Oil & Gas - 2017 A Turning Point
- Oil prices are off the bottom and inching closer to US$60 per barrel – a critical level that stimulates oil and gas activities.
- Government support measures to tide stronger offshore and marine players over.
- Corporate failings and M&As set to rise.
- Top picks: Medco Energi, Bumi Armada, Sembcorp Industries, Ezion and POSH. Introducing CNOOC (Not rated)
Theme #1: Oil price recovery.
- We are upgrading our Brent forecast for 2017 by US$5 per barrel (bbl) to US$55-60/bbl.
- Promises from OPEC and non-OPEC producers of supply reductions will accelerate oil rebalancing (achieving equilibrium in 1Q17) and price recovery. Confidence has also been boosted by Saudi Arabia’s tone for deeper cuts.
- For now, we are keeping our longer term price assumption intact at US$60- 65/bbl. We will be monitoring the response from US shale drillers if prices move towards more lucrative levels of US$60/bbl, and energy policy of US President-elect Donald Trump.
- The US dollar appreciation and interest rate hikes may add to pressure on oil prices as well.
- The wildcard remains the shift in geopolitics under US President-elect Donald Trump.
- Beneficiaries: E&P companies – we have BUY on Medco Energi (Medco) and PTT. We are issuing a not-rated note on CNOOC.
Theme #2: Government intervention.
- The Singapore government announced enhanced support measures for marine and offshore engineering companies on 25 Nov 2016, comprising:
- bridging loan facility of up to S$15m per group, and
- enlarged Internationalisation Finance Scheme (IFS, an increase from S$30m to S$70m) for asset acquisitions.
- Singapore is not the only country doling out assistance; South Korea recently announced plans to establish a state-backed ship financing company to assist struggling shipping firms and shipbuilders with potential newbuild orders of 250 vessels or more by 2020.
- Beneficiaries: Small-mid-cap oil and gas (O&G) players in Singapore –Ezion (BUY), PACC Offshore (POSH, BUY), Pacific Radiance (PACRA, HOLD), Ezra (FV).
Theme #3: Merger & Acquisitions.
- In the Asia Pacific region, O&G M&A activities were lacklustre in 2016, but there could be a slight pickup in 2017.
- The O&G-focused private equity (PE) funds have focused on upstream acreage with cheap valuations and this trend will likely continue. The appetite for asset owners (i.e. drillers and offshore supply vessel (OSV) players) remain lukewarm given the massive oversupply that will take years to clear, though some distressed asset sales are possible.
- In addition, we expect privatisation of companies with strong controlling shareholders to take place in view of undemanding valuations and consolidation of shipyards in order to stay competitive.
- Proxies: Privatisation candidates – POSH (BUY); Mermaid (HOLD); Merger - Singapore rigbuilders.
VALUATION & STOCK PICKs
Time to revisit the sector; pick up some oil & gas stocks to ride oil bounce.
- While a rising tide lifts all boats, we prefer to stay safe. The operational improvement will lag oil recovery by 2-3 quarters, thus, insolvency concerns remain for companies with high burn rate. The next indicator to watch will be the actual production decline by both OPEC and non-OPEC producers, and rebalancing in 1Q17.
- Upstream E&P players are the best proxies to a rising oil price – we have BUY on Medco and PTT. We reaffirm our BUY rating. CNOOC is the best proxy to the upstream sector among the Chinese oil majors.
- Service providers could also see a rebound off their low valuation base – we have BUYs on Ezion, POSH and Bumi Armada, which have higher survivability among peers, in our view.
- 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 upgraded Sembcorp Marine (SMM) to HOLD recently; reiterate Buy on Sembcorp Industries (SCI) as a safer proxy and undemanding valuation.