Investment Highlights

• Debate over peak oil demand set to intensify. Leading oil and gas agencies, US Energy Information Administration (EIA), International Energy Agency (IEA) and Organisation of Petroleum Exporting Countries (OPEC) recently released their respective oil market reports for January. The documents record a stark divergence in views over the near-term outlook on the global oil and gas (O&G) landscape, premised on their respective thesis of peak oil demand which is expected to arrive as soon as 2030, according to EIA and IEA. This will be largely driven by strong adoption of electric vehicles and the shift towards renewables as the preferred fuel source. In contrast, OPEC opposes the view due to the short time frame of 6 years to realisation and has brought forward its 2025 guidance to exhibit its confidence of even stronger demand expectations to the January edition, rather than the common practice at the middle of the previous year.

• In defiance or in denial? Though we believe the debate is academic for now as there are still too many moving parts, yet this does carry a meaningful implication to the oil and gas industry. Peak oil demand questions the rationale for increased investment, of which too little will lead to serious energy security concerns. In our observation, there has been no letdown in investments into the sector. Rather we find companies are becoming more disciplined with their capital allocation strategies. This is evidenced by the previous mega acquisitions by oil majors: (i) Exxon’s US$59.5bil acquisition of Pioneer Natural Resources; and (ii) Chevron’s US$53bil acquisition of Hess Corporation which holds ongoing developments in the Permian basin and offshore Guyana which are said to have lower production costs and in areas that are largely stable. According to estimates by Rystad Energy, global upstream investments in 2023 is expected to register at US$580bil, 80% of the peak in 2014 (Exhibit 2). We do not see a significant decline in upstream capex from current levels in 2024 given strong news flows on potential Final Investment Decisions (FID) to be made, particularly for assets in the Permian basin as well as deepwater field developments in South America and Africa.

• Growing divide in near term oil demand. Global demand for oil in 2023 maintained the strong momentum seen since early-2022 as global liquids consumption stayed largely above the 100mil barrels per day (mbpd) levels on a quarterly basis throughout the year. This is largely attributable to the strong rise in demand from non-OECD countries which accounts for 88% of estimated consumption growth, particularly China due to the economic recovery post-Covid-19 lockdowns (Exhibit 3). This brings the 2023 average to 101mbpd, a rise of 1.8 mbpd (+1.9% YoY) (Exhibit 4). Despite the strong base, views on the direction of global oil demand in 2024 see a stark divergence with EIA expecting consumption growth to slow down sharply by 1.4 mbpd vs. the OPEC’s forecast of a more flattish performance by 2.2 mbpd.

• China, China and China. The near-term demand growth differential is largely attributable to China (again), given its 43% contribution to total world liquids consumption growth in 2023, of which EIA expects oil demand growth of 2.0% while OPEC 2.6%. We believe there is an upside to these estimates, driven by the recovery in international air travel in China and stronger production activities by Chinese refiners. While 2023 saw the return of domestic air travel, international travel generally saw a lag in performance for China. The Civil Aviation Administration of China now expects to see a 30% increase in overseas flights by end-2024 to as much as 6k weekly international passenger flights, from the 4.6k levels currently. Within the refinery space, China released 179mil metric tonnes (mmt) of oil import quotas to independent refiners to offer companies more flexibility to manage their feedstock requirement rather than through the usual practice of 3 batches throughout the year. This comes to 60% above the quota issued in the same period in 2023 and at 88% of the total 2023 import quotas. Supporting our view, leading industry consultancies forecast China's 1H2024 oil demand to grow by 3.7% for Wood Mackenzie, 4.0% for Rystad Energy and 4.4% for Energy Aspects.

