KUALA LUMPUR (July 21): Hong Leong Investment Bank (HLIB) Research has maintained its "neutral" call on the oil and gas (O&G) sector as it expects crude oil prices to trade sideways from its June average price in the third quarter of 2020 (3Q20) on slower demand recovery arising from re-emergence of lockdown measures due to Covid-19.

HLIB Research analyst Low Jin Wu believes that Opec+ would continue its 9.7mbpd production cut target into 3Q20 to support oil prices.

“While compliance was only 85% in May and about 90% in June, we believe that Opec+’s compliance will be higher going into July and August despite its plans to reduce production cuts by two million to 7.7 million bpd from August onwards, which would bring the oil market closer to equilibrium.

"Furthermore, a decline in US production on the closure of shale rigs would also act as impetus for the oil market to reach equilibrium,” said Low in a note.

At the time of writing, Bursa’s Energy Index, which tracks share prices of O&G-related companies, was 18.37 points or 2.41% higher at 779.73 points.

The top six active stocks included Reach Energy Bhd, which rose half a sen or 6.67% to eight sen, followed by KNM Group Bhd, up one sen or 4.76% to 22 sen. Bumi Armada Bhd increased 2.27% or half a sen to 22.5 sen, Sapura Energy Bhd rose one sen or 11.11% to 10 sen, and Barakah Offshore Petroleum Bhd jumped 22.22% or one sen to 5.5 sen, though Daya Materials Bhd slumped 40% or one sen to 1.5 sen.

According to Low, Petronas had announced its plans to cut capital expenditure (capex) by 21% (about RM10 billion) due to a crash in oil prices as a result of Covid-19, and he did not rule out the possibility of this going beyond a 21% capex cut and assumed a 30% cut.

“Malaysian O&G service players are predominantly dependent upon Petronas’ spending for its survival, and any capex cuts by Petronas would directly impact most listed O&G players in Malaysia.

“We are negative on companies which are heavily reliant on Petronas’ capex spending as we believe that Petronas would be conservative in its capex spending at least until 1HFY21 (the first half ending June 30, 2021) and we remain neutral to positive on companies less reliant on Petronas’ capex,” he noted.

Besides, Low viewed that the share price of Petronas Chemicals Group Bhd (PetChem) had run ahead of its near-term fundamentals as most product prices (except for polyethylene and urea) were still significantly below their prices at the start of the year, while PetChem’s share price had recovered significantly.

Low named Bumi Armada Bhd as HLIB Research's top pick with a "buy" rating and a target price (TP) of 41 sen based on 10.3 times FY20 earnings per share for a stable and strong floating production storage and offloading (FPSO) earnings contribution (over 80% of revenue) and its undemanding valuations.

The second top pick is Dialog Group Bhd ("buy"; TP: RM4.23, based on the discounted cash flow method with a weighted average cost of capital of 7%) for its stable and cash-strong business model as tanker rates are holding steady.

“Overall, we expect demand from most countries (which are in their recovery stage) to recover, and this will mitigate potential loss of demand from nations severely affected by the pandemic. We believe that oil prices will be closer to equilibrium in 4Q20 and we expect Brent crude oil to average at US$55 (RM234.44)/bbl in 2021 as we expect a more balanced oil market then,” he said.