As a result of the fundamental change in the crude oil landscape, this report addresses the impact of the lower crude oil price environment on the companies under our coverage. For our Top Picks, we have chosen companies that are not materially affected by the lower crude oil price environment. Our top BUYS are Dialog, Ezion, Logindo, Nam Cheong, and PTT. Our top SELLs are MMHE and Vard.
This time it is different. The lower crude oil price environment is not new to the global scene. The fundamental reasons for the major swings in crude oil prices are: i) economic, ii) geopolitics, and iii) natural disasters. These events/situations, given time, will rectify themselves and allow commodity prices to revert back to norm, under the given demand and supply situation. This time, though, it is different. As a result of the US shale oil revolution, we are facing a change in the fundamentals in the dynamics of crude oil supply.
Something has got to give. At the moment, it seems that some of the higher cost producers are cutting capex/production. At the same time, it seems that calls from weaker Organisation of the Petroleum Exporting Countries (OPC) members to cut production quotas are also coming into play. Whatever happens, something has got to give. We believe that crude oil prices will see some positive movements, possibly over the next three to six months, as supply is lowered – either from the higher cost producers or from the OPEC members cutting production quotas. We expect that crude oil price will trade in the USD90-100/barrel (bbl)
range, averaging USD95/bbl over the next 12-24months.
The lower crude oil price environment impact. The bulk of the companies under our ASEAN oil and gas (O&G) coverage universe are in the services segment and will be relatively unaffected by the short term crude oil price volatilities. This is because these companies have short- to medium-term services contracts. For Thailand, though, the companies under our coverage are directly affected by the crude oil price volatility via their revenue streams – for exploration and production (E&P) business – and through stock gains/losses for their refineries.
Investment Summary
The fundamental change in the crude oil landscape. As a result of this fundamental change, this report addresses the impact of the lower crude oil price environment on the companies under our coverage. For our Top Picks, the weak crude oil price environment will not have any material impact on earnings. Our top BUYS are Dialog (DLG MK, TP: MYR2.25), Ezion (EZI SP, TP: SGD2.65), Logindo Samudramakmur (Logindo) (LEAD IJ, TP: IDR6,200), Nam Cheong (NCL SP, TP SGD0.58) and PTT (PTT TB, TP THB376.00). Our top SELLS are Malaysia Marine and Heavy Engineering (MMHE MK, TP MYR2.01) and Vard Holdings (VARD SP, TP SGD0.57).
This time it is different. The lower crude oil price environment is not new to the global scene. In recent history, crude oil prices have slumped to USD9/bbl and have skyrocketed to USD145/bbl. The fundamental reasons for the major swings in prices are: i) economic, ii) geopolitics, and iii) natural disasters. These events/situations, given time, will rectify themselves and allow commodity prices to revert back to norm. This time, though, it is different. This is because we are facing a change in the fundamentals in the dynamics of crude oil supply and trade flows as a result of the US shale oil revolution.
Something has got to give. At the moment, it seems that some of the higher cost producers, ie shale oil/Canadian oil sands, now have to cut capex/production. At the same time, it seems that calls from weaker OPEC members to cut the organisation’s production quotas are also coming into play. Whatever happens, something has got to give. We believe that crude oil prices will see some positive movements, possibly over the next three to six months, as supply is lowered, either from the higher cost producers or from OPEC members cutting production quotas.
Expect crude oil price to rise from here on. We expect crude oil prices will trade in the range of USD90-100/bbl, averaging USD95/bbl over the next 12-24months. At this price, the highest cost producers, namely the Canadian oil sands and Arctic producers, should be able to make relatively reasonable margins. Also, at this price range, most of the OPEC members will be able to finance their fiscal budgets with the oil dollars.
Lower crude oil environment impact. Fundamentally, weakening crude oil price will dampen the earnings of the E&Pcompanies, refineries will report stock losses, and petrochemicals spreads will be dependent on the demand and supply of each particular product. For the services segment, those in the exploration phase will be the first to be affected should there be a cut in spending. Those that are involved in the development and production part of the E&P business will be relatively safe fromcuts, depending on the type of fossil fuels being developed.
