During its virtual conference meeting last week, the OPEC+ coalition agreed to a production cut of 10m barrels/day in May and June 2020. This will be gradually eased to 8m barrels/day in July to December 2020, and further relaxed to 6m barrels/day from January 2021 to April 2022. This was a much more successful meeting, as compared to the previous OPEC+ meeting in March 2020, where they failed to land upon an agreement, sending oil prices free falling to an 18-year low. However, oil prices still failed to rally post the announcement of the cuts, as the market still deems the cuts to be insufficient to counteracting the drop in oil demand. The cut of 10m bpd represents ~10% of global supply, but the widespread Covid-19 pandemic may see 15-35m barrels/day of demand removed in 2QCY20. Furthermore, oil oversupply was also at a record-high of 10m barrels/day in March 2020, according to EIA data, and this is only expected to further escalate in the coming months. The cuts could still be further deepened to 15m barrels/day, although this would require participation from other countries such as the U.S., Canada and Mexico. Ultimately, while the cuts should temporarily halt oil prices from free falling, we believe it is clearly insufficient to prop up prices to previously “normalised” levels of USD50-65/barrel. We view that a cut of at least 20m barrels/day is needed before effects from a deliberate rebalancing effort can be significantly noticeable. As such, we keep our 2020 average Brent crude assumption unchanged at USD40/barrel (YTD average of USD49/barrel), still anticipating a subdued 2QCY20 (barring any changes in the macro environment). Maintain NEUTRAL on the sector, advocating caution and favouring proven resilient names (e.g. DIALOG, YINSON, SERBADK, MISC), although risk-on investors may look for bottom-fishing opportunities in stocks trading at steeply discounted valuations (e.g. ARMADA, DAYANG, UZMA and SAPNRG).

OPEC+ agrees to cut 10m barrels. Last week, during its video conference meeting, the OPEC+ coalition had finally agreed to cut productions by 10m barrels per day (bpd) in May and June 2020. This will be gradually eased to 8m bpd in July to December 2020, and then further relaxed to 6m bpd from January 2021 to April 2022. Another video conference will be held to reassess the market situation in June 2020. This virtual meeting was a much more successful one, as compared to its previous meeting in March 2020, where the coalition failed to settle on a production cut agreement, sparking an all-out price war and sending oil prices into a free fall towards its 18-year low.

Are the production cuts enough? Despite the cuts, crude oil prices failed to rally despite a mini uptrend leading up to the production cut announcement, as the market deems the cuts to be insufficient in counteracting the drop in demand amidst the Covid-19 pandemic. The cut of 10m bpd represents ~10% of global supply, but the widespread Covid-19 pandemic is expected to remove roughly between 15-35m bpd in demand for 2QCY20. As at March 2020, oil demand has fallen 13% from Dec 2019 levels, with market oversupply at a record high of ~10m bpd, according to EIA data. This is only expected to escalate in April 2020, with market oversupply potentially jumping by 50% in the coming month. The cuts could be further deepened to 15m bpd, should other nations such as the U.S., Canada and Mexico choose to opt in, although this has still yet to finalise into any official agreements.

Preventing oil prices from a free fall spiral. Ultimately, we feel that the current oil production cuts put in place could be sufficient to temporarily halting oil prices from going into a free fall spiralling downwards, but is unquestionably insufficient to prop up Brent crude prices to a “normalised” USD50-65/barrel level as before. As such, we feel that some forms of price correction could still be inevitable in the coming months, and output cut of at least 20m bpd is required before we can see any impactful effects from deliberate rebalancing effort. We keep our 2020 average Brent crude price assumption of USD40/barrel unchanged (versus YTD average of USD49/barrel), still anticipating a subdued 2QCY20, barring any changes in the macro environment.

Maintain NEUTRAL on the sector. Overall, we still advocate caution for the sector. Should one require exposure in the sector, we prefer proven resilient name with: (i) strong balance sheet, and (ii) ability to continue delivery earnings growth despite the challenging environment which include DIALOG, YINSON, SERBADK and MISC. Meanwhile, more “risk-on” investors may want to explore some bottom-fishing opportunities in ARMADA, DAYANG, UZMA and SAPNRG, given their steeply discounted trading valuations.

Source: Kenanga Research - 13 Apr 2020