Brent crude prices have enjoyed a rebound this year underpinned by weather-led supply disruptions and OPEC+’s decision to maintain output cuts. That said, we still see possible downside risks to oil prices (possibly even dipping below the USD60/barrel mark), given: (i) still fragile demand-supply dynamics with full recovery to pre-pandemic levels expected only in 2023, and (ii) inevitability of OPEC increasing productions during the year, given its record low production capacity utilisation. We revised our 2020 average Brent crude assumption to USD60/barrel (from USD50/barrel), while introducing 2021 assumption of USD65/barrel. Nonetheless, despite downside risks to oil prices, we believe that Brent crude prices hovering within the range of USD55-65/barrel are healthy enough to sustain a rebound in activity levels. Petronas’ capex commitment of RM40-45b per annum for the next five years, while still below pre-pandemic levels, is still a healthy rebound of ~20-35% from 2020. Realistically, we do not expect to see activities to recover to pre-pandemic levels any time soon, but the slow recovery will still be more than sufficient to keep contractors afloat. The dwindling interests in Malaysia from multinational oil majors could also see greater local participation in exploration fields, although we are still slightly mixed on this direction which will increase their exposure to oil price fluctuations, and also does not stand well with the overall ESG and clean energy transition agenda. We maintain NEUTRAL on the sector, given the limited upside for big-cap Petronas-named counters (i.e. PCHEM, PETDAG), but are increasingly optimistic on the contractors given the anticipated recovery in activity levels. TOP PICKS include DIALOG and SERBADK for their deeply attractive valuations, as well as their resilient and promising earnings growth prospects.

Oil prices in rebound. YTD, oil prices have enjoyed a rebound rally, touching a high of almost USD70/barrel. This was largely underpinned by: (i) weather-led supply disruption, especially in the U.S., (ii) OPEC+’s decision to continue current output cut levels in March, much to the market’s surprise (which was expecting OPEC+ will increase output to capitalise on higher oil prices), and (iii) anticipation of a recovery in global oil demand spearhead by vaccine roll-outs.

Despite so, we still see possible downside risks to oil prices from current levels, as we believe prices could have run ahead of demand-supply fundamentals for the past several weeks. This view is also shared by the IEA, which stated that data and analysis suggest that oil supplies remain plentiful, and that an oil “super cycle” is highly unlikely. Oil inventories in developed countries stood at 110m barrels above last year’s level as of January, and can be readily tapped as needed. Meanwhile, world oil demand is expected to only recover back to pre-pandemic level in 2023. Given the output cuts, OPEC’s production capacity utilisation is also at a historical low (see chart below), and as such, we believe further increase in production from the coalition within the year would be an inevitability, and may cause a further knee-jerk reaction to oil prices. Overall, based on the current oil market dynamics, we are expecting to see a weaker 2HCY21 (versus 1HCY21), with possibility of Brent even dipping below the USD60/barrel mark.

Nonetheless, we revised our Brent crude average for 2021 to USD60/barrel (from previous assumptions of USD50/barrel), while introducing 2022 average assumption of USD65/barrel.

Recovery in activity levels. While we still see possible downside risks to oil prices, we believe that Brent crude prices within the range of USD55-65/barrel will still be healthy enough to see a gradual resumption of activity levels. Locally, Petronas has guided capex of RM40-45b per annum for the next five years. While this is still below pre-pandemic levels, we do note that it is a healthy rebound of ~20-35% from 2020. Realistically, we do not expect to see activities recover to pre-pandemic levels any time soon, but nonetheless, the slow recovery in jobs will be enough to keep contractors and equipment providers busy, and will certainly be more than sufficient to keep the vast majority of companies afloat. In terms of value-chains, we see a possibility for brownfield players (e.g. Uzma) and hook-up and commissioning (e.g. Dayang) to see resumption of work orders in 2021 after facing numerous job delays in 2020. Meanwhile, global FPSO providers (e.g. Yinson) may also benefit from the resumption of tendering opportunities in the coming few years, amidst the lack of bidding competition in the international scene.

Greater local participation in oil fields exploration. We believe Petronas’ recent launch of the Malaysia Bid Round 2021 could see an increased number of local participation. To recap, the bid round puts 13 oil and gas exploration and undeveloped blocks for offer. Prospective bidders will have until early October to submit their tenders, with the award date expected to fall in 4QCY21, and the production sharing contracts to be signed in 2QCY22 (subject to draft clarification and finalisation). That said, we observe that many multinational oil majors have been intending to scale back on their investments in Malaysia, pointing towards recent examples such as (i) ExxonMobil putting all of its Malaysian upstream assets for sale, eyeing a valuation of USD2-3b, (ii) recent reports of Repsol also looking to exit Malaysia, (iii) Shell looking to divest some of its Malaysian non-core assets, although Malaysia was still named as one of nine remaining core global areas of the group as it embraces the energy transition trend, citing that the peak oil has already passed in 2019, and (iv) Murphy Oil’s exit from Malaysia in June 2019, after it sold its assets to Thailand’s PTTEP for USD2.13b. As such, given the dwindling interests from international players, we believe this could have a cascading effect, leading to greater participation from local players. According to press reports, several local players have been invited to participate in the bid round. These names include Dialog, Petra Energy, Hibiscus, Uzma and Sapura Energy. Likely, a consortium with foreign companies will be formed during the bidding to compensate for the lack of expertise. Dialog, Sapura Energy, Petra Energy and Uzma have prior experiences of marginal fields developments in the past via risk service contracts with Petronas. Meanwhile, with Hibiscus still actively looking to expand its upstream portfolio, participation from the company could also be likely. Overall, we are slightly mixed on this, especially for contractor names with limited expertise in E&P. While participation in production sharing contracts could help expand these companies’ earnings base, it will also increase their exposure to fluctuations of oil prices. Additionally, doubling down on hydrocarbons by increasing their upstream portfolio could also be sending a wrong message ESG-wise as the world is moving towards clean energy.

Maintain NEUTRAL, given the limited upsides on large cap Petronas-named counters (e.g. PCHEM, PETDAG). Nonetheless, we are increasingly optimistic on the sector, given the gradual recovery of activity levels. Our stock picks are as follows:

• Sector TOP PICKS: SERBADK (OP, TP: RM2.80), and DIALOG (OP, TP: RM4.35), given their hugely attractive valuations with promising and resilient earnings growth prospects.
• Oil price proxies: PCHEM (MP, TP: RM7.50) and HIBISCS (NR), given their high share price correlation to crude oil prices.

Source: Kenanga Research - 5 Apr 2021