Oil & Gas - OPEC agrees to curb output
- OPEC members to cut production by c.1.2m bpd.
- Non-OPEC producers promise cuts of 0.6m bpd.
- Rebalancing could be brought forward to 1Q17.
- Sector should see a near-term upswing. Buy PTT, Medco, SCI, Ezion, Bumi Armada. Upgrade Posh to Buy, SMM and PACRA to HOLD.
Member countries to cut output by c.1.2 million barrels per day (mmbpd).
- OPEC reached a landmark consensus yesterday to reduce output by about 1.2mmbpd, effective 1 Jan 2017. The duration of the agreement is six months, and is extendable for another six months (depending on market conditions). This would reduce OPEC’s output ceiling to 32.5mmbpd.
- The allocation was generally done on a percentage of current output basis, with participating members reducing output by an almost uniform c.4.5-4.6% from current levels. A monitoring committee chaired by Kuwait will oversee the implementation.
Non-OPEC promises sweeten the deal.
- An understanding has been reached with various non-OPEC countries, including Russia, that they would also contribute towards a reduction of 600,000bpd – bringing the total potential supply curtailment to about 1.8mmbpd. Russia’s Energy Minister has been quoted by the press saying that Russia would account for half (i.e. 300,000bpd) of the non-OPEC output cut, though he also said that any cut will only be gradual owing to technical constraints and will also depend on OPEC’s implementation.
Deal could bring forward demand-supply balance to 1Q17.
- Based on adjustments to the International Energy Agency’s (IEA) latest forecasts, we think the global crude oil rebalancing process could be brought forward to 1Q17, ceteris paribus. As a result, we think Brent crude oil price could average between US$50-60 per barrel (bbl) in 2017, depending on the actual extent of cuts.
- Higher output from US tight oil producers should cap oil prices at the US$60-65/bbl range in the medium-to-long term, as these players are likely to ramp-up production quickly as oil prices approach US$60/bbl.
Short-term uptick for share prices.
- The OPEC deal, which has already boosted oil prices by some 8.8% overnight, should provide a near-term boost to O&G share prices, especially to down-and-out stocks with relatively better fundamentals/lower risks.
- Upstream E&P players are the best proxies to rising oil prices – we have BUYs on PTT, and Medco. CNOOC is the best proxy among the Chinese oil majors.
- Service providers could also see a rebound off their low valuation base – we have BUYs on Ezion and Bumi Armada; upgrade POSH to BUY and PACRA to HOLD. POSH has strong parental backing and is amongst the potential privatisation candidates.
- Shipyards will likely lag the oil price recovery as they are near the bottom of the supply chain but risk premium should be reduced with improved macro backdrop. We upgrade Sembcorp Marine (SMM) to HOLD; reiterate Buy on Sembcorp Industries (SCI) as its undemanding valuation already implies a next-to-zero valuation for SMM.
Some were granted immunity.
- Nigeria, Libya and Indonesia – countries which had previously voiced opposition to curbing output – were not allocated any production cuts, while Iran was the sole country granted an increase (of 90mmbpd) to its production level.
- Surprisingly, Iraq, also formerly opposed to participating, acquiesced to a production cut. Incidentally, Indonesia has suspended its membership from OPEC.
US shale and Trump’s energy policies pose a cap on oil prices.
- There is uncertainty regarding the energy policy of the new US President, which could add more pressure on supply side in the medium to long term, given his policy to boost employment in the energy sector, revive investments in fossil fuel businesses, and lower incentives to promote green energy and renewable energy businesses.
- President-elect Donald Trump has vowed to “cancel job-killing restrictions on the production of American energy, including shale energy and clean coal, creating many millions of high-paying jobs.” US shale oil producers have been cautiously redeploying cash, rigs and workers and US shale rig count has gone up by 40% from the lows of 262 rigs in May 2016 to 367 rigs currently.
Boom time in the Permian Basin demonstrates shale oil resilience.
- Close to two-thirds of the new rigs have been deployed in the Permian Basin alone, where production is booming in 2016 despite declines in almost all the other key shale areas in the US, including Bakken and Eagle Ford.
- Productivity improvements mean that some projects are viable even at the US$40-45/bbl range and increased production from the Permian Basin area in 2017 is likely to keep US production largely stable in 2017, stemming the decline seen in 2016. If oil prices move up as now expected towards the US$55-60/bbl range in response to the OPEC cut, we could see shale oil production increasing again in 2018, and capping the recovery in oil prices.
Change in Recommendation / TP
- Shipyards will likely lag the oil price recovery as they are near the bottom of the supply chain but risk premium should be reduced with improved macro backdrop.
- We are upgrading SMM to HOLD with higher TP of S$1.55 based on 1.3x FY17 P/BV, in line with 1.5SD below mean (from 2SD currently) and recovery valuation post AFC. SMM is the most positively correlated by changes in oil price. Technical targets projects upside potential to $1.51-1.525 and should this resistance level be taken out, the next levels are $1.70 followed by $1.84 in the months ahead.
- Our TP for SCI is also lifted to S$3.10, factoring in the higher SMM TP. We reiterate our BUY on SCI as its undemanding valuation already implies a next-to-zero valuation for SMM.
- For the service providers, survivability is key. In addition to our existing BUY calls on Ezion and Bumi Armada, we are upgrading POSH to BUY with higher TP of S$0.41, based on 0.6x P/BV (previously 0.5x) and PACRA to HOLD with TP of S$0.16, based on 0.25x P/BV (previously 0.2x). POSH has strong parental backing and is amongst the potential privatisation candidates.