We remain NEUTRAL on the sector after attending the Oil and Gas Financial Forum (OGFF) 2015 organised by Malaysia Petroleum Resources Corporation (MPRC) recently. Bank Negara mentioned that impact from the oil price plunge on the Malaysian economy may not be as severe as anticipated by the market with Malaysia already reducing its reliance on oil revenue over the past few years while LNG demand remains largely intact with Japan’s nuclear reactors’ start-up time requiring a long lead time. Societe General pointed out that liquidity is still abundant in the market, although financing requirements are expected to be stricter and more selective given the tough market condition. Overall, we believe it is necessary for the sector to realign itself to the new environment of low oil prices with higher cost discipline and innovation in technology needed to fuel further growth in the industry.

To be a regional oil and gas hub. In his opening speech, Ir Dr Shahreen Madros, executive director of MPRC, highlighted that it aims to propel Malaysia to be the regional oil and gas hub through further developments in the downstream segment in contrast to its heavy focus on upstream business in the past. Moreover, it is also mentioned that human capital and technology level of the industry have to be improved further with more support from the financial market and consolidation in the industry.

Oil price impact to Malaysia not as severe as expected. While it cannot be denied that the oil price slump will cause a dent to government revenue, Bank Negara indicated that it is not all gloom as the economy had actually made inroads to diversify away from oil and gas revenue in recent years. With regards to concern about a drastic slowdown in LNG sales due to Japan’s (its biggest client) nuclear power generation restart, we understand that only three out of a total 80-90 reactors are involved only that require lead time of 1-2 years and this is not expected to cause any significant adverse impact on LNG demand in the medium-term.

The New Normal? Instead of a V-shaped recovery of oil price as in the 2009 crash experience, many of the speakers concurred that the current level of oil prices could stay for a while given OPEC’s decision to maintain its production level, at least in the near-term and increasing supply from shale oil revolution. Even if oil prices spike up again, additional supply from shale would come on stream with only months of lead time, therefore capping its upside. In the current environment, it is crucial for the industry players to adapt to the new environment to emphasise on efficiency and competitiveness compared to excess seen in the industry during the era of oil price at >USD100/bbl. Putting it into perspective, unit cost of oil has surged to USD43/bbl from merely USD7/bbl 4-5 years ago according to Boston Consulting Group. Margins of the service providers and oil producers are expected to shrink and normalise at a lower level for the whole industry to be sustainable under the current oil price scenario. This is in line with our view of more near-term hiccups expected in the industry while outlook in the long run is still positive.

Financing not dried up, but more stringent. Several speakers in the forum actually sounded that financing is still ample in the O&G industry despite the lower oil prices. Daniel Mello, Head of Energy Project Finance and Metals & Mining Asia Pacific from Societe General also mentioned that he has seen the industry functioning even at oil price of USD20/bbl. However, financing under the current scenario will be more stringent than before with only fundamentally robust companies being able to secure financing at reasonable cost. This is not entirely a piece of bad news for the market as it indicates that financing is now more prudent with capital allocated only to the ones with strong fundamentals, therefore, potentially removing excesses in the industry in the long run.

Market view largely in line, maintain NEUTRAL. In general, the market sentiment from the industry players and financiers and largely in line with our view of oil prices staying at current levels for a while. We believe it is time for O&G industry to consolidate and become more efficient. On the other hand, only players with strong fundamentals and financial standing will endure the near-term headwinds expected in the industry. At the moment, we believe OSV, fabrication and drilling players are facing the highest near-term earnings risks due to incoming rate revisions and delays in projects. On the other hand, maintenance-focused services, like UZMA (MP; TP: RM2.58), and FPSO players, such as YINSON (OP; TP: RM3.86) are in a better position to withstand the slowdown in the industry due to the more resilient nature of their businesses.

Source: Kenanga Research - 17 Jun 2015