• Strong US production to foil OPEC’s planned cuts. 2023 saw average global liquids fuel production rise to 101.7mbpd (+1.7 mbpd) driven by the increase by non-OPEC countries, particularly the Americas, which offset realised production cuts of 0.7mbpd by OPEC (Exhibit 5). We expect to see continuation of this trend in 2024 as the US remains committed to its oil production agenda to prevent the return of high inflation. This is especially so as the US has already released 180mil barrels (mbbl) from its Strategic Petroleum Reserves (SPR) last year, reducing total inventory levels to 354.7mbbl as at December 2023, the lowest in 40 years. As inflationary pressures moderate, the superpower is now focused on replenishing the SPR througmandated SPR sales of 140mbbl between 2023 to 2027. The EIA expects US oil production to rise by 0.38mbpd in 2024, through well efficiencies from deeper lateral drilling of shale fields from the Permian to Marcellus formations.
  
  This acts to counter the significant presence of OPEC in global oil production and the impact that its production cuts may create. The organisation makes up 50% of global oil exports in 2022 and has control over 70% of world 2P (proven) reserves. Most recently, OPEC announced production cuts of 2.2mil bpd up to 1Q2024, which includes the extension of existing voluntary cuts of 1.5mil bpd by Saudi Arabia and Russia. This brings the total pledged cuts since early 2023 to 3.36mil bpd, which represents 3.3% of global oil demand (Exhibit 6). Nevertheless, industry observers are skeptical over the effectiveness of these cuts, which are not mandatory and maintaining them may lead to a loss of market share for member states.

• OPEC spare capacity is the hidden bullet to any possible market rebalancing. Despite strong US production, the country’s commercial liquids inventory levels have tightened in recent years and recently ended at 1,606mbbl as of end-2023 (+2% YoY), driven mainly by the decline in SPR levels. Assuming SPR level remains constant, forecasts by EIA see US inventory levels becoming even more constrained as it registers a flattish growth of 0.1% by December 2024. To ensure inventory conditions remain in its current state, we estimate SPR levels will need to grow by at least 8.1% in 2024 to 383mbbl (Exhibit 7). This brings more attention to OPEC spare capacity which we believe will determine the dynamics of any market rebalancing in the near future. These currently remain buoyant at levels of 3.67mbpd as of December 2023, or 31% higher than its 10-year (20214-2023) average of 2.8mbpd. Given the current OPEC production quotas and expected cuts in production until 1Q2024, the EIA expects OPEC spare capacity to grow to 4.49mbpd (+22% YoY).

• Impact from the Red Sea crisis remains muted for now. Most recently, attention has shifted towards escalation of attacks on US-related vessels by the Iranian rebel group the Houthis in the Red Sea, a crucial route for the world’s seaborne O&G trade as it is a chokepoint for the Suez Canal and accounts for 10% of global crude oil and 8% of global LNG trade in 2023, data by IEA shows. Companies including Chevron, Shell and BP have suspended the use of the route for now, with Clarkson Research reporting crude tanker arrivals dropping by 35% in the period between 12-16 January 2024. In response, companies are opting to use alternative routes, such as through the Gulf of Good Hope which we gather may add up to 2 weeks of additional travel time (Exhibit 7). In a worst-case scenario, we may see the return of oil sanctions by the US on Iranian oil, which makes up 12% of OPEC production. However, we believe the impact will be negligible as China, given its Petro Yuan status, could be able to absorb Iran’s output as in the past.

• We maintain our Brent crude oil price forecast of US$85/barrel for 2024F. As a comparison, our forecast is broadly close to EIA’s Short-Term Energy Outlook expectation of US$83/barrel. Although Brent crude oil prices have seen a slight decline in January, we believe demand and supply dynamics still remain in favour of an elevated Brent crude oil price environment throughout the year.

• Maintain OVERWEIGHT on the sector. Our top picks are Dialog Group (BUY, FV: RM3.46), supported by its resilient noncyclical tank terminal and maintenance-based operations and highly strategic location in Pengerang; and Yinson (BUY, FV: RM4.00), the primary beneficiary of the FPSO upcycle. We also like Petronas Gas (BUY, FV: 19.97), which offers a decent dividend yield of 4.7%, which can be raised further from the optimisation of its capital structure together with sustainable recurring earnings for its gas transportation and processing operations.

Source: AmInvest Research - 24 Jan 2024