Investment Highlights

• Higher crude prices bouys optimism. WTI prices rose to US$54/barrel while Brent surged above US$60/barrel, the highest in two years amid enthusiasm that OPEC may extend its supply-restraint deal amid persistent Middle Eastern security issues. Saudi Arabian Crown Prince Mohammed bin Salman this week supported OPEC extension of production cuts beyond March next year amid reassurances that the Aramco IPO is still on track. Meanwhile, crude flows from Iraq to Ceyhan in Turkey, remain below normal levels with the Kurds and Iraqis yet to reach an official ceasefire.

• Largest US rig count continues to drop, but production normalised. The US rig count on 27 October declined by 4 rigs to 909 rigs, continuing the downtrend since the 2-year peak of 958 on 28 July this year. However, US crude production reversed its trajectory, normalising to pre-hurricane levels by rising 13% from last week to 9.5mil barrels.

• Rig counts still healthy as the overall US number is 2.6x higher YoY. The number of oil rigs in the United States increased by 1 this week to 737 while natural gas rigs decreased by 5. Canada, which accounts for 20% of the North American rig count, experienced a decline of 11 in the number of active oil and gas rigs.

• Equilibrium may be approaching. These are some indications that equilibrium may be approaching for the oil & gas industry, as the pace of US crude production and the momentum of rig count acceleration are still tapering off, while the lack of investment in offshore projects curtail global production in the longer term. While we do not foresee a significant decline in US output in the medium term, we expect diminishing pressure from the supply imbalance to support crude oil prices, which is stabilising at over US$50/barrel levels.

• Multiple push and pull factors. Nevertheless, we note that there are still uncertainties in the price trend clarity from: 1) the ability of OPEC to ensure quota compliance as prices stabilise; 2) significant capex reductions which signal under-investment for future needs; 3) increasing proportion of renewable sources for electricity generation which could reduce liquid consumption and lead to “peak oil demand”; 4) pace of US deregulation under the Trump administration that could further accelerate crude output growth; and 5) decoupling of global economic growth from carbon dioxide emissions since 2000 in tandem with the shift towards gas and other energy alternatives together with fuel-efficient hybrid automobiles.

• Still persistent low asset utilisation levels expected for the medium term as we do not expect any significant change in Petronas’ cautious approach to upstream exploration and development expenditures. For 2Q2017 to date, contract awards have risen by 15% QoQ RM2.2bil largely due to the lumpy award of the RM1bil Bokor central processing platform project to MMHE. For Malaysian operators, which operate wholly offshore, weak capex rollout prospects mean that the worst can stretch for quite a while for those struggling with high gearing such as Bumi Armada and UMW Oil & Gas. Locally-based companies such as Perisai Petroleum Teknologi, Alam Maritim and Nam Cheong Group are currently in financial distress.

• Most of Petronas’ capex spent on RAPID. Petronas’ capex declined 21% QoQ to RM9.4bil in 2Q2017, which led to a decrease of 15% YoY to RM21.3bil in 1H2017, of which 59% was spent on the US$27bil Refinery and Petrochemical Integrated Development (RAPID). RAPID has reached a completion stage of 70%, compared to only 20% for exploration and development. So far, the 1H2017 capex spending accounts for only 35% of the RM60bil guided by Petronas for this year with average Brent crude oil prices assumed at US$45/barrel.

• Flat oil price forecast for 2017-2018. As Brent crude oil spot has currently risen above US$60/barrel, we may review our 2017-2018 projection at US$50-55/barrel pending further significant declines in US crude production. As a comparison, Petronas is projecting an average Brent price of US$45/barrel for 2017 while the EIA Short Term Energy Outlook forecasts Brent prices at US$52/barrel for 2017 and US$54/barrel for 2018.

• Maintain NEUTRAL stance for now pending a change in Petronas’ investment strategy, which is based on a “lower for longer” view. Our top picks are companies with stable and recurring earnings such as Dialog Group and Yinson Holdings. Dialog’s earnings visibility is secured largely by the Pengerang Deepwater Terminal project with its enlarged buffer zone while Yinson’s Ghana floating production, storage and offloading vessel project will provide the earnings momentum over the next 2 years. Our HOLD calls are for Sapura, MISC, MMHE, Bumi Armada and UMW Oil & Gas while Petronas Gas is a SELL due to the upcoming implementation of the incentive-based regulatory tariff setting mechanism.

Source: AmInvest Research - 30 Oct 2017