Investment Highlights

• Breaching key US$60/barrel. West Texas Intermediate (WTI) crude oil prices finally breached the US$60/barrel threshold, up 5% since the beginning of December 2017, as Brent moved in tandem, rising by 7% to US$67/barrel. This is a key milestone as market concerns turn towards an acceleration in US shale production, which accounts for over half of the country’s oil output.

• Supply-demand imbalance persists. Even with the extension of OPEC production quotas until the end of 2018, US crude oil production still remains elevated at the near all-time high of 9.8mil barrels/day. However, this exuberance is dampened by the slight drop of 2 rigs to 929 rigs for US oil and gas rigs, which is still 2.3x up from the May 2016 low of 404, with the trajectory inching higher as this is less than half of the 2011 peak of 2,026. Barring a further deterioration shift in geopolitical tensions, we view the current price dynamics at a precarious position given the persistent supply-demand imbalance.

• Maintain 2018 price outlook. Our earlier 2017 crude oil projection of US$50/barrel-US$55/barrel has proven to be spot on as Brent crude oil spot has averaged at US$54/barrel and WTI at US$50/barrel for the year. Our 2018 crude oil projection of US$55/barrel-US$60/barrel is maintained given that the recent optimism stems from post-continuation of OPEC’s production quota and geopolitical concerns in the Middle East amid concerns of a US shale oil resurgence. As a comparison, the EIA projects crude oil prices at US$57/barrel for 2018.

• Improved contract awards from 2018 Pan-Malaysian umbrella jobs. Contract awards have declined by 15% YoY to RM7.6bil in 2017, even though 4Q2017 rose 20% QoQ to RM1.6bil mainly from the 2018 Pan-Malaysian Transport & Installation/Maintenance, Construction & Modification jobs to Sapura Energy. This was a hefty surge of 14x YoY vs. only RM112mil in 4Q2016. As these Pan Malaysian umbrella scope of works are mainly determined on a call-up basis, we still expect Petronas to maintain a cautious approach to upstream exploration and development expenditures. Hence, for Malaysian operators which operate wholly offshore, these weak capex rollout prospects forebode that the worst can stretch for quite a while for those struggling with high gearing such as Bumi Armada, Alam Maritim and UMW Oil & Gas.

• Multiple push and pull factors. The oil price trend clarity is muddled by: 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 and growing adoption of fuel-efficient-cum-electric vehicles 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) commitment by major countries, excluding the US, towards the Paris climate agreement.

• Possibility that ESG-compliant global funds may avoid oil & gas stocks. The recent decision to exclude oil and gas stocks from Norway-based Norges Bank Investment Management’s US$1tril fund may be an indicator of trends for other global funds in their commitment towards compliance to environment, social and corporate governance policies.

• Higher price sustainability is key to sector upgrade. We may upgrade the sector if the visibility improves for a faster pace of upstream capex rollouts, which ultimately hinges on higher crude oil price sustainability. In our view, the catalysts would be: 1) a stronger global economy to drive increased oil consumption, 2) deteriorating geopolitical tensions in the Middle East and West Africa, and 3) growth constraints to US crude oil production, which is set to exceed the all-time peak of 9.6mil barrels in March 2015.

• De-rating from further oil glut. On the other hand, we may downgrade the sector on prospects of an expanding oil glut due to: 1) continuation of US crude inventory expansion, 2) slower-than-expected global economic growth, and 3) non-compliance by OPEC members to their agreed quotas, which will again lead to aggressive measures to regain market shares.

• Maintain NEUTRAL stance as the prospects of the sector over the next 12 months are muted as offshore development prospects remain gloomy even though crude oil prices have risen above US$60/barrel given Petronas’ unchanged view that the longer term the direction for crude oil price appears to be “lower for longer”.

• Our top picks are companies with stable and recurring earnings such as Dialog Group and Yinson. 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. We maintain a HOLD for Petronas Gas due to the upcoming implementation of the incentive-based regulatory tariff setting mechanism in January. Our other HOLD calls are for Sapura Energy, MISC, Bumi Armada and UMW Oil & Gas.

Source: AmInvest Research - 2 Jan 2018