Oversupply Risk Remains Despite Rising Geopolitical Tensions Since the start of the Trump administration, Brent crude oil prices have declined from a peak of USD82/bbl to a low of USD60/bbl, averaging USD70.7/bbl YTD. The weakness in prices has been driven by escalating trade tensions, recession fears, and persistent oversupply, prompting key agencies to revise down their price and demand forecasts. On the supply side, US production remains elevated, while OPEC+ has unexpectedly tripled its planned unwinding of production cuts, signalling a strategic pivot away from price support to raising the risk of another price war. Adding to the volatility, Brent crude surged over 8% following Israel's strikes on Iranian nuclear and military sites. However, we believe the rally is likely to be short-lived as global supply remains ample with spare capacity providing buffer against sustained disruptions. Domestically, PETRONAS continues to face structural headwinds, including a prolonged dispute with PETROS, which has heightened regulatory uncertainty and delayed capex plans. These challenges, coupled with global oil price weakness, have weighed on the KL Energy Index, which now trades near -1 SD. We maintain our Neutral sector rating, expecting Brent to trade within a lower band of USD55-70/bbl in 2H2025, and revise our 2025 average forecast to USD65/bbl. While geopolitical tensions may introduce short-term upside risk, we believe prices would eventually normalise and reflect the fundamentals of demand-supply dynamics.

• OPEC+ has shifted its strategy from supporting oil prices to ramping up production, even as Brent crude tumbles to USD60/bbl, a level unseen since the pandemic-driven collapse in February 2021. Saudi Arabia is leading this shift, likely pressuring its fellow members over poor compliance with production quotas. To recap, below is the summary of OPEC+ strategy evolution since 2022.
• 2022: Russia-Ukraine conflict drove oil prices higher due to geopolitical instability. OPEC+ cautiously ramped up production to unwind pandemic-era cuts.
• 2023: Inflationary pressures and China's slow recovery weakened demand, prompting OPEC+ to impose fresh production cuts.
• 2024: US production remained record high, making OPEC+ cut less effective. The group extended reductions while geopolitical risks fueled price volatility.
• 2025: OPEC+ is accelerating the unwinding voluntary production cuts, tripling its initial plan
• PETRONAS faces inevitable cost optimisation and capex deferment as tumbling oil prices continue to shrink profit margins. With Brent crude hovering around USD65/bbl, we estimate that PETRONAS' operating cash flow could drop to RM69.2bn for FY2025, RM33.3bn lower than FY2024. As PETRONAS reassesses its investment strategy, greenfield projects may face delays, impacting domestic oil and gas players. Given this backdrop, we favor Hibiscus Petroleum (Outperform, TP: RM2.30) and Bumi Armada (Outperform, TP: RM0.59), which are less reliant on the domestic capex cycle, supported by steady cash flow generation and undemanding valuations.

Trade tensions and OPEC+ weigh on sentiment

From 2022 to 2024, geopolitical military conflicts were the primary drivers of oil price volatility, with events such as the Russia-Ukraine war and Middle East tensions causing sharp fluctuations. However, since the start of Trump's administration, the focus has shifted to trade war while OPEC+ supply strategies now dictating market dynamics. Concerns over oversupply risks have weighed on Brent crude, leading to a decline from a peak of USD82/bbl to a low of USD60/bbl, averaging USD70.7/bbl YTD. This trading range aligns with our previous sector report issued on 15 November 2024, which projected Brent to trade between USD60-80/bbl in 2025, with an annual average of USD70/bbl. While sentiment has been fluid, the decline remains fundamentally justified, reflecting broader macroeconomic and supply-side pressures.

