We came back from the Westwood Global Energy Group (WGEG)’s Oil and Gas Talk feeling more positive with expectations of higher activities in 2018 and oil prices to average at >USD60/bbl this year. Key positive surprises are: (i) elevating China’s crude import to drawdown of US oil inventory, and (ii) potential re-rating in oil prices post 2020-21 premising on supply deficit caused by the potential drop in US shale production after peaking by 2020 and under-investment in the upstream space. That said, be mindful that the cumulative job demand available for services players would be 25-30% lower than the peak activities during the heydays as Petronas is looking to award contracts more efficiently by sharing offshore assets with other PSCs instead of contracting them individually. Impairments, unfortunately, in their view, are here to stay, despite many companies already taking big cuts in past three years while service rates are expected to stay flattish. Keep NEUTRAL view with positive bias on the sector with SERBADK (OP; TP: RM3.80) and WASEONG (OP; TP: RM1.70) being the preferred picks.

Oil prices stabilising above USD60/bbl. As a sequel to our ‘The Ups and Downs of Crude Oil’ Talk series hosted in the past three years, we hosted Westwood Global Energy Group (WGEG)’s Director, Mr. Thom Payne and Karen Chan, Regional Manager, Asia Pacific for a follow-up talk yesterday. Payne sees potential retracement in oil prices from the current level of USD70/bbl on moderation of decline rate of US commercial inventory but is expecting oil prices to stabilise above USD60/bbl this year. He believes oil prices will re-rate significantly post 2020-21 premising on supply deficit caused by: (i) the potential drop in US shale production after peaking at 2020, and (ii) underinvestment in the upstream space. However, he believes that OPEC has to continue capping its production limit beyond 2018 in order to absorb the incremental shale production and additional 5mboepd from new projects committed back in the past few years.

Shale bubble bursting at 2020? Despite US shale production currently at the unprecedented level of 6.5mboepd, the consensus is expecting another wave of ramp-up in production to peak level of 8-9mboepd in the next few years largely underpinned by the potential expansion in Permian Basin. Payne pointed out that the number of rig count has fallen >50% in the past three years and is no longer a good indicator to gauge the increasing shale production. This is because the production per rig has gained >3x over the same period thanks to the technology advancement in fracking process. That said, the US shale production capacity would start to fall beyond 2021, which might lead to a supply deficit. On the other hand, similar to last year, Payne still sees the IPO of Saudi Aramco, Donald Trump’s policy and heightening geopolitical tensions as the potential wildcards to oil prices.

Elevating China’s crude import to drawdown US oil inventory. On a closer look on Asia, Karen is optimistic of China’s crude demand growth, backed by improving car sales especially for the larger vehicles segment. At the same time, China’s crude production is expected to stay flattish due to its uncompetitive cost structure, resulting in higher lifting cost at USD40/boe (vs. US Shale of >USD20/boe and Saudi’s

Anticipating higher activities in 2018. Payne reckons that the South East Asia (SEA) E&P market is in the midst of a recovery and is projecting the E&P spending to expand by CAGR of 5% in the next 5 years. This would translate into higher activities across the value chain of the sector. However, he highlighted that the cumulative job demand available for services players would be 25-30% lower than the peak activities during the heydays as Petronas is looking to award contracts efficiently by sharing offshore assets with other PSCs instead of contracting them individually. Meanwhile, services rates are expected to stay flattish given services players have low bargaining power amidst excess supply. Impairments, unfortunately, in their view, are here to stay, despite many players already taking big cuts in the past three years. That said, while 30-35% of the global OSVs are laid up, of which 55% are >15 years, there could be an uptick in OSVs’ utilisation if the scrapping of older tonnage increases.

Keeping NEUTRAL with positive bias. All in, WGEG appears to be more bullish than last year’s session, seeing the market as being in the midst of recovery with higher industry activities. However, the recovery of oil prices will be fragile depending on OPEC’s stance beyond 2018, and US oil output. Overall, we came back from the session feeling more POSITIVE as we concur that the sector is turning the corner. While we continue to feature counters with strong earnings delivery/potential earnings upgrade such as SERBADK (OP; TP: RM3.80) and WASEONG (OP; TP: RM1.70), watch out for bombed out counters such as UMWOG and ICON (Not-Rated) for a valuation catch-up play should exploration activities pick up. Keep NEUTRAL view with positive bias on the sector.

Source: Kenanga Research - 26 Jan 2018