For our ASEAN O&G coverage. We cover 44 companies in four countries across the value chain, ie from upstram to downstream. The coverage concentrates more on the services segment, where most of the listed oil and gas companies in Malaysia, Singapore and Indonesia are in. Thailand is an exception. Here, the listed names are dominated by oil refinery and petrochemical players. A majority of the listed companies under coverage in the services segment will be relatively unaffected by the short-term crude oil price volatilities, as these firms have short - to medium-term services contracts. For Thailand, the companies undercoverage are directly affected by the crude oil price volatility via their revenue streams (for the E&P business) and through stock gains/losses (for the refineries).
This Time It Is Different
The lower crude oil price environment is not new to the global scene. In recent history, we have seen crude oil prices plummeting to USD9/bbl – this was in Dec 1998 when OPEC approved a 10% quota increase at a time when Asian economies were entering a prolonged slump. Crude oil prices have also skyrocketed to a high of USD145/bbl in Jul 2008. Hence, crude oil prices can swing in a wide range in some years while, in others, there are periods of high stability.
In 2008, crude oil prices were on a rollercoaster ride. Brent crude prices began the year at USD97/bbl, peaking at USD145/bbl and ending at USD41/bbl. The price of crude oil hit its lowest point at USD34/bbl. This plunge was caused mainly by the financial crisis that wreaked havoc on the global economy and triggered a fall in the overall demand for crude oil. Currently, we believe that the global economy is slowing down and that this will result in steady adjustments in crude oil demand/supply. As such, we do not foresee a crash in prices (as in 2008).
2011 was another year of major swings. Brent crude prices began the year at USD94.73/bbl, peakin at USD126.74/bbl and ending the year at USD107.58/bbl. Crude oil prices hit their lowest point at USD92.98/bbl. Two major events caused these swings:
The Arab Spring. A revolutionary wave of demonstrations that began in Dec 2010 and spread throughout the countries of the Arab League and the nations surrounding them.
Tsunami in Japan. Nuclear power met 25% of Japan’s electricity needs but, after the Fukushima Daiichi nuclear disaster, all nuclear reactors have been shut down on safety grounds. The country replaced the significant loss of nuclear power with generation from imported natural gas, low-sulphur crude oil, fuel oil and coal.
The reasons. The fundamental factors behind the major swings in crude oil prices are: i) economic, ii) geopolitics and, iii) natural disasters. These events/situations, given time, will rectify themselves and allow commodity prices to revert back to norm, under given demand and supply situations.
This time it is different. This is because we are facing a change in the fundamentals in the dynamics of crude oil supply as a result of shale oil and the future shale gas revolutions. The current weaker crude oil price environment is a result of softer global demand and the surge in shale oil production in the US. As the boost in US oil production has lowered the country’s overall crude oil imports, producers such as Nigeria and Saudi Arabia have had to divert their exports to Asia. It seems like there culd be a rebalancing of crude oil trade flows as the global crude oil market continues to adjust to the surge in supply due to the new North American shale oil reality. Further details were discussed in our full report published on 16 Oct: Shale Oil Revolution Reality.
Note: Our expectations on crude oil prices are based on the fundamentals of the crude oil market. It does not take into consideration speculation and sentiment on crude oil prices, which can play a significant role in price volatility.
Source: RHB
The showdown: shale oil producers vs OPEC
Is there really a showdown between OPEC and the shale oil producers? Below are excerpts from Bloomberg over the past week:
When US shale companies talk about having more staying power in a price war, it is the weaker members of OPEC, ie Venezuela, Nigeria, Ecuador and Iran, that are the weakest links. Iran, Iraq and Algeria need at least USD100/bbl. At current prices only Kuwait, Qatar and the United Arab Emirates (UAE) will earn enough to balance their budgets. Although Saudi Arabia is awash with cash, some OPEC members’ financials are deteriorating quickly. Venezuela, for example, has burned though billions of dollars to stave off default, leaving its foreign reserves near a decade low. Nigerian officials are struggling to stem a sell-off in the NGN, which has left the currency at a record low. These financial strains have resulted in Venezuela, Libya and Nigeria calling for action. OPEC members are countries, not companies, so they tend to look not at the profitability of wells but at revenues for a fiscal or current account standpoint.
