OPEC+ is set to raise oil production by 500k bpd starting January 2021, effectively reducing production cuts to 7.2m bpd, from 7.7m currently, and also superseding earlier agreements of raising it by 2m bpd. While slightly falling short of expectations (the coalition was widely expected to extend current production levels until March 2021), markets are still expected to react positively as the deal is seen as a sign of stability amidst the tensions and disagreements running deep amongst member nations. In any case, the 500k bpd output increase is still far more desirable compared to 2m bpd in the status-quo agreement. While we opine that the deal failed to address several “big picture” issues going into 2021 (e.g. resurgence of Libya oil, possible lifting of Iran sanctions under the Joe Biden administration), we believe immediate-term demand-supply dynamics would not be overly disrupted, with oil markets still expected to remain in slight deficit at least for now (barring any sudden plunge in demand). Hopefully, any large disruptions in dynamics could be addressed in OPEC’s monthly review meeting starting January 2021. Overall, we are keeping our average Brent crude assumption intact at USD45/barrel for 2020 and USD50/barrel for 2021. Maintain NEUTRAL on the sector, as fundamentals still remain weak, although we see possible trading opportunities (in contrast to a fundamentally-driven investment strategy) amidst the vaccine-driven boost in sentiment. UZMA (OP, TP: RM0.64) emerges as our top trading pick, although SERBADK (OP, TP: RM2.75) is still our fundamentally-backed favourite.

OPEC+ to raise oil production. Last week, OPEC+ agreed to raise oil production by 500k barrels per day (bpd) starting January 2021. This would effectively reduce current production cuts to 7.2m bpd, from 7.7m currently, and supersede earlier agreements of raising output by 2m bpd starting January 2021.

Markets reacted positively. The modest raise in production is seen to slightly fall below expectations of industry experts, as it was widely expected for OPEC+ to extend current production cut levels of 7.7m bpd at least until March 2021, given the continued rise of Covid-19 cases globally. Nonetheless, markets still reacted positively (Brent crude oil jumped +1% on Friday), with the deal being seen as a diplomatic compromise amidst strains among member nations, and was welcomed as a sign of stability within the group. In fact, a deal was expected to be struck on Tuesday, but due to deep disagreements, talks were further extended by two days before this compromised deal was reached. From here, the group is expected to hold monthly meetings to review any further adjustments to production cuts.

Boost in sentiment, amidst weak but recovering fundamentals. Nonetheless, we opine that the deal to raise oil productions by 500k bpd may have failed to address several “big picture” key issues going into 2021 – e.g. (i) resurgence of Libya’s oil production, thanks to tentative peace between rival militaries, and (ii) the potential lifting of Iran sanctions under the Joe Biden administration. Hopefully, with OPEC+’s “take it one month at a time” approach, any factors leading to massive disruptions in the demand-supply dynamics could be resolved during its monthly review meeting after January 2021. For now, in the immediate-term, the mild rise in oil production by 500k bpd should still manage to keep global oil productions in a slight deficit (barring any sudden plunge in demand). Based on EIA’s data, global crude oil production was at a 3.4 bpd deficit as at October 2020. Drawdowns of inventories over the past few months have led to gradually reducing stocks since its peak in April-June 2020, but has still yet to recover back to Dec 2019 levels. A successful widespread roll-out of Covid-19 vaccines is also expected to help boost oil demand, particularly in 2H 2021, although complications regarding distributions and logistics must first be overcome.

Maintain NEUTRAL. Overall, we keep our average Brent crude assumptions intact at USD45/barrel for 2020 and USD50/barrel for 2021. The mild rise in production of 500k bpd from OPEC+, while still less-than-ideal (as compared to extending current cuts), would not overly disrupt the immediate-term demand-supply dynamics. In any case, a rise by 500k bpd is still far better than the status-quo agreement of a 2m bpd increase. While underlying fundamentals still remain weak, we see potential trading opportunities (in contrast to fundamentally-based investment strategies) to fully capitalise on the current vaccine-driven boost in sentiment, looking to take-profit in the next 2-3 months’ window once gains are sizable. As such, we favour names which have palatable balance sheets and are trading at steeply discounted valuations. Within our coverage, UZMA (OP, TP: RM0.64) emerges as our top trading pick, although we also see trading potential in DAYANG (OP, TP: RM1.20) and MHB (OP, TP: RM0.38). SERBADK (OP, TP: RM2.75) also remains our favoured fundamental pick, given its promising earnings growth potential coupled with decent attractive valuations.

Source: Kenanga Research - 7 Dec 2020