The announced production cuts by OPEC and Russia, amounting to 10 bpd or c.10% of global output is a timely welcome. OPEC and Russia expects other nations (big elephant in the room being US which have been the biggest beneficiary of OPEC+ cuts since 2016) to also participate in the production cut. On the demand side, market participants are bracing for weaker demand in 2Q20 as Covid continues to ravage the global economy. We are keeping our oil price assumption of USD47/bbl for 2020 on the premise of some recovery in demand in 2H20 against the backdrop of the announced production cuts. MISC and Dialog remains our top picks for the sector for their resilient earnings profile.

Renewing their vows. Following the Opec+ divorce back in early March, the unprecedented move coupled with an outbreak of Covid-19 infections globally resulted in crude prices hitting lows of USD23/barrel. The announced agreement of production cuts by OPEC and Russia, amounting to 10 million barrels per day (bpd) c.10% of global output is a timely welcome. The cartel will cut 10 million bpd in May and June, 8 million bpd from July to December, and 6 million bpd beginning in January 2021 to April 2022. We understand that all members will reduce their output by 23%, with Saudi Arabia and Russia each cutting 2.5 million bpd and Iraq cutting over 1 million bpd. Despite the nagging concerns over huge oversupply due to sagging demand due to Covid 19, a coordinated cut is better than staying idle.

G20. OPEC and Russia expects other nations (big elephant in the room being US which have been the biggest beneficiary of OPEC+ cuts since 2016) to also participate in the production cut. Post the G-20 meeting, it is understood that the G20 have agreed to support the output cut, however stopped short on committing to a volume figure. It is understood that the quantum amounts to 5mbpd to help deal with the deepest oil crisis in ages. Assuming compliance, the total production cut amounts to c.15% of global production.

Demand side. The EIA’s recently released STEO report in April highlighted that global demand has decreased by 10-11m bpd as at 1Q20 (see figure #1). Market participants are bracing for weaker demand in 2Q20 as Covid continues to ravage the global economy. Some reports have estimated that global fuel demand has plunged by around 30 million bpd (30% of global supplies), as steps to fight the virus have grounded planes, cut vehicle usage and curbed economic activity.

Petronas capex. The risk of Petronas cutting its capital expenditures in FY20 increases with the duration of the Covid 19 outbreak. This is especially due to the additional stress on the government’s fiscal position arising from (i) the Prihatin stimulus (ii) potential credit ratings downgrade resulting from low oil prices and (iii) the potential of another special dividend in 2020, (it has been reported that Petronas is embarking on a USD bond sale program). Despite this, we are of the opinion that the capex cut will most likely stem from its overseas operations first before cutting domestic capex. Petronas’s FY20 allocation towards domestic capex to c.RM26- RM28bn.

Forecast. We are keeping our oil price assumption of USD47/bbl for 2020 on the premise of some recovery in demand in 2H20 against the backdrop of the announced production cuts.

Maintain NEUTRAL on sector. We maintain BUY on MISC for its resilient earnings profile (c.70% of earnings coming from long term time charters). 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. We take this opportunity to downgrade Armada to a HOLD with a lower TP of RM0.17 (from RM0.35) as we increase our SOP valuation discount to account for its highly leveraged balance sheet (2.6x) and earnings risk from its OMS segment. We upgrade MMHE to BUY from Hold given the recent sell down. MMHE has an orderbook of c.RM2.9bn, enough to sustain it through this trough and a net cash position of 30.8sen or 72.5% of its market cap. We upgrade Wah Seong to a HOLD from Sell since the share price retracement of 13% since our Sell call.

Source: Hong Leong Investment Bank Research - 13 Apr 2020