Trump 2.0: Navigating Downside Risk The elected 47th US President, Donald Trump, is expected to fulfil his pledge to "drill, baby drill", signifying a substantial shift in US Energy Policy aimed at reducing inflation. Deregulations and tax cuts are widely expected to encourage oil producers to boost their production from 13.5MM bbl/d, although unlikely to be at the same rapid pace as 2020-2024. The President has also pledged to resolve the Ukraine-Russia conflict, potentially easing sanctions and allowing Urals oil re-enter the conventional market. On the demand side, China's crude oil imports have declined for sixth consecutive months on YoY basis, following the shutdown of major oil refineries due to overcapacity and weakened fuel demand. So far, OPEC+ is expected to continue supporting oil prices by delaying planned production increases; however, this could reduce its market share in the long run against US oil supply, potentially lead to price war as OPEC+ attempts to regain market share, in extreme case. Given these factors, we expect Brent crude oil prices to trade within range of USD60/bbl-USD80/bbl, averaging USD70/bbl for the year 2025. Consequently, we anticipate PETRONAS would adopt more cautious approach regarding future capital expenditure by deferring high risk investment to preserve cash flow. Nevertheless, we maintain our Neutral rating on the sector, with a bias towards a lower valuation.

• Boosting oil production with capital discipline. US is recording all-time high production at 13.5MM bbl/d and heading towards 13.7MM bbl/d by December 2025, according to US EIA projection. The deregulation and tax cuts would boost the production to the higher level as it would increase the economic feasibility for new investments. Nevertheless, we are not expecting a rapid growth in production in the near term as it requires companies to shift their reserve allocation from rewarding shareholders to ramping up in capex for new investments.
• EV impact on oil demand. The increase in electric vehicle adoption and slower economic growth in China has led to an oversupply of petroleum products. According to the IEA, electric vehicles have reached a 50% market share of new sales in China, a level anticipated to be achieved globally by 2030. This shift is projected to reduce global demand by approximately 6MM bbl/d.
• OPEC+ to support oil price but affecting its market share. Due to weakened demand from China, OPEC+ has postponed its planned gradual production increase by one month to December 2024 before the election. The bearish sentiment after the election may further delay planned production until 1Q 2025 under the base case scenario. We reckon the action to support the price appears to be less effective as OPEC+ is experiencing a reduction in its global market share amid increasing US oil supply.
• Bearish sentiment continues to sustain discounted valuation levels. The Bursa KL Energy Index shows a positive correlation with crude oil prices over the long term. However, the index valuation has remained depressed at -1SD since 2022 despite an oil price increase and sector earnings recovery. The current bearish sentiment may sustain throughout in year 2025.

2024: Geopolitical headlines fuel volatility

Geopolitical risk keeps the market volatile for 2024. Based on our listed headlines below, 9 out of 22 news headlines have kept Brent crude oil prices volatile, as Palestine-Israel conflict has extended to Iran since the attacks on its embassy in April 2024. Meanwhile, OPEC+ has become passive, a contrast from an active action in 2023 where there were multiple extension of voluntary production cuts to support the oil prices. Also, demand outlook remains gloomy despite an escalated geopolitical risk as well as monetary easing in the US and EU.

Supply: Upside risk from US production

US oil production has been steadily rising, from 13.2 MM bbl/d in December 2023 to 13.5 MM bbl/d in October 2024. This growth is driven by increased new well production and sustained output from legacy wells. Before the election, the US EIA projected that production would continue to climb, reaching 13.7 MM bbl/d by December 2025, thanks to productivity gains and new infrastructure. Deregulation and tax cuts under the new administration are expected to further incentivise oil producers, enhancing economic feasibility and returns on new production investments.

Since November 2022, the rig count has been steadily declining, primarily due to falling oil prices and rising costs for equipment and labor. As a result, oil companies have prioritised paying down debt and enhancing shareholder returns rather than increasing output. According to figure 3, dividends and buybacks from oil companies in the S&P 500 Energy Sector have consistently surpassed USD 180bn over the past two years, significantly outpacing capital expenditure (capex). While a substantial shift in capex is unlikely, these companies may gradually increase capex to maintain production levels, particularly as policymakers are easing regulations.

Demand: China disappointed oil market

China's crude oil imports have been declining for sixth consecutive months with October 2024 imports recorded at 10.5 MM bbl/d, a -9% decrease YoY. This decline is primarily due to the closure of PetroChina's refinery, which is set to fully shut down its largest refinery in 2025 to relocate operations to a smaller area. The Dalian Petrochemical plant, with a capacity of approximately 410,000 bbl/d-about 3% of China's total refinery output-has already seen half of its capacity shut down. Additionally, other independent refiners are facing challenges due to weak refining margins and low plant utilisation rates, driven by weak demand.

