We came back from the Douglas Westwood (DW)’s Oil and Gas Talk feeling largely NEUTRAL as their view of a challenging market environment and expectations for a gradual improvement in oil prices were very much within our expectations. DW believes that the current downtrend is worse than the previous one in 2008/09 and concurs with the consensus view on a U-shaped recovery in oil prices, premised on the oil market reaching equilibrium in 2018. Impairments, unfortunately, in their view, are here to stay, despite many companies already taking big cuts in 2015 while earnings outlook remains murky amidst dwindling tenders, utilisation and expectations for further cost cutting. We were pleasantly surprised by the shale breakeven price of USD70- 75/bbl which is higher than our view of USD55-60/bbl, providing more upside room for oil prices over the near-term. While the lacklustre outlook in the upstream segment is likely to persist, we prefer downstream players like PCHEM for its long-term growth story anchored by the RAPID project. Reiterate NEUTRAL.

Current industry downturn is worse than 2008-09. We hosted Douglas Westwood (DW)’s Associate Director, Mr. Thomas Payne in a small group presentation on Tuesday. According to him, unlike the 2008-09 decline which was demand-led, the current down-cycle is led by oversupply mainly dragged by the key culprit, US shale oil production. Payne sees USD35-40/bbl oil price as a fundamental trough and believed it to be oversold at recent lows of USD20+/bbl. He appears confident in consumption growth and appears less concerned on a slowdown in China’s economy.

Expecting US production to show a lagged decline after the sharp falls in US oil rig count. Payne highlighted that approximately 600k bpd shale oil is already off the market (~<1% of global supply) with further attritions likely as long as oil prices stay below USD75/bbl – or the shale break-even line. Drilled but unfracked shale wells remain short-term price cappers but over the longer-term, he believes the shale industry will be capped by availability of capital after this recent ‘turmoil’ as shale investments could be deemed as higher risk.

Payne concurs with consensus view on a U-shaped recovery in oil prices, premised on oil market reaching equilibrium in 2018 with a corresponding oil price of USD65-75/bbl. That said, geopolitical reasons could see a quicker-than-expected recovery. Interestingly, Payne does not see the need for USD100/bbl oil as market has seen 20% cost reductions with E&P players squeezing contractors and service providers. Payne believes there is still pressure until 30-35% levels are reached, more pressure to charter rates and longer period before new fabrication and FPSO jobs surface.

Not over with impairment. Despite the massive kitchen sinking activities carried out in 2015, Payne is still anticipating more impairment ahead in view of weaker cash generating ability but ‘what is the right amount of impairment’ remains a very qualitative matter and differs from one company to another. Owners with more than 10 years’ old uncontracted assets will likely see further write-downs. He emphasised that the impairment is necessary and healthy for players to stay leaner and cost effective.

Mixed outlook on key sub-sectors. Overall, Payne is expecting the South East Asia market to stay sluggish in the next two years and will recover in 2018 onwards especially the offshore asset-focused players. Drilling rates are likely to stay at depressed level until the oversupply is neutralised while robust installation in FPS segment is expected in 2016/17 arising from previous commitment before oil prices plunged but to trend downwards beyond that due to lack of orders at this juncture. Basically, Payne opined that capex spent on LNG project will pick up gradually from 2016 to 2020 as it is seen as a resilient market which is delinked to oil prices.

Maintain NEUTRAL. We came back from the session feeling largely NEUTRAL as the view of a challenging market environment and expectations for a gradual improvement in oil prices were very much within our expectations. However, we were pleasantly surprised by the shale breakeven price of USD70-75/bbl which is higher than our estimate of USD55-60/bbl, providing more upside for oil prices over the near-term. While the lacklustre outlook in the upstream segment is likely to persist, we prefer downstream players like PCHEM for its long-term growth story anchored by the RAPID project. Reiterate NEUTRAL.

Source: Kenanga Research - 31 Mar 2016