OPEC+ strategy shift may amplify oversupply risk

OPEC+ is continuously adjusting its strategy to navigate shifting global economic and geopolitical landscapes. In 2022, Following the Russia-Ukraine conflict, the surge in oil prices was driven by geopolitical instability while OPEC+ cautiously ramped up production to gradually unwind pandemic-era cuts. However, the bullish sentiment was short-lived as inflationary pressures and China's sluggish recovery in 2023 weakened demand, leading OPEC+ to impose fresh production cuts. Yet, as US production remained persistently high throughout 2024, OPEC+'s cuts proved less effective, forcing the group to extend reductions while geopolitical risks continued fueling price volatility. OPEC+ initially planned to gradually unwind its voluntary production cuts at a pace of 137,000 bbl/d over 18 months, starting in April 2025. However, the group later accelerated the pace, tripling the planned increase to 411,000 bbl/d, amplifying oversupply risks. While the official rationale remains unclear, reports suggest that poor compliance by Kazakhstan and Iraq with production quotas may have influenced the decision. This signals a strategic shift, potentially increasing market volatility and raising concerns about oversupply. -

OPEC+ may target US shale oil to regain market share,

as US production remains resilient despite market volatility. Advancements in horizontal drilling technology have significantly improved efficiency and allowed rigs to extract more oil per well since the shale oil revolution. However, moving forward, US EIA expect active oil rigs to decline over time due to capex reductions amid weaker oil prices. Despite this, US crude oil production is projected to remain steady at around 13.4 MMbbl/d throughout 2025 and 2026 before moderating further. Recent data indicates minimal change in production over the past two months, although the number of active oil rigs has dropped to 563, marking the lowest level since November 2021, when oil was trading around USD80/bbl. Meanwhile, Saudi Arabia has been sacrificing production capacity since mid-2022, while US crude output continues to rise. Given this divergence, Saudi Arabia may seek to retaliate and reclaim market share, potentially setting the stage for another oil price war. US shale oil remains profitable as long as WTI prices stay above USD60/bbl. Current breakeven costs range from USD38-58/bbl, averaging USD46/bbl. If OPEC+ is targeting US shale oil, its first price target could be around USD40/bbl, aiming to pressure the US producers and regain market share. Given the current supply dynamics, the likelihood of an oil price war is becoming increasingly possible, especially Saudi Arabia ramps up production while US output remains high.

Israel-Iran: all eyes on the Strait of Hormuz

The collapse of nuclear negotiations between the US and Iran has triggered a dramatic escalation of conflict, culminating in Israel's launch of Operation Rising Lion, a coordinated strike targeting Iran's nuclear facilities and military infrastructure in Tehran. The operation resulted in the deaths of several top Iranian military commanders and nuclear scientists. In a swift retaliation, Iran launched a barrage of drones and ballistic missiles, striking Israeli cities and military sites. The tit-for-tat conflict has intensified and expanded to target critical energy infrastructure. Notably, Iran's South Pars gas field, Fajr Jam gas processing plant and the Shahran oil facility.

Oil supply remains steady, but the Strait of Hormuz is the ultimate swing factor

. Iran's oil production currently stands at 3.3 MMbbl/d, with exports estimated at 2.0 MMbbl/d, primarily comprising crude oil and refined fuels. While any potential disruption to Iranian supply could be offset by spare capacity from Saudi Arabia and other OPEC+ members, we believe the Strait of Hormuz remains the ultimate swing factor due to its strategic role as a global energy chokepoint, facilitating nearly 20% of the world's oil flows. The strait, located between Oman and Iran, connects the Persian Gulf to the Gulf of Oman and the Arabian Sea, making it a vital artery for global energy trade. Recent reports suggest that Iran is considering the closure of the Strait of Hormuz, a move that could significantly escalate tensions and drive oil prices higher. However, we believe a full closure is unlikely. During the Iran-Iraq Tanker War (1980-1988), the strait was never completely shut, largely due to its importance for Iran's own oil exports and the risk of international military intervention. As such, while the threat of closure and military activities may inject short-term volatility, the probability of a sustained blockade remains low.