Key agencies lowered the estimates on China's oil demand

to reflect more realistic oil consumptions. US EIA cut China's consumption estimates for the year 2024 from 400,000 bbl/d growth in July 2024 to a merely 100.000 bbl/d in October 2024 due to decline in imports and refinery runs. Meanwhile, OPEC reduced its projection to 450,000 barrels per day (bbl/d), reflecting a 2.8% growth in November 2024. This is a significant decrease from the 758,000 bbl/d (4.6% growth) estimated in July 2024. OPEC attributed this revision to a decline in diesel consumption, driven by a slowdown in construction activities, weak manufacturing output, and the increasing use of LNG-fueled trucks.

China is leading the electricity mobility with 50% of new car sales mostly coming from electric vehicles (EV), according to IEA. The trajectory of the EV is expected to capture nearly 70% of new car sales in China by 2030. Consequently, oil demand in China is projected to peak at 17.4 MM bbl/d by 2030 (from 16.2 MM bbl/d in 2023) before declining to 16.4 MM bbl/d in 2035, due to the increasing electrification of road transportation sector. In October 2024 report, IEA expects oil demand from China only to grow by 150,000 bbl/d in 2024, lowering its initial forecast by 30,000 bbl/d in July 2024, due to slower economic growth and accelerated EV adoption. This is well below average annual increase of China's oil demand at 600,000 bbl/d in the past decades.

Forecasting lower oil prices: What lies ahead

We view that China is no longer the growth engine for oil demand. China's road transport electrification and slower economic growth despite the economic stimulus been put in place, have structurally reduced the demand growth for fuel products in the long run. As a result, China's oil refineries have suffered squeezed in profit margin, leading to a decline in utilisation rates. The situation could worsen for refiners as it may face new challenges to procure discounted crudes from Iran with intensified US sanction, and also Russia with potential easing sanction under Trump 2.0 administration.

Our base scenario, OPEC+ would continue to support oil price by extending its voluntary cuts or perhaps with deeper cuts if the price drops further below USD60/bbl. However, we doubt the effectiveness of deeper cuts in sustainably support the oil price given the shrinking market share. Meanwhile, US oil production would steadily expand but the pace of growth would depend on oil prices, investors' appetite, proposed regulations and tax incentives. Geopolitical factors continue to influence the oil price and we expect greater volatility, especially when comes to issues involving oil producer countries like Iran and Russia. All in, we expect Brent crude oil prices to trade within range of USD60/bbl-USD80/bbl, averaging USD70/bbl for the year 2025.

Under the extreme scenario, crude oil price war could happen if US continuously upsets OPEC+ members namely Saudi Arabia and Russia. In the event of a price war occuring, the Brent crude oil price may drop to below USD30/bbl, in order for OPEC+ to achieve their objective to remove US oil supply from the market. However, we would like to highlight that the situation is unlikely as it will result in a lose-lose situation and more harm to all producers in the market. As the excess supply risk is more prevalent, US oil producers and OPEC+ would be more cautious to boost oil supply in market.

PETRONAS to undertake capex prioritisation

In March 2023, amid a stable oil price outlook, PETRONAS revealed its plan to allocate RM300bn of capex for the next five years, averaging RM60bn per year (2023-2027). Following this, it stated that around ~RM113bn would be directed for domestic capex over the similar period, averaging RM22.6bn annually. Despite a volatile oil prices in the past, PETRONAS' capex spending appears to be on track, with no indication of any deferral in its capex plan. However, with PETROS emerging as the sole gas aggregator in Sarawak, PETRONAS stands to lose a significant source of income. Additionally, the Federal Government expects a similar dividend payment of RM32bn in Budget 2025, on the back of USD80/bbl oil price assumptions. These domestic and global uncertainties might prompt PETRONAS to reprioritise its capex plan to enhance its cash flow management, by decelerating greenfield and non-critical projects such as exploration activities for drillers e.g. Velesto (non-rated).

No major re-rating catalyst

Bursa KL Energy Index has positive correlation with Brent crude oil prices, except for a noticeable divergence when the index lagged behind oil prices during the onset of Russia's invasion of Ukraine in February 2022. This period also coincided with the reopening of the domestic economy post-COVID-19 pandemic. However, in terms of valuation, the earnings recovery has failed to excite the market to trade the index back to the mean. Instead, it has consistently trade at a -1SD forward PER of 8.5x despite the heightened geopolitical risk. We believe the bearish sentiment would persist in 2025, in view of the on-going structural decline in global demand with China's aggressive adoption of electric vehicles while global supply remains abundant. Though we see limited downside risk given the depressed valuation, we do not see any major re-rating catalyst in the near term. Thus, we maintain our Neutral call on the sector.

Impact on the respective stocks

In summary, lower oil prices will have both direct and indirect negative impacts on companies. Oil producers will be directly affected as their revenue is tied to the sale of crude oil. Other OGSE will experience indirect impacts primarily due to reduced capex allocations and maintenance budgets from oil producers. In light of the structural changes in oil market fundamentals and sector valuation, we are adjusting our PER time series analysis to focus on approximately 3 years of historical data, rather than the previous 5 years. This adjustment aims to exclude the anomalous valuation period during the COVID-19 pandemic (2020-2021) and to provide a more relevant analysis in the context of the ongoing structural changes. Below is an overview of the earnings and valuation adjustment within our coverage.

Source: PublicInvest Research - 15 Nov 2024