Investment Highlights

• Key takeaways from OTCA. We list below the salient takeaways from the Offshore Technology Conference Asia (OTCA) which was held last week.

• Focus on fiscal prudence. While activities in the upstream sector are starting to pick up, cost-push inflationary pressures are unlikely to materialise given the focus on fiscal discipline by oil majors. This is underscored by Petronas executive vicepresident and upstream chief executive officer Datuk Mohd Anuar Taib, who affirmed the continuation of a tight fiscal discipline emphasis to ensure no “sudden spikes” in capital and operating expenditures within the group’s role in providing energy in the most reliable, affordable and sustainable manner to consumers.

• 3-pronged strategy. Petronas’ three-pronged upstream strategy involves: 1) strengthening the group’s existing cashgenerating assets; 2) expanding core oil and gas business by enhancing an integrated model approach both internally and externally; and 3) expanding into adjacencies such as downstream petrochemicals and renewable alternatives.

• Expect more integrated tenders to contain cost pressures. In a session with Petronas senior vice president, corporate strategy Mohd Firouz Asnan, he highlighted that Petronas is still looking for the domestic sector to consolidate given Malaysia’s 3,500 vendors compared to 700 for Norway, which has a comparable hydro-carbon production. Pragmatically, local service providers need to scale up to provide the needed depth of capability, skill sets and integrated model solutions to contain cost pressures and optimise delivery lead time. As such, Petronas’ contracting structures will involve more integrated packages vs. piece-meal tenders, which will drive operators to further invest in new technologies or expertise.

• Rising gas attractions. Against the background of the Paris climate accord, energy supply is expected to shift towards cleaner sources such as gas, driven by rapidly growing demand from Asia which is underscored by China’s shift away for pollution-causing coal consumption and India’s under-served power system wherein 300mil citizens still lack access to electricity. In 2017, LNG supply rose by 30mil tonnes or 11% but demand kept pace due to new emissions policy, high coal prices and storage expansions. As the 2014-2015 plunge in energy prices has derailed high-cost gas developments in Australia and Canada, the impending market convergence has brightened the prospects of gas developments regionally such as India, Indo-China and East Malaysia.

• Emphasising digitalisation and big data. A key emphasis by the operators is a need to maximise digitalisation solutions and big data to integrate production from the well to finished products while ensuring safety and security. In our view, a large part of the sessions felt more like a technology conference instead amid players bracing for a “lower for longer” oil price scenario.

• Rising East Malaysian risks. We were fortunate to meet up with some key personnel from the Sarawak Chief Minister’s Office, who affirmed that Petroliam Sarawak (Petros) is definitely aiming to collaborate with Petronas in developing the state’s hydrocarbon reserves. Recall that Sarawak Chief Minister Datuk Patinggi Abang Johari Tun Openg has recently announced that the state will assume full regulatory authority over the upstream and downstream aspects of the oil and gas industry by July this year, which involve the issuance of necessary licences, permits, leases and approvals required under either the Oil Mining Ordinance or the Gas Distribution Ordinance.

• Possibility of lower Petronas equity stakes in East Malaysian PSCs. As the aim of these new regulatory regime is mainly to ensure a higher share (currently only a 5% state royalty on revenue) of the state’s hydrocarbon revenues to be deployed to Sarawak, there is a possibility that the state may assume half of Petronas’ equity share in the production sharing contracts (PSC) in the state, besides novating the federal government’s royalty of 5%. As Sabah may follow suit, these new considerations which will entail another bureaucratic layer of approvals may weigh down Petronas’ final investment decisions in East Malaysia notwithstanding closely-guarded negotiations currently between these concerned parties.

• Maintain OVERWEIGHT view on the sector given the stabilising crude oil prices above US$60/barrel notwithstanding Petronas’ cautious capex strategy amid our unchanged 2018-2019 Brent crude oil projection of US$60/barrel-US$65/barrel vs. the EIA’s WTI crude oil prices at US$58/barrel and Petronas’ internal target of US$52/barrel for 2018.

Our top picks are still 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 also have BUYs for MMHE, Sapura Energy and Bumi Armada, which are trading below their intrinsic values. We maintain a SELL for Petronas Gas due to the Energy Commission’s upcoming announcement of the transportation tariff setting mechanism next month, which we expect to be value-eroding due to an expected lower targeted rate of return on asset values.

Source: AmInvest Research - 26 Mar 2018