Is investing in oil stocks worthwhile?

  • Energy
  • Saturday, 15 Aug 2020

Fluctuating prices: Drilling rigs seen at sunset in Midland, Texas. The outlook for oil prices remains volatile in the coming months due to excess supply. — Reuters

OIL prices have been been under pressure for a long time.

Since the big crash in late 2014, oil prices have struggled to recover sustainably, as supply of the commodity continues to outstrip demand all over the world.

For instance, in April this year, at the height of the Covid-19 fallout in the United States, future prices for West Texas Intermediate (WTI), which is the standard for US crude oil pricing, slipped into negative territory amid fears that the sector would run out of storage for a glut caused by the lockdown. During this period, futures for Brent crude, the benchmark used by the rest of the world, plunged below US$20 per barrel.

While oil prices have since rebounded, overall, they are still down by at least 30% year-to-date (YTD).

Similarly, oil and gas stocks in Malaysia, as measured by the Bursa Malaysia Energy Index, are still down by some 34% YTD.

And the outlook for oil prices remains volatile in the coming months due to excess supply of the commodity and weak demand amid a sluggish global economy.

The Organisation of the Petroleum Exporting Countries (Opec), for one, projects global oil demand will fall by 9.06 million barrels per day (bpd) this year, more deeply than the 8.95 million bpd decline it expected a month ago.

Over the week, the International Energy Agency (IEA) also cut its 2020 oil demand forecast due to unprecedented travel restrictions. The Paris-based agency said reduced air travel due to the pandemic would lower global oil consumption by 8.1 million bpd to 91.1 million bpd this year.

For 2021, the IEA expects global oil demand to average at 97.1 million bpd. That’s a cut of 240,000 barrels bpd from its earlier estimate in view of the anticipated weakness in jet fuel demand next year.

Still-weak prices

Oil prices have been range-bound since mid-June, with Brent trading between US$40 and US$46 per barrel, and WTI between US$37 and US$43 per barrel.

According to the US Energy Information Administration (EIA) forecast, Brent spot prices are expected to average at US$41.40 per barrel in 2020, representing an upward revision from its previous estimate of US$40.50 a barrel.

WTI spot prices, on the other hand, are expected to average at US$38.50 per barrel in 2020, slightly up from its previous estimate for the year at US$37.55 per barrel.

For 2021, the EIA expects Brent spot prices to average at US$49.50 per barrel, which is a slight reduction from its earlier projection of US$49.70 per barrel, while WTI spot prices are expected to average at US$45.53 per barrel, down slightly from its previous prediction of US$45.70 per barrel.

Capex cut

Analysts observe that as long as prices remain weak and volatile, it will be hard to induce oil majors including Petroliam Nasional Bhd (Petronas) to increase their capital expenditure (capex). This means projects in the sector will remain limited, and prospects will remain dull for most oil and gas companies, particularly those in the upstream sector.

AmInvestment Bank notes that while sentiment on oil prices has turned somewhat positive in recent weeks stemming from the progress in novel coronavirus vaccine trials and a weaker US dollar, it expects oil producers to proceed with their planned production cuts for 2020.

It explains this is because global demand is still depressed amid the prolonged Covid-19 movement restrictions and social distancing measures which could potentially lead to long-term changes in energy usage.

Petronas, which had earlier indicated intentions to maintain domestic capex, has announced cuts of 21% for capital and 12% operating expenditure (opex) this year, the brokerage points out.

This is similar to the 20% to 30% capex reductions for 2020 which were earlier announced by Exxon Mobil, Royal Dutch Shell, Saudi Aramco and Petrobras, it says.

In the first half of 2020, new contract awards to Malaysian oil and gas operators dropped 62% year-on-year to RM2.2bil, with the worst fallout to come in the second half of the year, according to AmInvest.

In its recent report, the brokerage says it maintains its “neutral” view on the oil and gas sector, with a mixed number of “buy” and “sell” calls on local players.

It recommends “buy” on Dialog Group Bhd and Serba Dinamik Holdings Bhd for their resilient non-cyclical tank terminal and maintenance-based operations, as well as Petronas Chemicals Group Bhd due to its high correlation to the recent oil price upturn.

“However, as we continue to view the still-low oil prices and earnings of upstream service companies to be worse than the previous 2015–2017 downcycle, which led to multiple financial distress to oil and gas corporations, we retain our “sell” calls for Bumi Armada Bhd, Sapura Energy Bhd and Velesto Energy Bhd, ” says AmInvest.

Retail interest

Data from Bursa Malaysia shows there was a surge in buying volume for oil and gas stocks on Tuesday after Brent crude oil prices briefly rose past US$45 per barrel. But the counters have since gave up gains towards the end of the week in tandem with the decline in oil prices.

One broker tells StarBizWeek the certain oil and gas counters attracted buying interest because of their low prices.

“Valuations aside, some of the oil and gas stocks are cheap, and they are affordable for many retail investors. Hence, even a slight upturn in oil prices will attract a lot of retail investor interest, ” he says.

“Some are just willing to park their money in these counters for a longer period of time, as they think there is always a chance for a significant upside or gain (when a stock trades as such low prices) if oil prices ever start climbing again, ” he adds.

Meanwhile, UOB Kay Hian Research cautions against investing based on oil price momentum.

The brokerage advises investors to avoid companies that are dependent on Petronas’ local contracts. It is, however, positive on internationally competitive companies such as Yinson Holdings Bhd, which is its top stock pick for the sector.

“We base our sector valuations on a US$40 per barrel oil price, which factors in oil demand recovery, but we advise against investing based on oil price momentum, ” the brokerage says in its recent report.

“Even if oil prices continue to rise, we think Petronas will still face cash flow challenges amid Sarawak’s revenue claim and another delayed start-up for the Pengerang Refining and Petrochemical and methanol plants. These may increase its need to cut costs, ” it adds.

UOB Kay Hian says while Yinson remains its top pick on event catalysts, other non-rated companies that are less dependent on Petronas include Hibiscus Petroleum Bhd and KNM Group Bhd.

“With consensus expecting Brent oil to average at US$47 per barrel in 2021, Hibiscus is the only direct beneficiary to the rise in oil prices backed by strong financial strength. Aside from FPSO (floating production storage and offloading) players and Serba Dinamik Bhd, we identify KNM fitting into our sector theme of minimal dependency on Petronas contracts, ” it explains.

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