OPEC and Russia had failed to agree on production cuts during their meeting last week in Vienna, sparking an end to the OPEC-Russia alliance. In retaliation, Saudi has engaged in an all-out price war and is now ramping productions to maximum capacity in order to flood the market. This had led to the largest single-day plunge of Brent prices in recent history. While a market correction is still possible as low oil prices could remove some shale oil output, we believe a sustained disruption could throw the entire market into disarray, given how well balanced the oil market was. As such, we cut our 2020 average Brent crude oil price assumption to USD40/barrel (from USD60/barrel previously). As for stocks, we see possible disruptions across the entire sector value chain. First to be hit are players with E&P exposure (e.g. SAPNRG, HIBISCS), while greenfield beneficiaries may see delayed project FIDs – impacting fabricators (e.g. SAPNRG, MHB), FPSO providers (e.g. YINSON, ARMADA), and pipe providers (e.g. WASEONG, PANTECH). Meanwhile, low oil prices could also assert further margin pressure to all equipment and services contractors across the board – e.g. DAYANG, UZMA, DIALOG, SERBADK, VELESTO, among many others. PCHEM may also be affected, given the high correlation between petrochemical prices and crude prices. We maintain NEUTRAL on the sector amidst the heavy sell-down, but with no preferred stock picks. We recommend avoiding the sector entirely until uncertainties are cleared. Should one really require exposure in the sector at this moment in time, we suggest going for proven resilient plays such as DIALOG, YINSON and SERBADK. MISC also deserves a special mention as its consistent dividends may provide some defensiveness. Bargain hunters may re-look at SAPNRG and ARMADA once things start to turn around, as these names are currently trading at near liquidation valuations.

Collapse of OPEC-Russia alliance sparking all-out price wars. OPEC and Russia had failed to agree on production cuts during their meeting in Vienna last week, marking the collapse of the OPEC-Russia alliance. In retaliation, Saudi engaged an all-out price war, slashing its prices for crude by the most in more than 30 years and ramping up its production by approximately a quarter to ~12m barrels per day to flood the market. This has led to Brent crude prices gapping down by >30% - marking its largest single-day plunge in recent history.

Market correction still possible? With oil prices pushed down this low, we believe a market correction could still be possible, although we are unable to ascertain the timeline for a correction to materialise. At current prices, shale oil players will be producing at losses, with break-even price reported to be roughly at USD45/barrel. As such, a prolonged low oil price environment could see a reduction in shale production, leading to a slight rebalancing of the market’s demand-supply dynamics. Note that the U.S. is the largest oil producer in the world at ~21m barrels/day, which roughly two-thirds coming from shale. Additionally, with Russia’s fiscal breakeven oil prices reported to be ~USD42/barrel, a sustained price war could also possibly pressure Russia to do a U-turn and return to OPEC’s negotiation table, although this is not in our base-case assumptions.

A new down-cycle for oil? Given how well-balanced the oil market is, we believe a sustained disruption could very much throw the entire market into disarray, sparking the possibility of a new down-cycle for oil, especially amidst fears of a demand slowdown. We have always maintained our view that an extended oil production cut from OPEC+ is necessary to just maintaining the oil price levels (let alone driving prices higher), and such, recent developments have caused us to fear that the worst-case scenario could be gradually unfolding. Hence, we cut our 2020 average Brent crude oil price assumption to USD40/barrel (from USD60/barrel previously), anticipating a slight rebalancing to occur in 2H 2020, with 2Q 2020 to see Brent prices hovering around the USD30/barrel mark.

Disruption in entire value chain. As for the stock market, the first casualties from low oil prices are ones with E&P exposure - e.g. SAPNRG, HIBISCS. Up next, low oil price environment could ignite a slowdown in global sanctioning of new projects, potentially impacting names benefiting from greenfield projects, e.g. fabricators (e.g. SAPNRG, MHB), FPSO providers (e.g. YINSON, ARMADA), and pipe players (PANTECH, WASEONG). Meanwhile, all equipment and services contractors across the board are also expected to face even greater margin pressure – e.g. DAYANG, UZMA, DIALOG, SERBADK, and VELESTO, among several others. PCHEM may also be impacted, given how correlated petrochemical prices are to crude oil.

(TLDR: every single oil and gas name could be impacted, in one way or the other - none spared, although at differing severities. Avoid sector for the time being until uncertainties are being cleared.)

Source: Kenanga Research - 10 Mar 2020