Oil surplus could persist through 2017

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KUCHING: Most of the global oil reserve are sub-economic at less than US$40 per barrel (bbl) prices but analysts believe that the oil market would likely stay oversupplied.

Affin Hwang Investment Bank Bhd’s research arm (Affin Hwang Capital) noted that while 68 per cent of global oil reserves are sub-economic at less than US$40 per bbl prices, the oil market should stay oversupplied.

“Gulf-state producers are unlikely to cut production, as they remain profitable at current prices. 60 billion barrel of equivalent (boe) of US oil reserves could attain commercial viability, if crude prices rebound to US$60 per bbl.

“The US EIA has cut its Brent forecast to US$34 per bbl in 2016 estimate, and US$40 per bbl in 2017 estimate (also our view), driven by a larger inventory build,” the research team highlighted.

It also believed that it is unlikely that Saudi Arabia would voluntarily cut its production in the near-term.

“Cutting production at this point will mean Saudi Arabia giving up market share to its competitors, while the associated beneficial impact on crude prices will not be evident, as the US shale producers will come roaring back.

“On the other hand, by continuing to pump as much as it could (or as much as the market can take), Saudi Arabia can maximise its oil revenue and income, as its oil output remains largely profitable at current crude prices.

Meanwhile, it noted that the US EIA has forecast that non-organisation of petroleum exporting countries (OPEC) production will decrease by 0.4 million barrels per day (mmbd) in 2016 estimate, mainly driven by the decline in US shale oil production.

“As a result, the oil market is expected to remain oversupplied through 2017. The US EIA forecasts global oil inventories to increase by 1.6 mmbd in 2016 estimate, and 0.6 mmbd in 2017 estimate. Previous expectation was for the global oil inventories to increase by 1.0 mmbd in 2016’s estimate, and 0.6 mmbd in the first half of 2017 (1H17) with the oil market returning to balance in the third quarter of 2017 (3Q17),” it explained.

Domestically, Affin Hwang Capital pointed out that Petroliam Nasional Bhd’s (Petronas) lower spending would likely hit the overall oil and gas (O&G) industry in Malaysia.

“The Malaysian-listed O&G companies are predominantly involved in the Oil & Gas Equipment and Services (OES) segment.

“Several OES companies such as SapuraKencana Petroleum Bhd (SAKP) and Petra Energy Bhd (PENB) have ventured into the upstream segment, but OES still accounts for the major part of their businesses. As demand for OES companies are dependent on the industry capex spending, we believe the Malaysian-listed O&G companies will be negatively affected by the expected industry capex down-cycle this year,” it said.

The research team projected that Malaysian-listed OES companies could collectively see their revenue fall by 10 per cent year-on-year (y-o-y), in response to a RM20 billion spending cut by Petronas in 2016.

As for exploration and development segment, Affin Hwang Capital believed that this division would be the hardest hit from Petronas’ capex down-cycle.

“We expect the industry capex down-cycle to affect O&G exploratory and development projects, with weak crude prices leading to diminish project economics. OES companies involved in this part of the value chain will likely be hardest hit by the reduced capex spending with contract pipelines drying up and pricing compression for whatever little new contracts that they can secure this year.

“OES companies involved in this part of the value chain are also usually asset-heavy, and thus will see a double whammy effect from negative operating leverage,” it said.

Production-focused contractors would also be likely hit by lower service rates. The research team foresee a cut in service rates for the OES companies involved in the production stage of upstream segment, if weak crude prices continue to persist.

“Oilfield operators remain committed to optimise production from existing brownfields in order to sustain their project cash flows amid weak crude prices, but there are talks that they are seeking to revise service rates in a bid to reduce production costs. Indeed, Petronas has indicated that they are doing so,” it added.

Even players with firm contracts are unlikely to be spared the turmoil, the research team pointed out. It explained, “The lopsided bargaining power of the oil majors as well as the difficulties in enforcing O&G contracts lead us to conclude that OES players will not be able to resist pressure to cut service rates.

“This is especially so in Malaysia, with Petronas being the largest customer in the country.”

All in, Affin Hwang Capital retained its ‘underweight’ rating on the sector. It noted, “Most of the O&G stocks are trading below book value, and we believe this represents a permanent de-rating on long-term repricing of oil.”