021 award of fresh fabrication jobs. The sector’s contract awards in 4Q2021 to Malaysian oil & gas operators rebounded 3.5x YoY to RM5.3bil (Exhibit 2), largely from a lumpy RM4.5bil contract to Coastal Contracts involving the construction of an onshore gas sweetening plant in Mexico. Excluding this contract, 4QFY21 orders would have been halved YoY as fabrication jobs awards remain weak amid the rising cases of Covid-19 Omicron variant globally. Meanwhile, major fabricator Sapura Energy continued to suffer from liquidity concerns which hampers the group’s capacity to secure fresh jobs from Petronas and other multinationals.

• Better prospects of selected segments. We expect selected segments in the value chain to be better positioned to benefit from higher oil prices and projects sanctioned by national oil companies. Operators directly exposed to upstream production such as Hibiscus Petroleum and the floating production storage and offloading (FPSO) sub-sector stand to benefit given the decimated number of operators during the previous downturn in 2015–2017.

• Rising Brent oil price projections. We have raised Brent oil expectation by US$20/barrel to US$100–US$110/barrel for 2022 and US$10–15/barrel to US$90–100/barrel for 2023. As Brent oil prices have averaged at US$97/barrel to date and remains above US$100/barrel despite recent corrections, we expect crude oil prices to stay elevated from the uncertain geopolitical impact from Russia’s Ukraine invasion that has triggered cascading sanctions, voluntary shunning of investments by international oil companies, substantive global supply chain disruptions and elevated risk premiums for commodities.
  Besides voluntary corporate sanctions on Russia, supply shortfall risks are escalating with major oil exporting nations unable to ramp up production to pre-pandemic levels due to chronic under-investment over the past 5 years amid investors’ persistent energy transition-driven prerogatives. However, we expect oil prices to soften next year on a stagflation outlook that could dampen global demand while spurring fresh investments in the sector and reignite production expectations.
  As US inventories have tumbled 17% from the YTD peak of 502mil barrels on 26 March 2021 to below pre-pandemic levels at 416mil barrels presently (7% below 2019 average of 448mil barrels), our Brent crude oil price projections are currently higher than the EIA’s Short-Term Energy Outlook which recently raised average forecasts to US$105/barrel for 2022 and US$89barrel for 2023. Downside risks stem from an amicable resolution to the Russia-Ukraine conflict, the emergence of new vaccine-resistant viral variants, the possibility of Iranian crude re-entering the global market and significant rebound in US shale production.

• Maintain OVERWEIGHT rating on the sector as escalating crude oil prices and rising global demand will catalyse faster order flows across the value chain. We continue to like Hibiscus Petroleum’s direct upstream exposure to higher crude oil prices and Dialog Group’s expanding, yet resilient non-cyclical tank terminal and maintenance-based earnings base. Meanwhile, Petronas Gas offers highly compelling dividend yields from its optimal capital structure strategy and resilient earnings base.

Source: AmInvest Research - 21 Mar 2022