Highlights 

Oil price lower on multiple factors …  Recent decline in crude  oil prices  was driven by several factors, including (i)  ample  global  crude  supply  boosted  mainly  by  US shale oil and gas; (ii) weak ening demand outlook due to dimmer  economic  pros pects  in  China  &  Euro  zone;  (iii) diminishing financial  demand;  and (iv)  US$ appreciation .

Lack  of  short -term  price  catalysts…  We  expect  the “ample  supply - weak  demand”  scenario  to  persist  into 4Q14  and  early  part  of  2015.  US $  may  appreciate further,  especially  after  QE3  tapering  in  Oct -14  which gives  rise to divergence  of global monetary policy .

Limited  macro  impact...  Lower  crude  oil  price  is negative on exports, trade balance and GDP growth, but mildly  positive  on  government’s  finance  (immediate year) and headline  inflation.

Oil  price  still  above  critical  US$80/bbl  breakeven level…  The  break even  for  US  shale  oil  is  estimated  at US$50- 80/bbl while ultra deepwater at US$70 -80/bbl. In our  opinion,  we  view  US$80/bbl  as a key level, if Brent crude  fell  below  US$80/bbl  level,  oil  majors  might reduce capex o n new projects which will negative impact E&P companies such as SPAC, drilling and OSV servic e providers.

Unlikely  to  drop  below  US$80/bbl…  We  understand many  OPEC  countries  favour  oil  prices  above US$100/barrel  in  order  to  meet  the  bu dget  need.  In additio n,  shale  oil  projects  in  US  have  breakeven  price range  from  US$50- 80/bbl.  Hence,  any  price  less  than the  cost  of  production,  investment  in  future  new  supply will stop.

Dry  spell  for  O&G  sector  in  near  term…  Decreasing oil  price  coupled  with  lack  of  near  term  sizeable contracts  newsflow  for  local  upstream  sector  will dampen  investor’s  sentiment.  

Our  Strategies:  Focus  on  RAPID  and  brownfield development  plays …  Favourite  picks  for  RAPID  are KNM (BUY;TP RM1.35) and Pantech (Non -Rated) while Scomi  Energy  (BUY;TP:  RM1.23),  Uzma  (BUY;  TP: RM4.19),  Dayang  (BUY;TP:  RM4.07)  and  Perdana (BUY;  TP:  RM2.18)  will  be  benefit  from  increasing brownfield  development.

Catalysts 

• Upgrades:  New  Discoveries,  marginal  field  contract awards, M&A.
• Downgrades:  Sharp plunge  in oil prices.

Rating

OVERWEIGHT

• Positives:   We  believe  that  the  ETP  driven  RM300bn Capex  spending  to  enhance  exploration,  EOR  and Marginal  fields will drive  earnings in the sector.
• Negatives:  execution  risk,  delay  in  contract  rollout  and investors’  perceptions   on previous  disappointments.

Valuation

• Top  picks:  Big Cap: SapuraKencana,  Mid to Small cap: KNM and Scomi Energy.

Source: Hong Leong Investment Bank Research - 23 Sep 2014