We maintain our NEUTRAL call for the sector, as well as our CY23 average Brent crude oil price assumption of USD80/bbl (vs. USD99/bbl in CY22). We believe oil price (YTD: USD80/bbl) will remain resilient due to: (i) robust demand from non-OECD economies, especially China, (ii) OPEC+’s resolve to support oil price via production caps, (iii) subdued inventories, and (iv) Strategic Petroleum Reserve (SPR) restocking. On the back of this, we believe that O&G capex spend will remain robust and propel upstream contractors. On the flipside, the demand outlook is weak for: (i) petrochemicals due to the shift in Chinese demand away from consumer goods, and (ii) crude transportation due to OPEC+’s supply cuts. Our top picks include YINSON (OP, TP: RM3.65) and DIALOG (OP; TP: RM3.10).

1. Upstream

Record oil demand driven by China. According to OPEC, CY23 global oil demand growth is forecast at 2.35m bpd (CY22: 2.49m bpd). The lion’s share emanates from non-OECD economies (2.3m bpd), whilst OECD oil demand will merely grow by 50k bpd. In particular, oil demand is largely propelled by China (+840k bpd) on the back of: (i) higher consumption of jet fuel due to uptick in tourism and business travel, (ii) increased demand for light distillates following the startup of new petrochemical plants, (iii) rise in usage of diesel due to government stimulus and infrastructure spending, and (iv) expansion of gasoline and diesel requirements following upliftment of Covid-19 travel restrictions. To a smaller extent, demand is also boosted by healthy consumption at the Middle East (+380k bpd) and India (+240k bpd) due to increased air travel. Evidently, IEA reported record all-time high demand from both China and India in April-May CY23 due to the factors highlighted above. Whereas for OECD, the subdued growth is primarily dragged by contraction in European demand and flattish US consumption. This is mainly attributed to a lingering manufacturing slump and lacklustre economic growth.

Net supply shortfall in CY23. On the same note, EIA anticipates CY23 demand growth to be mainly driven by China (+800k bpd). However, vis-à-vis OPEC and IEA forecasts, EIA expects relatively lower global consumption growth of 1.6m bpd (OPEC: 2.35m bpd). The variance mainly emanates from EIA’s expectations of lower demand from non -OECD countries. Meanwhile, in terms of supply, EIA expects global production to expand by 1.5m bpd (CY22: 2.3m bpd). This is mainly driven by a spike in US production (+1.05m bpd) that will more than offset the decline in OPEC (-650k bpd) and Russian (-230k bpd) supply. Against this backdrop, EIA forecasts supply shortfall of 400k bpd in CY23 (CY22: 500k bpd shortfall). Similarly, IEA is on the same page in predicting net global production deficit of 1m bpd in CY23. As such, our view of resilient oil price in CY23 is reinforced by the significant production deficit.

Deep OPEC+ cuts will support oil price. Additionally, we believe that oil prices are well supported by OPEC+’s active market intervention. Since its inception, the cartel has consistently adjusted production levels to regulate supply and boost sentiment. To recap, at its most recent meeting in early June, OPEC+ decided to extend previous production cuts of 3.66m bpd until end CY23. Moreover, the alliance will reduce combined production by an additional 1.4m bpd in CY24. On top of that, Saudi Arabia asserted its leadership yet again via additional voluntary production cuts of 1m bpd from Jul CY23 onwards. Hence, Saudi’s output is now estimated to drop to a two-year low of 9m bpd, versus its capacity of 12.3m bpd. This is after accounting for earlier voluntary cuts of 500k bpd that were implemented in early CY23. Understandably, we believe it is in Saudi’s best interest to ensure prices hover at its CY23 fiscal oil breakeven price of USD81/bbl (IMF estimate). Hence, this will enable it to fund its CY23 budget deficit (IMF estimate: 1.1% of GDP), and implies sustained measures to prop oil prices.

Multi-year low inventories due to drawdowns. Meanwhile, EIA expects global oil inventories will decline every quarter starting from 3QCY23 until 3QCY24. This is underpinned by expectations of short supply in the market following the OPEC+ production cuts. On the back of this, OECD inventories are expected to remain at multi-year lows, below their 3 and 5-year moving averages. Meanwhile, the US Strategic Petroleum Reserve (SPR) has dwindled to 372m bbls, its lowest level since CY83. The decline was following the record release of 180m bbls authorized by the US government in Mar-22 following Russia’s invasion of Ukraine. Therefore, according to Reuters, the US administration plans to purchase circa 12m bbls as part of replenishment efforts. Hence, on the back of depressed inventories and SPR restocking, we expect limited downside to oil price.

