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Oil & gas sector
Maintain neutral:
How low will oil go? Prices continue emerging at fresh lows and trending towards US$40 (RM142)/barrel levels, though there are some (but minimal) occasional rebounds.

We can expect equity markets to react to even the smallest jump in overnight oil prices. As prices of both Brent and WTI crude oil struggle to find a base level, we can only continue business as usual and focus on the more fundamentally intact equity investments.

Our view is that the dip in oil prices offered a shake-up in the industry, sifting out the “riders” versus the real operators. During the boom we saw many new non-oil and gas (O&G) players entering the market and continuously supporting the move for the sector to trade at rich valuations.

Following the plunge, companies are trading at more reasonable valuations, and is more detached from the “Petronas premium”, which saw the national oil company somewhat protecting the domestic O&G players.

To recap, the plunge in oil price was supply-led, heightened further by the decrease in imports from the United States, a net importer until recently and the world’s largest oil consumer.

The surge in horizontal drilling and hydraulic fracturing has increased US shale supplies, while technology has unlocked Canadian tar sands — two main forms of “tight oil”. We should also be mindful of the costs and financing of these operations, which would not be cheap.

Rather than worrying about how low oil prices will go, we are more focused on companies that are able to manage their costs more effectively. Our top picks are Bumi Armada (outperform, target price [TP]: RM1.77), Perdana Petroleum (outperform, TP: RM2.07) and Petra Energy (outperform, TP: RM2.40).

Major oil price influences including China’s economic performance would impact the price of oil, as the nation has been the world’s largest importer of liquefied fuels since 2013, and currently the world’s second-largest consumer of oil.

Also, the Organization of the Petroleum Exporting Countries (Opec) producing 30 million barrels/day, supplying about 40% of global oil supply, would drive the sentiment of oil trends with any decisions.

American shale was estimated to produce about nine million barrels/day of oil, an 80% increase since 2007.

At these price levels, can the US drillers remain sustainable and maintain output?

Stronger demand is the ultimate factor that could send oil prices upwards, or at least to a new point of equilibrium with current supply.

Geopolitical circumstances could hinder the production supply as has been demonstrated historically.

Thre is no change in Opec’s decision to maintain its target output levels of 30 million barrels/day, unless the US and other countries are seen to cut production first.

All eyes are on Petronas for announcements such as capital expenditure allocations and operational expenditure review, and Tan Sri Shamsul Abbas’ contract, which is expiring in February — these are crucial points that could determine the flow of contracts to be awarded.

Studying the trend of the last oil price dip in 2008, it took about six months to gradually rebound. The 2008 drop in oil prices was mainly caused by a demand shortfall from the global recession.

This time, it is a supply-led issue, thus we do not expect a sharp spike in oil price rebound but a more gradual one similar to the oil price trend in the 1980s. It is unlikely that the surge in production would be immediately curbed. We expect a slowdown in production to match the gradual inch-up of any rebound in oil prices. — PIVB Research, Jan 16

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This article first appeared in The Edge Financial Daily, on January 19, 2015.

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