Oil and Gas – Singapore - The Beginning Of The End Of Low Oil Prices?
- OPEC has announced a deal that will see their production reduced by 1.2mbpd, effective Jan 17. The deal sets the stage for the oil market to reach an earlier balance in 2017. We expect the sector to remain a trading play, as we expect continued oil price volatility from factors that may cap or break current price levels.
- We re-run our P/B to Brent crude price regression and update valuations accordingly.
- Upgrade to MARKET WEIGHT.
- OPEC cuts a deal, setting the stage for an earlier market balance in 2017. Effective 1 Jan 17, the deal is contingent on an additional 600,000 bpd in production cuts from non-OPEC countries.
- Russian Energy Minister Alexander Novak has already committed to half the amount (300,000 bpd), which it will gradually reduce over 1H17.
- Assuming the cuts are achieved, this will amount to 1.5-1.8mbpd being removed from global supply, surpassing IEA’s current implied global supply imbalance of 0.9mbpd (Oct 16 supply: 97.8mbpd, 3Q16 demand: 96.9mbpd).
Sector remains a trading play at best.
- We expect continued oil price volatility in the near term, owing to several factors that could break or cap current price levels. The “price floor” may be broken if OPEC fails to adhere to the production cuts proposed, of which OPEC is known to have a chequered history with adherence.
- Oil price upside may also be capped as supply from US shale players kicks in as price rises. Critical swing factors that could break/cap current oil price level of US$50/bbl include:
- monthly non-OPEC/OPEC production figures,
- rig/production counts from US shale players,
- global inventory/demand trends, and
- start-up of new projects over 2017-19.
- We expect O&G stocks to trade in line with oil price sentiment in the near term.
Positive sentiment boosting the segment for now.
- Fundamentally the environment remains largely unchanged. The recovery in activity will lag oil price as oil players will require price stability before committing to higher activity levels.
Prefer other names with a strong balance sheet with earnings potential from an upturn.
- Between now and the eventual recovery, we prefer names with a strong balance sheet that can weather continued depressed service prices. Asset owners will be the first to benefit from the uptick in activity.
- Within our coverage, we recommend Ezion (EZI SP/Target: S$0.39) and Wintermar (WINS IJ/Target: Rp370).
Top BUY: Sembcorp Industries (SCI SP/Target: S$3.05 [UNDER REVIEW]).
- Sembcorp Industries remains our top pick within the overall oil and gas sector given its utilities segment’s earnings growth and exposure to oil. Utilities growth will be led by India, with 2017 to see earnings from its second power plant come on-stream.
- At the same time, share price will likely rise as 61%-owned Sembcorp Marine re-rates.
- Our target price of S$3.05 is currently under review, pending a valuations review for the Singapore shipyards.
Updating valuations to reflect higher oil prices.
- We have re-run our regression of the sector’s P/B against Brent crude and updated our valuations. Despite prospects of higher oil prices, we are cognisant of impairments/kitchen-sinking in the sector for FY16 and have accorded a 20% discount across the board to account for this.
- A discount of 50% was accorded for companies with high net gearing, or negative operating cashflows.
Upgrade to MARKET WEIGHT.
- Bankruptcy and contagion risks still remain. At this juncture, the candidates have mostly been identified and we think any fallout should be contained. Given rising positive sentiment over share prices, upgrade to MARKET WEIGHT.
Production cut of 1.2mbpd from Oct 16 levels.
- The OPEC deal entails participating nations except Iran each taking a surprisingly consistent ~4.5% reduction in production from their Oct 16 level. Saudi Arabia, as the largest producer will take the largest cut at 486,000 bpd. The reduction of 1.2mbpd in production shrinks OPEC’s production to 32.5mbpd. The deal is effective 1 Jan 17 and will last six months, and extendable for another six months.
- A monitoring committee composed of Algeria, Kuwait, Venezuela and two participating non-OPEC countries will be established to ensure members’ adherence to the deal.
Russia faces challenges implementing a production cut.
- In an interview with CNBC, Chris Weafer, co-founder of consulting agency Macro Advisory Partners, commented that Russia faced hurdles in implementing production cuts.
- On a technical perspective, most of its production comes from areas with freezing temperatures which require drillers to keep oil flowing.
- Additionally, the Russian government, which owns a majority share in Russia’s big oil companies, faces a potential revolt from minority shareholders should production be limited.
Non-OPEC supply growth of 665kbpd in 2017 offsets targeted non-OPEC reductions.
- IEA in its Nov 16 report expects total non-OPEC supply to grow by 665,000 bpd, led by developments in Brazil (+280kbpd), Canada (+225kbpd) and Kazakhstan (+160kbpd). This more than offsets the 600,000 bpd reduction OPEC seeks from nonOPEC countries. Unless these countries as well as US shale players join in limiting production growth, the impact of OPEC’s deal will be dampened.