Oil prices fell 68% from this year’s peak to the lowest level since 2002 - below USD23/bbl as demand appeared to have been hit by work and travel lockdowns globally as part of efforts to contain the spread of Covid-19. It was exacerbated further by a price war between Saudi Arabia and Russia after its 3-year alliance fell through over Saudi’s calls for greater production cuts to support prices. After reaching a low last week, oil prices have rebounded by 46% however on the prospect of a win-win deal between the world’s three top producing countries. While there may be hope for the supply crisis to be resolved, we foresee worries over the Covid-19 global pandemic remaining as the recovery period may take longer than expected, leading to an unprecedented demand loss as lockdown period are extended. While we maintain our Neutral stance on the sector, we trimmed earnings forecast of various companies as we note that the 28-day movement control order (MCO) has reduced their efficiency levels despite no revision on work order quantum by oil majors thus far. We also re-visiting our valuation parameters to better reflect the current operating climate.

• Supply glut – any hope? After reaching a multi-year low last week, oil prices rebounded on the prospect of a truce in Saudi-Russia oil production and price war with a reversion to the previous OPEC+ output cuts agreement. There were talks that the key players were ready to lead the world by cutting up to 15 mbbls/day, pending a meeting later this week. The meeting may also involve other energy ministers from the G20 which will bring on board the US and other big oil producers such as Canada and Brazil on wider contributions to a production deal. Should this materialize, this will be the largest ever coordinated reduction in the oil market. Earlier in March, Saudi slashed its prices in an effort to gain market share and subsequently increased its production to a record high of more than 12 mbbls/day after the OPEC+ agreement broke down. With this additional supply flooding the market, the EIA expects inventory builds will be largest in 1H2020, rising at a rate of 5.7 mbbls/day in the 1Q and increasing to builds of 11.4 mbbls/day in the 2Q due to a sharp fall in demand.

• The unprecedented demand loss. Covid-19 has gone from being a China centric health crisis to a global health pandemic. While China has taken strong measures in response to the outbreak, the situation appears to be worsening around the world, with more than 200 countries reporting cases. While the Covid-19 pandemic is having a much bigger international impact than SARS, impact of the disease had been underestimated earlier. The world’s 3 big oil agencies - IEA, EIA and OPEC highlighted the uncertainty over the virus’ repercussions for global oil demand then, but only with minimal impacts. OPEC cut its forecast by 400 kbbls/day while the IEA and EIA slashed its 1Q global oil demand forecast by 435 kbbls/day and 900 kbbls/day respectively. Based on recent data by EIA, demand is estimated to decline by 5.6 mbbls/day in 1Q and to collapse by 12.2 mbbls/day in 2Q due to significant disruptions to global economic activity along with reduced travel globally, a stark contrast to before.

• Petronas - reassessing its plans and budget. While there is no sign of lower work order by oil majors thus far, it is understood that Petronas is still assessing its plans and budget in light of the price plunge. Based on our channel checks with some industry players, discussions are currently on going with the main focus including the assessment on the sector and areas to cut. That said, we are not surprised with its plans to continue its domestic capex of RM26bn to RM28bn despite the lower oil price, going by the 2016 and 2017 period (relatively similar price conditions) where it cut overseas capex by 66.1% and 25% while increasing the domestic portion by more than 80% for two consecutive years. It also intends to maintain its dividend payment of RM24bn to the Government for FY19. Nevertheless, if the low oil price environment prolongs, Petronas may need to preserve some cash for future investments while also preparing for potential requests from the Government (special dividends) in the current challenging economic climate. With expectation of lower overseas allocation in order to spur the domestic economy, areas of work that might be affected (either defer or revision on the rate) will include the capex-heavy jobs like greenfield projects and FPSO, exploration and development services such as EPCC, drilling and OSV. Maintenance jobs will likely be continued with minimal rate adjustments.
• Earnings will be slightly affected by MCO first. While not imputing any impact from lower work orders yet, our earnings forecast for some companies have been adjusted lower to reflect the 28-day MCO which has affected efficiency levels. Although the industry has been classified as part of the essential services that allows them to remain operational, stricter operating procedures in relation to health and safety still needs to be performed however, in order to protect their workforce while minimizing the risk of spread of infection. With the need of keeping distance between one worker to another, the number of workers also needs to be reduced. While the operations are still on-going, restricted mobility has thereby curtailed speed at this juncture. Our channel checks indicate that efficiency levels during this period are around 50% - 70%. Meanwhile, some companies with overseas exposures are also experiencing slower activities owing to the need to stop due to total lockdowns in those countries. Our adjustment on earnings are summarized in Table 2.
• Our views: Uncertainty remains. While there may be hope for the supply crisis to be resolved, we foresee worries over the Covid-19 global pandemic remaining as the recovery period may take longer than expected, leading to an unprecedented demand loss as lockdown period are extended. The impact on energy markets are still evolving and have caused significant changes in supply and demand patterns. According to the IEA, even if OPEC+ and other producers agreed to a cut of 10 mbbls/day, global oil inventories would still rise by 15 mbbls/day in the 2Q as the pandemic destroys unprecedented volumes of demand with more than 3bn people worldwide remaining in lockdown. This also after considering that the vaccine for Covid-19 has yet to be found, hence consumer sentiment remaining weak. We maintain our Neutral call on the sector. During this period, we prefer Serba Dinamik and Dialog Group given its defensive and recurring income business natures.

Source: PublicInvest Research - 8 Apr 2020