Fundamentals remain weak despite geopolitical risk premium

Since mid-2024, the US EIA, IEA, and OPEC have repeatedly trimmed their global oil demand growth forecasts for 2025, with significant downward revisions following the "Tariff Liberation Day" in April 2025. In its April report, the IEA cut its 2025 demand growth outlook from 1.03 MMbbl/d to 0.73 MMbbl/d, citing new US tariffs and retaliatory trade measures that are dampening economic activities mainly in both the US and China. Similarly, the US EIA lowered its forecast by 0.4 MMbbl/d, noting that the tariff war is weighing on demand across OECD economies and creating substantial uncertainty. Meanwhile, OPEC trimmed its 2025 outlook by 0.15 MMbbl/d, warning that policy risks, particularly escalating US-China tensions pose significant downside threats to global oil consumption. For 2H 2025, OPEC+ is set to ramp up production by 411,000 bbl/d per month and is expected to fully unwind its voluntary cuts by September 2025. Meanwhile, US oil production remains persistently high, hovering around 13.4 MMbbl/d. Despite this, oil prices are expected to remain volatile, largely due to US-China tariff tensions as the administration seeks to address its trade deficit. Any aggressive tariff measures could dampen oil demand, triggering a slowdown in global economic activities. While a temporary tariff truce between the US and China may provide short-term relief, volatility is likely to persist until major economies reach a broader settlement. Given these dynamics, we expect Brent crude oil prices to trade within the lower band of USD55-70/bbl for 2H 2025, leading us to revise our 2025 average forecast to USD65/bbl (down from USD70/bbl). Although global geopolitical tension may add trading premium on Brent crude oil prices, we believe this will be short-lived as the broader market remains anchored by fundamentals. A drag from ongoing domestic structural change Back in March 2023, PETRONAS announced its RM300bn capex plan, outlining investments for 2023-2027, averaging RM60bn per year, a 43% increase compared to the previous five-year cycle. The plan prioritised core business expansion and clean energy initiatives, reflecting the oil giant's commitment to energy transition and sustainability. Subsequently, PETRONAS refined its capex strategy by allocating RM113bn out of the RM300bn for domestic capex over the same period, averaging RM22.6bn annually to strengthen energy security and sustainability, while simultaneously positioning itself for new business growth. This optimism was also largely driven by a stable oil price outlook, with Brent crude oil prices hovering around USD80/bbl, supported by OPEC+ output adjustments despite demand uncertainties as a result from inflationary pressures and tightening global monetary policy. PETRONAS' operating cash flow is highly correlated with oil price fluctuations, making it a crucial factor in managing capex and dividend commitments. When Brent crude averaging USD101.3/bbl in FY2022, the company recorded highest profit of RM101.6bn with operating cash flow reaching RM135.3bn. Despite oil prices moderated to around USD80/bbl, PETRONAS maintained strong cash flow of above RM100bn for FY2023-2024. Throughout this period, the company had sufficient operating cash flow to fund its capex of RM52-54bn and dividend commitment of RM32-40bn.

Falling oil prices prompted PETRONAS to implement cost-cutting measures and defer capex

