Investment Highlights

• OPEC+ cuts by 10mil barrels/day. According to media reports, Saudi Arabia and Russia have reached a preliminary agreement to reduce production with Opec+ expected to cut output by 10mil barrels. Saudi Arabia and Russia are expected to trim production by 5mil barrels/day while the rest of Opec+ by another 5mil barrels/day. However, Mexico, which produces 2mil barrels/day and is not an Opec member, refused to participate in the production cuts. The cartel also called on the US and Canada, among other countries, to cut another 5mil barrels/day when G20 energy ministers hold an extraordinary meeting later. Given that US production is undertaken by private corporations, US President Donald Trump has said that market forces will cause the supply imbalance to correct itself.

• Lowering Saudi-Russian production by 22%. Currently, we are uncertain on the level which Saudi Arabia and Russia will cut their 5mil barrels/day as both countries were ramping up their production after the expiry of production quota on 31 March this year. Recall that Saudi Arabia was ramping up its daily production from its quota-restricted 10mil barrels to 12.4mil barrels while Russia was also raising output from 10mil to 11mil. However, based on these current numbers, a daily production cut of 5mil barrels will mean a combined cut of 22% from Saudi Arabia and Russia’s production currently.

Earlier last week, Trump indicated that those 2 countries may be cutting production by a higher 10mil–15mil barrels/ day. This translated to an improbable 44%–66% reduction for the 2 major oil producers and would have relegated them to production levels which would have been only half of the current US output of 13mil barrels.

• Necessary given storage constraints. Even though parties may be unwilling to agree, we view these cuts as necessary given that global storage facilities are rapidly reaching full utilisation due to the massive Covid-19-depressed demand loss, which the oil trader Trafigura has estimated that global oil demand could drop by 30mil barrels/day or by 37%. Nevertheless, this appears that the Opec+ cuts of only 10mil barrels/day, compelled by lower offtake, are inadequate to prevent oil prices from sliding back below US$30/barrel

• Lowered 2020 oil price estimate to US$35–40/barrel. YTD, Brent crude oil prices have averaged US$49/barrel while the current spot price of US$31/barrel appears to be heading downwards again. With US crude oil inventories steadily rising by 13% YTD to 484mil barrels, we have lowered our crude oil price forecast for 2020 to US$35–US$40/barrel from US$40–45/barrel, while maintaining 2021 at US$45–US$50/barrel. For comparison, the EIA is projecting crude oil price at US$33/barrel for 2020 and US$46/barrel for 2021.

• Catastrophic supply chain impact from oil demand cuts. We view lower oil prices as less of a concern compared with the drastic plunge in demand as national oil producers have begun to cut back on production. Brazil’s Petrobras has recently doubled its daily reduction to 200,000 barrels — 9% of its current output of 2.1mil barrels, which it did not resort to during the 2015–2017 down cycle when oil price fell to US$26/barrel. This major offshore producer has signalled intentions to delay payments and renegotiate contracts with its suppliers to conserve cash flows. If other major oil producers are forced to employ similar measures, this will have a catastrophic impact on the supply chains which multiple service providers rely on.

• Most service providers will be impacted. We maintain our view that most participants in the sector, except those in storage services, will be adversely impacted. Those with upstream production sharing contracts such as Sapura Energy and Hibiscus Petroleum will suffer from lower prices and offtake, followed by fabricators such as MMHE and offshore support providers Bumi Armada and Velesto Energy. While service providers as Dialog Group will benefit from heightened demand for tank terminal storage facilities, we expect project deferrals and cost renegotiations on existing contracts by oil majors to compress margins and volume for specialist/maintenance services as well as engineering, procurement and construction activities.

• Remain UNDERWEIGHT on the sector as fair values of the stocks under our coverage remain pegged to 5-year P/BV lows. Regardless of upstream, midstream or downstream segmentation, we expect the massive global demand destruction from the uncertain extent and duration of the Covid-19 pandemic to continue depressing industry sentiments extensively in the foreseeable horizon. As we continue to view the decimation in oil prices and companies’ earnings to be worse than the previous crisis which led to multiple financial distress to O&G corporations, we retain our SELL calls for Bumi Armada, Dialog Group, Sapura Energy, Serba Dinamik and Velesto Energy.

Source: AmInvest Research - 10 Apr 2020