Highlights

• OPEC production cut. OPEC has announced cut worth 1.2m bbl/day on the condition that non-OPEC countries, to be led by Russia, would cut 600,000 bbl/day. While it is positive in the near term, we opine that oil price would not move beyond U$60/bbl level in 2017 due to (i) lack of quota discipline exercised by OPEC producers (ii) some non-OPEC countries should be ramping up due to irreversible projects planned (iii) US could be ramping up whenever oil prices rallies and (iv) IRAN is still being exempted from the cut.

• US$50-60/bbl target maintained. We are still maintaining our oil target for 2017 at US$50-60/bbl as we opine that oil price would face resistance when it nears US$60/bbl as more US shale producers would ramp up their oil production swiftly, bringing it back to its old vicious cycle.

• Oil majors’ CAPEX to be similar in 2017. CAPEX of oil majors are expected to only increase marginally in 2017 if the countries were to adhere to the production cut quotas. Malaysia, for instance, would be expected to cut 20,000bbl/day worth of production from Jan level and this presents a hurdle for aggressive increase in CAPEX in 2017 if it is to be adhered.

• Impact on companies? Upstream oil producers (such as SKEPETRO, Reach Energy and Hibiscus Petroleum) would be the prime beneficiary of improvement in oil prices on higher oil revenue and earnings. . However, drilling market in Malaysia would still be oversupplied in 2017 with 11 rigs owned by listed companies alone (Perisai and UMWOG), of which circa half of it is still idle at this juncture.

• The others. Fabricators experienced a slow 2016 with minimal EPCC jobs awarded while RAPID EPCC jobs have been secured mainly by foreign contractors. In 2017, we expect some job flows, namely Bokor EOR wellhead platform EPCC and Hibiscus North Sabah EOR contract for the fabricators, but would not be sufficient to bring amount substantial recovery for local contracts. Other production service players are expected to see mild improvements in 2017 but the expected earnings growth does not warrant a rerating.

Catalysts

• Weaker than expected oil production growth.

Risks

• Further slump in oil prices.

• Significant supply overhang in jack up rig market

Rating

NEUTRAL

• While O&G companies’ earnings under coverage is believed to have bottomed in 2016, earnings recovery overall in 2017 is still not sufficient to justify a rerating on the sector as a whole. We are turning slightly more positive on the sector and we have upgraded sector valuation PBV target by 0.1x overall and +1x for PER-driven stocks. We elect to wait clearer signs of recovery to warrant a more drastic upgrade in sector. Our top pick is REACH (BUY; TP: RM0.83) .

Source: Hong Leong Investment Bank Research - 11 Jan 2017