Saudi Arabia and Russia failed to agree on deeper production cuts beyond the agreement to maintain production cuts of 1.7m (+0.5m in 1Q20) bopd up to March 2020. This divorce in the OPEC+ cartel will theoretically result in a free for all production rush beyond the agreed March deadline, thus resulting inevitable downside price risk. We selectively downgrade stocks that are collateral damage should Petronas and other oil majors delay activities to preserve cash flow should oil prices continue to slide further. MISC emerges as our top pick for its resilient earnings profile backed by long term time charters, whilst its spot tankers are potential beneficiaries from higher oil trading. MISC also has a relatively decent dividend yield (FY20: 4.3%).

The ugly. Saudi Arabia and Russia failed to agree on deeper production cuts beyond the agreement to maintain production cuts of 1.7m (+0.5m in 1Q20) bopd up to March 2020. It is understood that OPEC had proposed to increase production cuts by a greater quantum (1.5m bopd) throughout 2020 to curb the effects of Covid-19 on global demand. This divorce in the OPEC+ cartel will theoretically result in a free for all production rush beyond the agreed March deadline, thus resulting inevitable downside price risk to our USD60bbl assumption with some touting a possible return to USD30bbl as players scramble to shore up market share.

The geopolitical dimension. We expect short term oil price risk and earnings risk to the sector to be elevated on these recent developments. It is understood that Russia views further production cuts will be to the benefit of US shale producers at its detriment, and is using this opportunity to hit back at US shale producers in a tit for tat response to USA’s sanctions against Nordstream 2 and Rosneft’s Venezuelan businesses in what is seen as the weaponization of oil by the Trump administration.

Petronas capex. In FY20, Petronas’s capex target of c.RM50bn was premised against a crude oil price assumption of c.USD50/bbl, with an increase of >10% YoY allocation towards domestic capex to c.RM26-RM28bn. In view of the recent developments, we foresee that the probability of Petronas reducing or delaying activities in 1H20 could materialize in an effort to protect its cash flow as crude prices trend downwards. Earnings visibility on upstream services companies such as rig players - Velesto (BUY, TP: RM0.26), Dayang (BUY, TP: RM1.81) for MCM and HUC and yards such as MMHE (HOLD: TP: RM0.74) enters opaque territory.

Collateral damage. In the immediate term, expect players such as Hibiscus (NR), Reach Energy (NR) and to a lesser extent Sapura (BUY, TP: RM0.14) and Dialog (BUY, TP: RM3.87) to take a hit due to their direct exposure to upstream assets. We also expect PChem (HOLD, TP: RM5.06) to be affected on further downward pressure on ASP’s whilst Naptha based players such as Lotte (NR) to benefit from improved feedstock spreads further adding to the ASP woes of downstream petrochemicals amidst soft demand on weak global growth.

Forecast. We view Saudi’s immediate reaction to slash official selling prices to Asia, Europe and North America by as much as USD8/bbl as at 7th March as a measure to get to get the Russians back to the negotiating table, which at this juncture, remains a possibility. We are revising our oil price assumption for 2020 from USD60/bbl to USD50/bbl on the premise that (i) in the last price war of 2014 prices, crashed 65% over a 6-month period, (ii) in 2014 the global economy was in much better shape, (iii) USA is energy independent in 2020 and (iv) Covid-19 exacerbates the weaker demand.

Maintain Neutral. In view of all this, we are selectively downgrading stocks in the sector that are (i) potential collateral damage due to potential delay in activity by Petronas/other oil majors, and (ii) fundamentally affected by lower oil prices on its operating margins - PCHEM (See Figure #1). We are upgrading MISC to BUY from HOLD as it earnings profile remains resilient with c.70% of earnings coming from long term time charters, furthermore their spot tankers could benefit from higher oil trading as Asian buyers take advantage of the deep discounts emerging from this crisis. We also reiterate our BUY call on Dialog, a beneficiary of global oversupply of oil as its tank terminals should see an uptick in utilisation rates, partially offset by a downturn in its upstream assets.

Source: Hong Leong Investment Bank Research - 11 Mar 2020