OPEC+ fails to meets target production. Despite OPEC+’s pledge to increase its modest oil output (additional +400k/barrels per day each month) during the April meeting, the actual production has consistently trailed (Figure#1) the implied targets, thanks to: (i) US shale producer bankruptcies, (ii) carbon pricing and other climate driven regulations, (iii) under-investment in expanding oil capacities, and (iv) ESG mandates to decarbonize. In the wake of the disruptions, we reckon the already multi year low global oil inventories (eased 17% to 2.65bn barrels in Feb 22 from a high of 3.2bn barrels in Jul 20) is set to prolong, exerting further upward pressure on global oil prices going forward.

The rising geopolitical tension. Prior to the Russia-Ukraine war, crude oil price was already on an ascending trend as demand was supported by post-Covid reopening. Overall, the protracted Russian-Ukraine war and the EU's plan to ban Russian oil imports in response to the invasion of Ukraine will further escalate oil price, as the EU relies on Russia for 26% of its oil supplies. According to IEA, close to 3m b/d of Russian production could be offline due to the international sanctions. In this regard, we note that the oil supply gap is widening and unlikely to be fulfilled by third party countries, given Russia supplies c.10% of the world oil together with some world oil producers is near their maximum cap spare capacity (Figure#2).

Further relaxation of Covid-19 lockdown in China soon? Based on Bloomberg, China has signaled that the Shanghai’s lockdowns could end soon (source), possibly by end of May. Once the government begins to lift the mobility restrictions that have disrupted the lives of millions of people in the country’s most populous city and disrupted everything from traveling to industrial production, oil imports should pick up ahead of the high-demand summer season, further bolstering prices for the commodity amid tight market supplies.

Overweight call. With elevated oil price, it is not far-fetched to imagine that the upstream oil & gas companies, may be incentivized to expand their capacities to capitalize on the lucrative oil revenues. We reiterate an Overweight call in the Oil and Gas sector, with Brent oil expecting to average at USD85-90 for 2022 (with an upside bias). Tactically, we prefer companies who have exposure in upstream exploration and production (E&P) such as HIBISCUS (BUY-TP: RM1.85) and DNEX (BUY-TP: RM1.64) as they are deemed the direct beneficiaries. On the other hand, we also like ARMADA (BUY- TP: RM0.84) for its recurring nature FPSOs business and inexpensive valuation.

Trend reversal. Technically, Bursa energy index has staged a strong breakout above the long-term downtrend line, indicating a trend reversal had happened. In this regards, the index might advance further toward 900-940-965, forming a higher high pattern.

Source: Hong Leong Investment Bank Research - 18 May 2022