To win the showdown with US shale, the Saudis are trying to bring OPEC’s weaker members in line. OPEC is lining up between the haves and the havenots. Iran, Venezuela, Nigeria and Ecuador are really going to be struggling very mightily at these prices. That is who the shale producers are counting on.
Shale oil drillers will be hurt by the fall in crude prices before members of OPEC because their costs are higher, said the group’s secretary-general, Abdalla el-Badri. As much as 50% of tight oil output will be “out of the market” at current prices. Executives at several large US shale producers, including Chesapeake Energy Corp (CHK US, NR) and EOG Resources Inc (EOG US,
NR) have vowed to maintain – and even raise – production as they reported earnings. They say their success in bringing down costs meant that they make money even if prices slump further. OPEC is expected to decide on future production quotas when it meets in Vienna, Austria, on 27 Nov.
Meanwhile, the slide in crude oil price is now threatening to curb the production boom in the US shale oil formations, Bloomberg reported. Peak rig count was 1,609 in October and the count is now down 49 rigs since peak. It is expected to fall by more than 100 rigs by year -end. According to Halliburton (HAL US, NR), the second largest O&G services company by market value, it
was told by its US customers that they would not be changing fracking activities for 1H15.
Something has got to give
Weaker OPEC members feeling the pain. The point of the matter is, at the moment, crude oil prices have slumped to a price point where many OPEC members are now calling for action as oil dollar revenues are falling. These members need oil dollar revenues to finance their fiscal budgets. As mentioned earlier, OPEC members are countries and they look at the revenues from a fiscal standpoint. It is only the lower cost producers/oil-rich Gulf nations, ie Saudi Arabia, Qatar and Kuwait, that can stand lower crude oil prices.Higher cost producers are also in pain. At this price point, several shale oil producers, ie one of the higer cost producers, are also hurting. Shale oil producers work on the economies of the wells. They also work on the pure technologies. With constant improvements and innovation in technology, the economic costs of such wells could be at much lower breakeven price points in the future.
Will OPEC or shale oil producers fold first? As global oil demand has slipped below expectations, due to weaker-than-expected global economic growth, crude oil production will have to readjust to balance out the market. Therefore, it will have to either be the OPEC member countries having to cut crude oil production or the shale oil producers – including, possibly, the Canadian oil sands and Arctic producers –that will have to shut down their wells at the current – or lower – crude oil prices. Something has got to give. At the moment, it seems that some of the higher cost producers now have to cut capex/production while – at the same time – it seems that
calls from weaker OPEC members to cut the organisation’s production quotas have also come into play. Whatever happens, something has got to give. We believe that crude oil prices will see some positive movements, possibly over the next three to six months, as supply – either way – is lowered.OPEC meeting: 27 Nov
Less crude oil required from OPEC. OPEC has been quoted as stating that the world will need less of its oil than previously estimated for most of the next two decades as growth in shale production in the US grows. The organisation lowered every forecast for its crude through 2035 except for next year. The market is now expecting the oil cartel to possibly look to reducing its production quota by around 500,000 barrels per day (bpd) to perhaps 1.5mbpd. (Source: Bloomberg)
Our take. As such, we believe that 500,000bpd is a reasonable cut in production by with OPEC or the shale oil producers. We believe that the cut will have to come from OPEC more than any other producers. We believe that such a move could allow crude oil prices to rebound to our forecasted range of USD90-100/bbl over the next 12-24months. Should agreements not be concluded during the upcoming round of talks among OPEC members, we believe that the next round should bear fr uit.
