We came back from the Douglas Westwood (DW)’s Oil and Gas Talk feeling largely NEUTRAL as we concurred that the sector has yet to enter into an upcycle in view of sluggish capex growth. South-East Asia (SEA) region is lagging behind other regions for its conventional shallow-water fields coupled with longer contracting terms. Meanwhile, DW sees more stability in oil prices, in line with market expectations of oil prices stabilising at an average of USD56/bbl this year while falling oil production in China will serve as a “Bamboo Floor” to oil prices. Saudi Aramco’s IPO and Trump factor are seen as wildcards to oil prices. Impairments, unfortunately, in their view, are here to stay, despite many companies already taking big cuts in 2015/16 while service contractors’ earnings outlook remains murky amidst dwindling tenders, and vessel utilisation. SENERGY (OP, TP: RM2.24), in our view, remains the best proxy to trade the volatility in oil prices and ride on the gradual recovery of the sector while YINSON (OP, TP: RM3.73), on the other hand, is our top pick for non-Shariah compliant investors looking for earnings resiliency within the upstream space.

Forming of Bamboo floor. As a sequel to our ‘The Ups and Downs of Crude Oil’ Talk series hosted in the past two years, we hosted Douglas Westwood (DW)’s Associate Director, Mr. Thomas Payne for a follow-up talk yesterday. Payne sees more stability in oil prices, concurring market expectations of oil prices stabilising at an average of USD56/bbl this year. Furthermore, OPEC’s production cut extension which will be decided in end of May, which would likely to lift oil prices up to USD60/bbl but potentially neutralised by inventories building and increasing shale production in US. Interestingly, Payne believes that the falling oil production in China from a peak of 4.3mbpd to 3.9mbpd would serve as a “Bamboo floor”, limiting downside risk in oil prices.

What are the wildcards? The move by the Saudi government in taking its national oil company Saudi Aramco public would potentially serve as a wildcard to oil prices. Apart from giving more incentives for Saudi Arabia, the leader of OPEC to support oil prices for better valuation in the near term, the IPO will allow higher transparency to the well managed entity, including its potential reserves. This would probably affect oil prices positively if the reserves/productions do not meet the market expectations or vice versa as the company has the world’s largest proven oil reserves and highest oil productions. On the other hand, Payne also sees that the US President Donald Trump as another wildcard to oil prices whom is prone to heightening geopolitical tensions and accelerating oil and gas exports. Note that oil prices rose about 2% following the US attack on a Syrian airbase beginning of the month.

Onshore E&P to lead the recovery. As most oil majors remain cautious in their capex spending, Payne reckons that the global E&P spending recovery in the next two years will be largely driven by North America onshore fields while offshore E&P spending will lag behind. In addition to that, the South-East Asia (SEA) region is also deemed to be lagging behind other regions for its conventional shallow-water fields coupled with longer contracting terms delaying the dwindling of services contractors’ earnings. Hence, SEA’s E&P spending would probably recover materially in 2019, underpinned by deep water project sanctions. Meanwhile, services contractors are still not out of the woods where the fittest will survive in a limited job and price slashing environment.

Maintain NEUTRAL. Despite the massive kitchen sinking activities carried out in 2015/16, Payne is still anticipating more impairments ahead in view of weaker cash generating ability. OSV market is expected to stay oversupplied unless there is vigorous enforcement on age restrictions on older vessels and merging of contractors to enhance competitiveness to shake out more inefficient players. Overall, we came back from the session feeling largely NEUTRAL as we concur that the sector has yet to enter into an up-cycle in view of sluggish capex growth. SENERGY (OP, TP: RM2.24), in our view, remains the best proxy to trade the volatility in oil prices and ride on the gradual recovery of the sector given: (i) the company being the largest integrated oil and gas services player in Malaysia in terms of market capitalisation providing sufficient liquidity, (ii) its oil production profile, which is directly related to stronger oil prices, and (iii) its undemanding valuation at 0.9x FY18E PBV. YINSON (OP, TP: RM3.73), on the other hand, is our top pick for non-Shariah compliant investors looking for earnings resiliency within the upstream space.

Source: Kenanga Research - 20 Apr 2017