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This article first appeared in The Edge Malaysia Weekly, on January 4 - January 10, 2016.

 

O&G_14_TEM1091_AFPFOR a world that is addicted to oil, an abundant supply of the black gold seems to have caused a lot of anxiety. Oil traders, analysts, stock market enthusiasts and government economists have spent the best part of 2015 crunching numbers, keeping an eye on regional geopolitical developments and anticipating volatile crude oil price movements in order to avoid placing the wrong bets on oil.

Brent crude lost 35.3% in 2015 and hit its lowest price for the year at US$36.1 per barrel, sending chills down the spines of market observers. So, the question of how low crude oil prices can go must seem old by now. Yet, for those who are still looking to wager on the beaten sector, recent developments in the oil market show investors could be in for another rough ride in 2016.

In September 2015, US investment bank Goldman Sachs, and more recently the International Monetary Fund, warned that crude prices could plummet to as low as US$20 a barrel in 2016 on the back of a persistent glut. With the possibility of Iran, which owns the world’s fourth largest oil reserves, pumping more after Western powers lift sanctions, the US Congress lifting a 40-year ban on crude exports and the Organization of the Petroleum Exporting Countries (Opec) continues playing hardball over scaling down production, it is reasonable to expect the market to be flooded with cheap oil next year.

Local analysts, however, tell The Edge that the forecast may be overbearish. MIDF Research analyst Aaron Tan says, “The main issue with the oil price is not just oversupply, but deliberate oversupply.

“So, when you talk about the oil price, you have to consider two factors — the asset break-even point, which is the point at which a particular oil asset can generate positive cash flow, and the fiscal break-even point at which the minimum sale price for a barrel of oil for a country to reach a budget surplus. After a certain point of decline, low prices become unsustainable.”

Deliberate oversupply by Opec in its relentless drive to knock out shale competition will eventually have to end, he says. Opec has an unofficial production ceiling of 30 million barrels per day (bpd), but is producing 32 million bpd. Opec can still ramp up production to 36 million bpd, but the strain of overproducing in a climate of low prices is starting to show.

Saudi Arabia has unveiled cuts to government expenditure, raised taxes and slashed fuel subsidies to cope. Bahrain has approved measures to cut state spending by 30% to weather the oil storm. The emir of Kuwait has pressed parliament to implement similar fiscal reforms. Even the oil cartel itself is reportedly tightening its belt by reducing expenditure on travel and freezing recruitment at its headquarters in Vienna. The same is being done by non-Opec countries like Malaysia.

Further, worries over US oil flowing into the open market may also be overplayed. US shale oil is “heavy” and has a higher sulphur content than its competitors. A higher API gravity of shale means many refineries in the world are still unable to process it.

“Even if you want to export US crude, you need to have offtakers. Globally, not many refineries can process heavy oil. To do that, you have to recalibrate your facilities and that can take six months to a year,” Tan says.

Taking these factors into consideration, he says the chances of oil prices reaching US$20 per barrel and staying there is very unlikely. “I expect prices to rebound in the second half of 2016, and oil to trade around US$50 per barrel.”

That, though, is not to say there is nothing to worry about for investors looking to put their money in oil and gas stocks. Analysts say even as oil prices recover in 2016, corporate earnings for oil-related stocks are expected to come under more pressure, the value of contracts to be awarded next year to shrink and an increasing number of impairments and assets and revision of prices of tendered projects.

Such a prognosis makes even cherry-picking stocks difficult. However, Kenanga Research analyst Sean Lim says although catalysts for a rally in oil and gas stocks will be hard to come by, opportunities can still be found in companies whose share prices have been beaten down during the oil price collapse.

“Icon Offshore Bhd and SapuraKencana Petroleum Bhd are two companies that have suffered in 2015 due to their share prices. In a sense, their prices already bottomed out during the global stock market rout in August and have stopped reacting wildly to crude oil price volatility. The plus side here is that these stocks should rally when there is a sustained recovery in oil prices,” says Lim.

Longer-term recommendations for the sector include companies that have a resilient cash flow to weather the weakness in crude oil prices.

“Yinson Holdings Bhd, which is expected to secure at least another floating production storage and offloading contract, and Dialog Group Bhd, which has Petroliam Nasional Bhd’s Refinery and Petrochemical Integrated Development project in Pengerang to back its earnings, are safe longer-term options,” says Lim.

Tan says the downstream subsegment is also expected to remain robust and relatively insulated from crude oil price troubles. His stock picks include Petronas Chemicals Bhd, which has announced three petrochemical projects within the Pengerang Integrated Petroleum Complex, and KNM Group Bhd, which stands to be a beneficiary of the supply of specialised process equipment. 

For investors seeking exposure to a more predictable downstream company offering stable earnings, he recommends Gas Malaysia Bhd, as the adoption of the incentive-based regulation regime will provide better earnings visibility and predictability.

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