The Lower Crude Oil Price Environment
As a result of the fundamental change in the crude oil landscape, this report addresses the impact of the lower crude oil price environment on the companies under coverage.
For our ASEAN O&G coverage, we cover 44 companies in four countries across the value chain, from upstream to downstream. The coverage concentrates more on the services segment, where most of the listed O&G companies in Malaysia, Singapore and Indonesia are in. Thailand is an exception, where the listed names are dominated by oil refinery and petrochemical players.
Regression analysis: USD and crude oil price
Since crude oil is priced in USD, it seems that the market – at times – tends to look at the strengthening or weakening of the greenback as one of the factors for changes/impact on crude oil prices. We performed a simple regression analysis on the correlation between crude oil prices and the USD index, which comprises th e EUR (c.57.6%), JPY (13.6%), GBP (11.9%), CAD (9.1%), SEK (4.2%) and CHF (3.6%). Based on our simple regression analysis between crude oil price – European Dated Brent and Forties-Oseberg-Ekofisk (BFOE) – and the USD index (using 1,235 observations from Jan 2010-Oct 2014), we found no relationship between the two variables. We regressed crude oil prices per day on the daily USD index to roughly estimate the impact of the change in the USD on oil prices. However, we found no significant linear relationship between the two variables. Our regression model produced a low R square value of only 16%. The reason for the low correlation between the two variables could possibly lie with the fact that crude oil prices are dependent upon many other factors and not only the USD.
Crude oil market still adjusting to the new reality
The crude oil market is currently adjusting to the new global demand and supply balance reality. This, along with how OPEC manages its crude oil trades over the medium term, will determine at what price crude oil settles at. It has become a rather difficult task to pinpoint where prices will average over the medium to long term. According to media reports, it would seem that the market has put the crude oil price average in the range of USD80-105/bbl. We expect prices to trade in the USD90-100/bbl range over the next 12-24 months. At this price, the highest cost producers (Canadian oil sands and Arctic producers) should be able to make relatively reasonable margins. Also, at this price range, most of the OPEC members will be able to finance their fiscal budgets with their oil dollars. As such, we expect crude oil prices to average USD95/bbl, down from our previous forecast of USD100-105/bbl. Please refer to our report dated 31 Oct on Exploration & Production (PTTEP) (PTTEP TB, BUY, TP: THB167.00), 9M14 Net Profit Falls 6% YoY, dated 31stOctober, for more details.
Weakening/lower crude oil price environment
During times of weakening or lower crude oil prices, oil companies in general will look to cut their spending to match their cash flows streams. The capex budget on individual companies will be separated int o committed and uncommitted spending. Committed spending will be for long-term projects under development and production phase. Uncommitted spending will be for the likes of M&As and the exploration portion of the E&P business. Spending cuts will first be on the uncommitted budgets. Further cuts can be on the committed budgets, should these projects be viewed as uneconomical under current/future crude oil price expectations. Under this current environment, it will be the projects that are in the higher costs fossil fuels category (deepwater, Canadian oil sands, shale oil/gas). Once spending cuts occur, this will, in turn, have a negative impact on the overall spending environment going forward. Crude oil price weakening will dampen earnings on E&P stocks, the refineries will report stock losses and petrochemical spreads will be dependent on the demand and supply of each particular product. For the segment, ie chartered vessels, drillings rigs, etc, which are in the exploration phase of the business, will be the first to be affected should there be a cut in spending. Services companies that are involved in the development and production portion of the E&P segment will be
relatively safe from cuts.
National oil companies (NOCs) like Thailand’s PTT, Pertamina and Malaysia’s Petronas operate with slightly different strategies than those of general oil companies. NOCs look at the longer-term, with national interest being at the forefront of their strategies going forward as they have to consider the long-term economic benefits of their respective nations. However, we believe that it is highly likely that some downward adjustments in capex are possible going forward, given the current global economic environment and crude oil price slump.
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Created by kiasutrader | Jun 14, 2016
Created by kiasutrader | May 05, 2016