The fall-out between OPEC and Russia over the weekend has drastic implications for the O&G sector. Brent oil prices hit an intraday low of US$32/bbl (down 30% overnight). Correspondingly, the Malaysian Energy indices dived 25% at closing. We maintain our Neutral rating on the sector but cut the target prices for stocks under our coverage to factor in a higher risk premium to take into account near-term volatility.

Saudi Arabia Vs Russia

Saudi Arabia launched an all-out oil price war with Russia after rejecting OPEC’s proposal to cut an additional 1.5mmpd from global supply. Out of the 1.5mmbpd, OPEC would cut 1mmbpd, while non-OPEC would cut 500kbpd. Both countries depend heavily on oil, making up a big percentage of their exports. With the deal falling apart, OPEC plans to ramp up production by 2mmbpd to 11-12mmbpd by April 2020, and has slashed its prices by US$7- 8/bbl for export to Europe (Russia’s key market) and the US in an attempt to squeeze both producers. Prices in Asia have also been cut by US$6/bbl by Saudi Arabia. Russia has yet to show any retaliatory moves.

Revising Our Brent Forecasts

Given the softer 1Q20 oil demand due to negative implications from the Covid19 outbreak and OPEC’s recent oil price war with Russia, we lower our Brent oil price forecasts to US$50-55/bbl (from US$60-65/bbl). However, calm often only comes after the storm. We expect OPEC and Russia to achieve some form of compromise in the coming months and a gradual recovery in oil demand as the Covid19 situation is already showing some signs of containment, especially in China. We expect long-term Brent to trade in a range of US$60-65/bbl.

Petronas Capex Allocation Based on US$50/bbl

In the event Brent oil prices stay below US$50/bbl, we see risk of Petronas cutting its RM50bn capex guidance in 2020 as its current capex allocation is based on a US$50/bbl assumption. Nevertheless, we believe brownfield projects may face lower risks as projects/work scopes are categorized as opex rather than capex.

Earnings Growth During the Past 2014 Crisis Affected Small/mid Caps

To put things into better perspective, the earnings among our coverage contracted by 2.8% in 2014 but grew by 5.1% in 2015 due to growth seen in PCHEM, MISC and Sapura Energy. The oil price crisis mainly impacted the small/mid cap players which generally rely heavily on Petronas jobs. Fabricators, rigs and offshore support vessels also saw a slower roll-out of contracts and a big slash in daily charter rates.

Slashing Our Target Prices Across the Board

We lower most of our coverage target prices to factor in a higher risk premium, taking into account the near-term volatility. For Petronas Gas, Dialog, Bumi Armada and Velesto Energy, we used a 3-year beta (as compared to historical 5 years) from the previous oil-price crisis in 2014 in calculating our WACC. The rest of the companies’ valuation multiples have been lowered following this sector de-rating event. Please refer to Figure 7 for the summary of targetprice changes made.

Source: Affin Hwang Research - 10 Mar 2020