Against the backdrop of resilient oil price, we expect sustained traction in O&G capex spend. This is due to our belief that O&G projects will remain commercially feasible as long as oil price trades north of USD70/bbl. Evidently, on the global front, IHS Markit expects global offshore exploration and production capex spend to expand by 12% YoY to USD151b in CY23. Meanwhile, nearer to home, investments will be anchored by Petronas’ target to spend RM300b in capex over CY22-27. This translates into substantial annual capex of RM60b vis-à-vis average spend of RM42m p.a. over the past 5 years. Correspondingly, based on Petronas’ Activity Outlook 2023-35, YoY demand will rise in 2023 for most jobs and projects. This includes: (i) fabrication of wellhead platforms, (ii) decommissioning of platforms/subsea trees, (iii) supply of offshore support vessels and jack-up rigs, (iv) topside maintenance, (v) platform maintenance, construction and modification, and (vi) offshore hookup and commissioning. As such, we believe that upstream service providers are leveraged towards a recovery in daily charter rates (DCR), fleet utilization and new contract awards. Our OP recommendations in this space include UZMA (OP; TP: RM0.90), and WASCO (OP; TP: RM0.97).

Whereas for floating production storage and offloading (FPSO) contractors, the global vessel market is poised for a huge uptick in the coming years. This is according to Rystad Energy, which forecasts 48 FPSO awards for new greenfield developments in CY23-30. Meanwhile, Clarksons is projecting four FPSO conversions and 11 newbuild awards, which translates to an all-time high. The total value of FPSO awards that Clarksons forecasts in CY23 is in excess of USD19b. Therefore, this augurs well for ARMADA (OP, TP: RM0.62) and YINSON.

2. Midstream and Downstream

On the other hand, the outlook is less rosy for midstream and downstream players. This includes petrochemical and shipping companies such as MISC (MP; TP: RM6.70) and PCHEM (UP; TP: RM6.20). According to Tradewinds, OPEC+’s surprise production cuts of 1.7m bpd will likely impact tanker markets. This is on the back of substantially lower demand for crude transportation. Evidently, Bloomberg reported that benchmark rates for oil supertankers collapsed by three-quarters in May.

Whereas for petrochemicals, we believe that demand recovery will be muted in the near term. This is due to tepid consumer spending, particularly in China as inflation hits consumer spending. Moreover, Chinese consumption has shifted from consumer goods during the pandemic to services currently. This behaviour change is likely driven by the upliftment of Covid-19 lockdowns. Hence, Chinese consumers are now prioritizing travel and social activities. In turn, this has dented demand for consumer goods that require petrochemical feedstock as raw material input.

We maintain our NEUTRAL view on the sector. In essence, as highlighted above, we continue to be positive due to: (i) sustained traction in O&G capex spend leads to strong DCRs, fleet utilization and new contract awards for upstream service providers, (ii) the global FPSO market being poised for a huge uptick in the coming years, and (iii) resilient regional tank terminal storage rates exceeding SGD6 per m3. On the other hand, we believe that recovery in demand will be muted in the near term for petrochemicals and crude tankers.

Our top picks for the sector include:

YINSON due to: (i) its diversification into renewable energy and green tech ventures that may translate to earnings expansion and enhance its ESG profile, (ii) it is currently the sole contender to supply and operate an FPSO for BP’s Block 31 SE-PAJ project at Angola, and (iii) strong earnings visibility and growth – underpinned by large outstanding orderbook of USD22.3b with contract tenures that stretch up to CY48.

DIALOG on the back of: (i) resilient non-cyclical earnings with multi-year growth prospects from future capacity expansion at Tanjung Langsat (17 acres) and Pengerang Phase 3 (500 acres), (ii) active diversification into upstream production assets enables the group to capitalize on oil price rallies, and (iii) near term earnings expansion from Tanjung Langsat Terminal Phase 3 (capacity: 24k m3) that is targeted for completion by end-CY24.

Source: Kenanga Research - 7 Jul 2023