Friday, 31 July 2015

The Oil and Gas sector is prone to intense cyclicality.

Oil and Gas sector

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…

Author: PublicInvest   |   Publish date: Tue, 28 Jul 2015, 09:59 AM 

…from 2HFY15 onwards as the market seems to have digested the shock of the oil price collapse and subsequent fluctuations, companies have continued business as usual. PETRONAS too has taken the opportunity to restructure their contract terms and award structure. They have launched a Cost Reduction Alliance, Coral 2.0, an industry-wide effort to expedite cost discipline, but are not cutting investments in innovation and research-related projects of which its CEO Datuk Wan Zulkiflee commented “stands to win in an increasingly difficult playing field”. In view of the lower oil price to be the new „normal' level, we believe the sector would be re-rated and thus retain our Overweight call. We anticipate contract types in the pipeline to include engineering, procurement, construction, installation and commissioning (EPCIC), fabrication, maintenance services and various jobs for the Refinery and Petrochemical Integrated Development (RAPID) project. Meanwhile, Iran has been keeping everyone on their toes as United Nations Security Council endorsed a deal to lift the nation's economic sanctions, but place strict limits on its nuclear programme. The agreement is still pending approval from US Congress and nuclear inspectors' confirmation that Iran is complying with the terms however, thus would unlikely be removed until next year. Assuming the successful end to the sanctions, the oil output post sanctions, is estimated to be an additional 1m bbl/day.
Global O&G market. Sentiment in global markets is currently weak, spurred by crude oil futures hitting 4-month lows after a steep fall in China's stock markets. China currently the world's largest energy consumer could be signaling concern on its economic health, while evidence of a growing crude glut is building up. Oil price has also been pressured with rise US drilling activity with data showing 21 rigs added last week, the most in over a year. The financial pressure faced by oil majors with severe earnings dips in the latest quarter has fueled concerns further. Much of this is resulting from the lower prices that oil field service companies are charging their customers to continue its works. The situation is further heightened by capex cuts in upstream spending, which have filtered through to the oil service providers, first-hand. Our concern remains on how long oil prices would remain low (or fall lower). Further weaknesses could be seen if the rebound continues to be delayed, as smaller drillers may lose their financial support and encounter debt or liquidity crises. We urge investors to focus on companies with reliable cash flow at present and to be cautious about rapid growth at this juncture.
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).
Coral 2.0. Under Coral 2.0, 11 key initiatives have been introduced to better implement plans and review the potential estimated savings target of between RM4.0bn and RM7.5bn, to be achieved before the end of the next 5 years in response to the decline in global oil prices. 25 petroleum arrangement contractors (PAC) in Malaysia including Royal Dutch Shell plc, Repsol S.A.'s subsidiary Talisman Energy Inc., Total S.A., Exxon Mobil Corp. and ConocoPhillips Co. have signed on to share best practices under CORAL 2.0 and are on the look-out for innovative platform designs that can be standardized across field developments to reduce capex and project delivery cycles. Key milestones include i) Proactive Demand Management, ii) Spend Consolidation, and iii) Driving Innovation. The initiative aims at instilling a cost effective approach across the industry, while uplifting the benchmark of the industry to a world-class level. This involves collaboration and operation with global best practices in Malaysian E&P.
Outcomes of Coral 2.0 workshop. Agreed since end-March, 8 initiatives to be implemented include; i) Joint Sourcing (Material Category), ii) Joint Sourcing (Services Category), iii) Technical Standard, iv) Logistic Control Tower, v) Warehousing Centralization & Common Stocking, vi) Cost Driver Benchmarking for OPEX, vii) Cost Driver Benchmarking for CAPEX, and viii) Late Life Field Optimization. The targeted potential annual cost saving to be achieved before the end of the next 5 years is RM4.0 to RM7.5bn. Factors Affecting Oil Price
Still-possible Greek default shadowing global equity markets, has pushed on the strength of the US dollar. The US dollar is often a form of safe haven during economic turmoil, however does not bode well for oil prices since oil is traded in dollars and thus would be more expensive. Greece's debt crisis moreover could dampen European energy demand.
Federal Reserve interest rate “gradual” hike - a short-term variable that could send oil prices up or down. Where a quicker decision is expected to increase interest rates which could press down oil prices, a looser policy may push prices up.
OPEC may see a change in leadership, as 79-year-old Ali al-Naimi, the Saudi oil minister is anticipated to retire and has a successor being groomed. Mr. Naimi's legacy strategy to keep output steady amidst a growing oil supply glut that caused prices to plummet, would indeed make him memorable. With Iran and Mr. Naimi's potential retirement on the table, the next OPEC meeting in November could be far more exciting. Indonesia was also seen to push to rejoin the cartel since its membership suspension in 2008 when it became a net oil importer. Indonesia wants to secure supply contracts with OPEC members, following its plans to ramp up its refinining capacity and thus would need crude supplies to fuel the production. They are seen to be aggressive in lobbying for this and could be reinstated by as early as the November meeting.
Geopolitical escalations, in particular in the Middle East and between Russia and the US.
IEA landmark report on recommendations to achieve “peak emissions” by the end of this decade.
Iran’s “appealing” oil contract terms include a collection of attractive contract terms to international oil companies which would pay more for higher production. It is also rumoured that Iran may even be prepared to offer production sharing contract (PSC) terms. It is also believed that Iran needs to JV with international oil majors to share its technology. With the world powers reaching a historic agreement to lift the sanctions on Iran but place strict limits on its nuclear programme.

Top Picks

Uzma will be buoyed by i) full year contribution from MMSVS (Hydraulic Workover Units), ii) full year contribution from Premier Enterprise Corporation (PEC) for trading of chemical and other commodities in oil refinery, iii) increase in strategic stake in Setegap Ventures from 30% to 49%, and iv) remuneration fee when RSC production begins 2HFY15.
Bumi Armada (BAB) will be supported by its long-term contracts coupled with its reputable execution abilities that would allow it to be enhanced by new contracts. We remain positive on BAB, considering its initiatives to stay focused and to dissolve potentially non-viable divisions such as the Oilfield Services division amidst the oil price uncertainties landscape. Earnings growth will be sustained by its RM25.6bn orderbook, comprising of long-term FPSO projects such as Kraken, 15-06, Madura and the latest Malta floating storage unit (FSU), BAB's foray into the liquefied natural gas (LNG) business.
Petra Energy will see the i) early activation of the Topside Major Maintenance Services (TMM) contract by PETRONAS Carigali Sdn. Bhd. (PCSB) for SBO effective since 4 July 2014, and will last until 20 May 2018. ii) Higher work orders for the PANM contract. iii) The KBM cluster RSC whereby Kapal and Banang Fields have produced c.4.0mbbl of oil to-date, with an average of c.700,000bbl/quarter. The Group has taken key measures to manage costs and operation expenditures while exploring new opportunities to attain new revenue streams.
Source: PublicInvest Research - 28 Jul 2015

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