Malaysia - Oil & Gas Stock Top Picks

Platts: Malaysia Commodity Market Insights
We attended the Platts’ Malaysia Commodity Forum. Oil will continue to be a long- term dominant in the global energy mix, with Asia’s modernisation driving the growth of oil/ petrochemical demand. Short-term and long-term views on oil and LNG fundamentals, coal, petrochemicals, shipping and steel were highlighted. Maintain MARKET WEIGHT on the sector, with a preference for internationally- competitive companies like Serba, Bumi Armada and Yinson.
WHAT’S NEW
• Platts’ outlook on world energy and Asia markets. Oil will continue to dominate the world’s energy mix at around 30% of the primary energy mix by 2040. Although, energy mix of oil and coal declined from 40% and >20% respectively in 1990 due to the advancement of gas, electric vehicles and renewable energy. Asia, which comprises 42- 44% of world demand despite housing 54% of the global population, will drive the growth in oil consumption.
• Energy transition: Malaysia’s perspective. Malaysia’s energy demand is expected to grow by 2-3% p.a., depending on policy scenarios. It is transitioning into an energy importer, as O&G production is expected to decline on technically challenging fields.
Malaysia is strengthening its position as an O&G hub, and is rolling out various reforms to enhance the competitiveness of domestic supply. However, this shift in energy landscape will be gradual due to regulatory inertia, and the long-term nature of power purchase agreements. A suggestion was for a “regulatory sandbox” approach, which can act as a medium to explore new technologies. For instance, using blockchain fo distributed energy generation. Malaysia and Singapore can explore a potential regional integration of energy systems, such as an ASEAN gas infrastructure and electricity grid.

ACTION
• Sector rating still depends on earnings. Despite the higher oil prices (Brent approaching US$75-80/bbl levels), local O&G stocks have yet to benefit from earnings visibility. We still prefer internationally competitive companies as they fit into our sector theme on visibility for earnings upgrades and they do not depend on Petronas work orders.
• Our top BUY is Serba Dinamik (Target: RM4.30). The international O&M/EPCC contractor is expected to see an earnings rerating from a growing orderbook to >RM7b. We like FPSO players: a) Bumi Armada (Target: RM1.06): investor confidence will improve on higher Kraken/Olombendo recognition by 1H18, and b) Yinson (Target: RM4.45), on long-term earnings potential from FPSO Layang and another mega contract. Our SELLs are MISC (Target: RM6.25) and Barakah (Target: RM0.18), both due to earnings risks.
• Other themes. Sapura Energy’s gas fields are tied to the sustainability of long-term gas sales agreements for LNG. MISC may allocate yearly capex of US$0.2b for vessel upgrades by 2020 to comply with International Maritime Organization (IMO) bunker fuel standards. Serba and Dialog benefit from refinery expansions in the Middle East and Asia. Lotte Chemical Titan and Petronas Chemicals depend on the outlook of Asian aromatics and olefins.

Oil & Gas Stock – Peer Comparison (click to enlarge view)

ESSENTIALS
• Permian Basin, the centre stage of US crude production. Platts commented that the US oil land rig count had rebounded from 1H16’s low to about 816 as of 13 April. US exports now account for a bigger share of production, from ~5% in 2014 to as high as 20% since Sep 17 (2,000 bpd). In line with other major oil consultants, Platts expects US production to rise by 670,000 bpd during 2018. About 75% of global crude production growth in 2018 will be of light sweet crude and condensate, while nearly half of the global production growth in 2018 will be of US shale. The increase in US production will be almost entirely from the Permian Basin.
• IMO standards vs refinery expansion. The new IMO 2020 standards stipulate that the global bunker specs must be capped at 0.5% sulfur beginning Jan 20. This will spur: a) shipping companies (like MISC) to invest in scrubbers and dual fuel engines capable of burning LNG or other cleaner liquid fuels. However, the economic environment is difficult, and there is no visibility for payback from early investments in these equipment; b) LNG’s role as a marine fuel is also developing, but Platts views that it would not be a significant market until 2025. This is due to the lack of delivery infrastructure, costs and price uncertainties; and c) refineries also need to prepare for IMO standards, with a need for additional resid desulfurisation capacity. At the same time, there are a lot of new refinery expansions across Asia, China and the Middle East to meet the demand growth of crude and petrochemicals.
• Summary of Asian olefins outlook. On Ethylene, China is expected to diversify ethylene imports mostly via the Middle East (vs US). On Propylene, China’s C3 demand will continue to rely on Korean imports. On PP/PE, China continues to import PE from the Middle East, but US PE imports may be impacted by trade war concerns. On Butadiene, C4 supply will increase due to new China capacity, but the downstream auto industry demand is slow and US-China trade war concerns are acute.
• LNG demand in Asia may grow 50% by 2028. This is the key driver of global LNG demand as Europe/US demand have more or less reached maturity. Asia demand may outpace supply over the next five years, which may tighten markets and hence increase reliance on supplies from other regions. Nevertheless, global supply growth is expected to outpace demand growth in 2018, with 31.8mtpa of new capacity due to come online vs a forecast demand growth of 23.3mtpa. More than 50% of 2018’s new supply will come from Australia, while US supply is expected to ramp up over the next 5 years as the capacity of its LNG export terminals is set to increase from 10mtpa in 2016 to 70mtpa by 2021. The LNG industry is also experiencing a paradigm shift, whereby LNG supplies under contract are expected to roll over in 2019, opening up a new era for global gas pricing. LNG buyers are favouring shorter term contracts from 20-25 years to 5 years on average. Platts commented that if the market tightens after 2020 it is possible for long- term contracts to be back in favour, but unlikely to be as long as 20-25 years. Also, buyers may still want favourable terms such as volume optionality clauses or “walk-away
clauses”.

source: UOBKayhian – 26/04/2018