Highlights

• 2Q17 a weak quarter for oil prices. Average Brent crude oil prices weakened 7.5% sequentially to US$49.6/bbl in 2Q17 (compared to US$53.6/bbl for 1Q17) due to increase in US crude oil production. As per latest update from Baker Hughes on 7 th Jul 2017, US land rig stood at 927 rigs (+12 QoQ increase), further reaffirming US oil production ramp up being the major contributor to the weak oil prices.

• 2H17 to be supported by seasonal demand and inventory drawdown. EIA’s forecast implies that world oil demand would be strong in 2H17 due to seasonality. Sizeable world oil inventory drawdown is expected to occur in 3Q17 by an estimate of 0.4m bbls/day due US summer driving season. Draws on oil inventory is expected to taper off in 4Q17 before inventory build-up resumes in 2018.

• 2017 oil price target reiterated. In 1H17, Brent has averaged at US$51.6/bbl, still within our forecast range of US$50-60/bbl for whole year of 2017 albeit at the lower end. As we anticipate strong demand support with inventory draw down in 2H17, our full year forecast remains unchanged. YoY, oil price would still register an improvement from a low base of US$43.7/bbl average in 2016, leading to a firmer footing for the O&G industry.

• Days of US$100/bbl more distant than ever. Beyond 2017, the industry might not see oil prices reaching US$100/bbl within the next 5 years; oil prices might take longer than that to recover to its previous heights mainly due to US shale technology improvement allowing shale oil economics to be viable even at US$50/bbl level. Short investment cycle of shale rig has also given US shale producers the ability to produce more oil within 6 months’ time, lowering oil supply shock possibility for world oil market.

• However, oil prices are well supported. Despite bleak long term outlook, significant downside appears to be limited as OPEC countries would more than likely to be incentivised to extend their production cut beyond March 2018 to cover their government’s fiscal budget. EIA has also factored in the extension of production cuts by OPEC in their global oil production forecast. Overall net deficit of world oil market is expected to materialize in 2017 but will soon return to surplus in 2018 which points to stable oil price outlook rather than improving oil prices.

Risks

• Further plunge in oil prices.

Rating

NEUTRAL ( ↔ )

• Call maintained on the sector with oil prices expected to remain range bound. The sector is expected to continue trading sideways while gradual increase in CAPEX in the upstream segment is expected.

Valuation

• Top Pick: DAYANG (BUY; TP: RM1.42) –Attractive valuation with potential value unlocking corporate exercise expected to refloat Perdana shares.

Source: Hong Leong Investment Bank Research - 17 Jul 2017