Oil and gas sector to still face volatile oil prices

UB Kay Hian Research maintains its Market Weight with Bumi Armada as its top pick

KUALA LUMPUR: UOB Kay Hian Malaysia Research forecasts the oil and gas sector to still face volatile oil prices, with critical periods from January 2017, when OPEC’s output adjustments take effect. 

It pointed out that OPEC delivered the four million barrels per day (bpd) cut in 2008-2009 but global production fell by only 1.7 million bpd due to many factors. 

“For 2017, we see swing factors from execution, US shale activities, and start-ups of new projects. The floating production, storage and offloading (FPSO) units, not oil prices, will be the key sector earnings driver for 2017. Maintain Market Weight with Bumi Armada as our top pick,” it said in its report.

The FPSO unit is a floating vessel used by the offshore oil and gas industry for the production and processing of hydrocarbons, and for the storage of oil, according to Wikipedia.

A FPSO vessel is designed to receive hydrocarbons produced by itself or from nearby platforms or subsea template, process them, and store oil until it can be offloaded onto a tanker or, less frequently, transported through a pipeline.

UOB Kay Hian Research also sees oil markets entering a transitionary phase as the output “adjustments” of -1.2 million bpd by OPEC a clear intention of setting a price floor, at the very least. 

“Near- term sentiment will be supported by more non-OPEC newsflow, Russia committing to a 300,000 bpd cut, and a Dec 9, 2016 meeting with non-OPEC members may target for a 600,000 bpd output cut. These make 2017 consensus US$55 a barrel Brent price a near-term possibility,” it said.

The research house noted the sector remains a trading play due to “many moving parts”. 

As January 2017 is the effective date of the output adjustments, we see oil prices remaining volatile, depending on both the execution of the “adjustments” and response from other major producers like US shale players. 

Hence, the critical swing factors are: a) monthly production statistics, b) rig counts and production trends from shale players, c) Trump’s policies for the oil & gas (O&G) industry, d) inventory trends and demand growth, and e) oil majors’ start-up of new production projects in 2017-2019. 

“In our view, OPEC’s announcement does not cover these moving parts, which can still limit the upside for oil prices or may destroy the price floor. In the previous OPEC output cuts in September-December 2008 (a total planned cuts of 4.2 million bpd), OPEC production did decline by 4 million bpd from September 2008 to March 2009 (six-month timeframe), but global production was cut by only 1.7m bpd. 

“Overall, O&G stocks may trade in line with near-term oil price sentiment, but we still advise exit prices, given risks of a sell-down in oil prices by traders in the near future,” it said.

Commenting on the corporate results for the quarter ended Sept 30, 2016, it said it was a disappointing season, with some companies recording losses. 

It expects weak earnings in the industry (which remains in overcapacity) as long as Petronas stays conservative on cash flow spending. It believes consensus Brent forecast of US$55/bbl for 2017 appears realistic, but insufficient to justify a near-term fundamental re-rating. 

“Until the trend of sustained high oil prices and removal of the crude oversupply is clear, we retain our US$50 barrel P/B benchmark for the stocks in our coverage. 

“Fundamentally, 2017-18 sector earnings growth and margin improvement will mainly be driven by asset owners (Overweight) which comprise Bumi Armada and Yinson which will start up new FPSO projects.

Its top buy is Bumi Armada (Target: 92 sen) as the company remains a key proxy in FPSOs. Despite the recent poor earnings, there is no cause for concern for BAB’s loan covenants, and it is on track to deliver the four floating projects by end-2016. 

“We expect a doubling of profits and a strong improvement in cash flow by 2017,” it said.

Sapurakencana (Hold/Target: RM1.40) has a high correlation to oil prices as it also has oil production revenue. Other beaten-down stocks with strong cash flow and/or relatively resilient business model are Uzma (Hold/Target: RM1.45), Deleum (Upgraded to Hold/Target: RM0.85), and MMHE (Hold/Target: RM1.11),” it said.