Price war could spark new downcycle for oil, disrupt value chain

KUALA LUMPUR: A sustained disruption to the price of crude oil could throw the entire market into disarray and spark a new downcycle for oil, especially amid a demand slowdown, says Kenanga research.

"We have always maintained our view that an extended oil production cut from OPEC+ is necessary to just maintaining the oil price levels (let alone driving prices higher), and such, recent developments have caused us to fear that the worst-case scenario could be gradually unfolding," it said.

The research house slashed its 2020 average Brent crude oil price assumption to US$40 a barrel from US$60 a barrel previously.

Kenanga is anticipating a slight rebalancing to occur in the second half of this year while Brent price is expected to hover around the US$30 a barrel mark in 2Q.

Kenanga believes a market correction is still possible given the low oil prices although it is unable to determine a timeline for it to materialise.

A such low prices, shale oil producers would be producing at a loss, which could result in a reduction in shale production and a slight rebalancing of the market's demand-supply dynamics, it said.

A sustained price war could also pressure Russia to return to the Opec negotiation table as its fiscal breakeven oil price is reported to be about US$42 a barrel, although Kenanga added that this is not in its base-case assumption.

Investors are advised to avoid the oil and gas sector until uncertainties are cleared as all related counters could be affected by the recent reduction in crude oil price.

The research house said the first casualties from the low oil prices are companies with exploration and production exposure such as Sapura Energy and Hibiscus.

The low oil price environment could also ignite a slowdown in global sactioning of new projects, and potentially impact those benefiting from greenfield projects such as fabricators, FPSO providers and pipe players.

Sapura Energy, MHB, Yinson, Armada, Pantech and Waseong fall within this category, it noted.

Kenanga added that all equipment and services contractors across the board are also expected to face even greater margin pressure, which would include Dayang, Uzma, Dialog, Serba Dinamik and Velesto among others.

Lastly Petronas Chemicals may also be impacted given the correlation between petrochemical prices and crude oil.

In the event investors are looking for exposure in the sector, Kenanga suggests resilient plays such as Dialog, Yinson and Serba Dinamik.

It also recommends MISC as its consistent dividend may provide some defensiveness.

Meanwhile, Sapura Energy and Bumi Armada are currently trading at near liquidation valuations and could be a target for bargain-hunters when things start to turn around.
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