Kenanga Research:
Oil & Gas - All-out Price Wars; Sector-wide De-rating
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
AMResearch : Oil & Gas Sector - Oil Price War Reignited
Investment Highlights
- Aggressive new front in oil price war. Following the failure of the meeting between Opec and its allies on additional production cuts to stabilise oil markets, Saudi Arabia has launched an aggressive oil price war targeting its rivals after Russia refused to participate in the oil cartel. Newspaper sources indicate that Saudi Arabia will produce over 11mil barrels/day next month from 9mil barrels/day currently after the current production quota agreement lapses.
- Unprecedented Saudi price discounts. Saudi Arabia has announced unprecedented discounts of almost 20% in key markets, apparently targeting Russia and the US shale industry as well as other higher cost producers. Saudi Arabia is set to announce that its crude into northwest Europe, a key market for Russian barrels, will be sold at discounts to its reference price of over US$8/barrel compared to that of March 2020. In the US, the country is also set to discount its crude by US$7/barrel in April compared with March. Saudi Arabia also made price cuts of US$4–6/barrel to Asia. This aggressive price war is evident as monthly Saudi price adjustments are usually only by a few cents to US$1.
- Uncertain if Russia will return to negotiating table. While Saudi Arabia could be hoping that the price war would bring Russia back to the negotiating table to discuss cutting output to try to rescue the price, newspapers reported the deterioration in the atmosphere between the Saudi and Russian negotiating teams. Russian President Vladimir Putin had rejected requests from Saudi Arabia’s King Salman for a rapid response to the coronavirus impact on the oil market back in February. Whether this recent action will bring Russia back to the negotiating table remains uncertain given that Russia’s budget oil breakeven price of US$40/barrel is lower than Saudi’s over US$70/barrel.
- Worse than 2014–2017 decimation. In our view, this new price war impact is likely to be worse than the 2014–2017 period when Saudi Arabia waged against US shale oil producers given that: i) US crude oil production has now risen to 13.1mil barrels/day – 3.9mil barrels above 9.2mil barrels which US was producing in 2016 when Brent oil price crashed to US$26/barrel; and 2) speculated China oil demand loss of up to 3mil barrels/day following the impact of the novel coronavirus.
- Lowered 2020 oil price forecast to US$40–45/barrel. Brent spot crude oil price has fallen by 32% since the beginning of the year to US$45/barrel while April futures contract is trading lower at US$35.80/barrel currently. If Saudi Arabia restores its capacity of 12mil barrels/day, we expect crude oil price to easily crash below US$30/barrel.
As such, we have lowered our 2020 crude oil price forecast to US$40–45/barrel and 2021 to US$45–50/barrel from US$60– 65/barrel given the rising excess oil capacity that is likely to flood global markets amid weak demand softened by the novel coronavirus pandemic.
- Oil price crash prelude to service sector curtailment. While US rig count remains robust, rising 12 units YTD to 793 currently amid decent offshore rig utilisation rates of over 70%, we view these as lagging indicators of future demand trajectory. Even though offshore projects have 4–5 years of gestation cycles, a sharp drop in oil prices will raise credit risk premiums while banking institutions tighten lending criteria to the sector, effectively prolonging or even derailing the final investment decisions of oil majors in the near to medium term, as demonstrated by the disruptions in the 2016–2018 period.
Recall that Malaysia’s 2019 contract awards slid 6% YoY to a lower-than-expected RM11.5bil following a lull in 1Q2019 and slower pace in 4Q2019, which registered declines of 35% QoQ and 46% YoY. We view this as the remaining fallout from the 2016–2018 award cycle dislocation.
- Downgrade sector call to UNDERWEIGHT from OVERWEIGHT, with revised calls to SELL for Bumi Armada, Dialog Group, MISC, Sapura Energy, Serba Dinamik and Velesto Energy. Our fair values have changed to P/BV targets based on their lower 5-year valuations (See Exhibit 2 and 3).
As such, the companies which have the most reductions in fair values are Velesto Energy (-64%), Sapura Energy (-62%) and Bumi Armada (-59%). Even though Dialog Group and Serba Dinamik have stable and recurring earnings profile underpinned by operation and maintenance services and their strategically located projects in Pengerang, the current deterioration in sentiment for the sector will still translate to substantive selling pressure. Hence, we have lowered Dialog’s fair value to RM2.81 and Serba Dinamik to RM1.90.
Source: AmInvest Research - 9 Mar 2020