Commodity prices (oil) are cyclical, as are the sector's profits.
The energy sector is prone to intense cyclicality.
Small changes in available supply and market demand tend to have an oversized effect on commodity prices and profits.
However, neither cyclical peaks nor valleys tend to last very long. It is important to realize this before investing in the sector. Otherwise, you might be tempted to sell when the sector is doing relatively poorly (when things are about to begin looking up again) or buy at the peak when the companies are reaping a windfall (when growth is about to go into reverse).
It is better to buy when prices are at a cyclical low than when they are high and hitting the headlines.
From the ground. Upstream - Exploration and production (finding and mining the oil and gas.)
To the Pipelines. Ships and pipelines (transporting the oil and gas to refineries and then again to the end users.)
To the Refineries. Downstream - refining (breaking apart crude oil into its component parts and refine it into end products, such as gasoline, jet fuel, and heavy lubricants.)
To the Consumers. Downstream - marketing (operating petrol and convenience stations, as well as marketing fuels for industrial uses and electricity production).
Oil & Gas - Pause and Replay…
The domestic O&G market is treading along in a more positive light, largely supported by PETRONAS' initiatives. The domestic market is more protected as its “contractor” is largely the country's national oil company (NOC) which continues to sustain and enhance oil production. PETRONAS will continue to spend, but to revert to the previous capex levels of c.RM40bn/year which we believe would still continue to stimulate the domestic O&G industry nevertheless. The cost of oil production for this region also averages between USD30 to USD40/bbl hence still below current oil price levels deeming operations to still be viable.
Overweight. We had recently upgraded our recommendation to Overweight, in anticipation of upcoming contracts that was expected since 2H14 but was halted due to the oil price uncertainties. Malaysia O&G counters are trading on average at c.13x PE, vs. high double-digit PEs in the past and thus we see potential upside. Our top picks are Uzma (Outperform, TP:RM2.98), Bumi Armada (Outperform, TP: RM1.48 and Petra Energy (Outperform, TP: RM1.88).