The PSC award of block SK-410B to PTTEP, KUFPEC and Petronas Carigali is a positive surprise to us as it indicates a potential pick up in offshore exploration activities, which will eventually benefit the local services players. We do not discount the possibility of further PSC awards since the sector has been muted for more than one and an half years since the last PSC award back in Nov 2014. While flattish oil prices outlook, in our view, will cap the sectors’ valuations, we advocate investors to be nimble and selective and look out for strong contract flow as firm earnings recovery indicator. YINSON (OP, TP: RM3.90) and WASEONG (OP, TP: RM0.86) are our preferred picks within the upstream segment on resilient earnings outlook and improved earnings visibility arising from large contract wins, respectively. Downstream-wise, we like PCHEM for its long-term growth story anchored by the RAPID project. All in, we maintain NEUTRAL call but turning more positive on the sector.

First PSC award in 2016. Yesterday, Petronas announced the award of Production Sharing Contract (PSC) to PTTEP HK Offshore Limited (PTTEP), KUFPEC Malaysia (SK-410B) Limited (KUFPEC) and Petronas Carigali Sdn Bhd for the exploration Block SK410B. This block is located in the shallow waters offshore Sarawak, with acreages of approximately 1,800km2. Both PTTEP and KUFPEC will have 42.5% participating interest respectively and the remaining 15% interest held by Petronas Carigali. This is the first PSC award in 2016. According to news report, seismic survey and one exploration well would be conducted for the three year exploration period.

More to come? This is positive to the sector as it indicates that offshore activities, including exploration and development could pick up. SK410B is one of the 13 blocks being featured in Petronas’s block promotion exercise in 2015. The other 12 blocks include PM320 and PM321 in Peninsular Malaysia, SK304A, SK304B, SK405A, SK405B, SK405C, SK405E, SK410A, SK333 and ND11 in Sarawak and DW 2K in Sabah. In 2016, there are nine focus blocks consisting of both onshore and shallow water listed under the promotion exercise, with four blocks locating in Peninsular Malaysia, three from Sarawak and two from Sabah. We do not discount the possibility of further PSC awards since the sector has been muted for more than one and a half years. Recall that the most-recent PSC award was back in November 2014, when oil prices were on a steep decline. In November 2014, two blocks namely SB331 and SB332 in Sabah were awarded to local companies, SapuraKencana Energy Sabah Inc, M3nergy Bhd and Petronas Carigali.

PTTEP’s first operatorship in Malaysia. PTTEP HK Offshore Limited is a subsidiary of state-owned Thai giant, PTT Exploration and Production. The SK410B PSC award marks the first operatorship for PTTEP in Malaysia while Kuwait Foreign Petroleum Exploration Company (KUFPEC) has established its presence since 1998 and is currently holding interest in two exploration blocks (SB312 and DW3W) and one producing block (PM304).

Brewing for recovery? Stepping into 2H16, patchy news flow regarding contract award is bubbling within the upstream segment. Earlier on, Upstream reported that Petronas called for tender on Pan Malaysia transportation and installation contracts with contract period of 2+1+1. In our view, the contract size could be substantially smaller to the existing T&I contracts which is expiring end of this year due to re-adjustment of service rates. However, it signifies that Petronas could potentially unwind more opex spending in the event of oil prices stabilisation providing more confidence to the local oil major to dish out more jobs. Potential T&I winners include the incumbent contractors, SKPETRO (MP; TP: RM1.48), BARAKAH and PUNCAK.

Retain NEUTRAL call but slightly more positive on the sector. We maintain forecast of 2016 year-end Brent crude price at USD47/bbl as we see limited upside in crude prices from current level in 2H16, largely capped by: (i) potential revival of US production as evident by the rise in rig count, (ii) no intention of trimming oil production among OPEC members, and (iii) possible normalisation of short-term supply disruption. While flattish oil prices will cap the sectors’ valuations, we advocate investors to be nimble and selective and look out for strong contract flow as firm earnings recovery indicator. For instance, we recently upgraded WASEONG to OUTPERFORM in view of massive new contract awards that improves its earnings visibility for the next three years, arguing that the discount to book value would be narrowed on better risk-reward ratio. In all, YINSON (OP, TP: RM3.90) remains our preferred pick within the upstream segment on its resilient earnings outlook while we like PCHEM for its long-term growth story anchored by the RAPID project.

Source: Kenanga Research - 22 Jul 2016