, though the impact was not immediate.During the FY2015-2016 oil price slump, the company gradually scaled back investments, reducing capex from RM71.1bn in FY2014 to RM44.5bn in FY2017, a steady decline averaging RM8.8bn per year. It then maintained capex below RM50bn for FY2018-2019. This measure pullback reflects the nature of long-cycle projects, where ongoing developments must proceed toward completion, while new greenfield investments require reassessment under a shifting economic landscape and revised oil price assumptions. Additionally, the prolonged oil price weakness from 2015 to 2019 led to a workforce reduction of 5,480 employees, from a peak of 53,149 to 47,669 by 2019. This was despite an initial announcement in 2016 to cut only 1,000 jobs. The scale of these adjustments underscores PETRONAS' strategic response to market volatility, balancing financial discipline with long-term operational sustainability. Moving ahead, PETRONAS is facing deeper structural challenges in 2025 than in the 2016 and 2020 downturns, as it prepares to lay off 5,000 workers in response to shrinking profit margins. The sharp decline in oil prices from USD82/bbl to USD60/bbl continues to pressure cash flow, prompting the company to streamline operations and preserve liquidity. Our sensitivity analysis indicates that at an average Brent crude price of USD65/bbl, PETRONAS would generate operating cash flow of RM69.2bn, marking a YoY decline of RM33.3bn. This financial strain will challenge PETRONAS' ability to meet its dividend obligations of RM32bn and threaten its capex commitments outlook as we estimated at over RM40-50bn for FY2025. Additionally, the domestic capex outlook has increasingly been shaped by heightened regulatory risks, particularly amid ongoing negotiations between PETRONAS and PETROS. The dispute originated from the overlapping jurisdictional claims between the federal Petroleum Development Act (PDA) 1974 and Sarawak's Distribution of Gas Ordinance (DGO) 2016, creating legal friction over gas distribution rights in the state. A notable example of this uncertainty is ConocoPhillips' withdrawal from the USD3.3bn Salam-Patawali deepwater oil and gas field, despite being on the verge of launching a front-end engineering and design (FEED) competition for a floating production unit. While the company officially cited a country strategy review as the reason for its exit, media reported that industry executives have suggested that regulatory uncertainties played a role in the decision. 71.164.7 50.444.5 46.8 47.8 33.4 30.4 50.1 52.8 54.2 99.0 52.543.7 54.3 71.064.3 What to look out for in the sector? Overall, the oil and gas sector are currently facing mounting headwinds, driven by weak oil price sentiment and heightened domestic regulatory risks. Structural shifts in global demand, compounded by tariff tensions initiated by the US administration, remain key factors influencing oil price volatility. Meanwhile, OPEC+ continues ramping up output, adding further downward pressure on prices. On another note, PETRONAS' capex outlook is trending downward, as deteriorating cash flow from lower oil prices and regulatory uncertainties in Sarawak weigh on investment decisions. Given these factors, we expect Bursa KL Energy's depressed valuation to persist throughout 2025. As a result, we maintain our Neutral call on the sector, with a bias toward lower valuations amid ongoing market volatility. We believe the risk premium from Israel-Iran conflict should gradually unwind, barring direct disruption to critical infrastructure like the Strait of Hormuz. PETRONAS' cost-cutting measures and capex deferment are expected to impact domestic oil and gas service equipment (OGSE) providers, particularly those reliant on orderbook replenishment and short-term work orders, which have limited earnings visibility and are highly sensitive to industry downturns. Although OGSE players such as Dayang Enterprise (Neutral, TP: RM1.80), Uzma (Neutral, TP: RM0.45), and Dialog (Neutral, TP: RM1.70) - downstream segment have secured multiple new contracts and some with higher margin from PETRONAS, the realisation of these orderbooks depends on short-term work orders and call-out basis. This structure makes them vulnerable to lower maintenance activities and capex cuts, as non-critical works are deferred, limiting the scope of these contracts. Meanwhile, Wasco (Neutral, TP: RM0.85) is experiencing a depleting orderbook, as the global capex slowdown continues to impact major pipeline projects. Despite its low exposure to domestic projects, delays in global tender awards have weighed on its orderbook replenishment, with oil majors deferring project commitments amid weak oil prices. We like Hibiscus Petroleum (Outperform, TP: RM2.30) for its robust cash flow generation, supported by stable output operations of approximately 27,000-28,000 boe/d. While its revenue is directly linked to oil prices, we believe its annual operating cash flow of RM1bn is sufficient to fund ongoing capex and sustain dividend payments of 8-10 sen per year. This translates into a dividend yield of at least 5.2% at current levels, while the stock trades at an undemanding valuation of 2.7x PE ratio. We also favor Bumi Armada (Outperform TP:RM0.59), given its fixed charter contract terms for its Floating Production Storage and Offloading (FPSO) units, which provide long-term stable cash flow and earnings alongside an improving balance sheet. It also currently trading at undemanding valuation of 5.3x PE ratio and 0.47 P/B ratio.

Source: PublicInvest Research - 17 Jun 2025