Crude oil price remains volatile on demand worries, growing supply

Oil prices will continue to be susceptible to major socio and geopolitical developments throughout the year


CRUDE oil price would remain under pressure on concerns that demand would recover slower than expected as an increase in supply fades optimism of falling crude and fuel inventories.

The Brent crude contract for November delivery was trading at US$42 (RM174.72) a barrel, down 66 cents or 1.62% (at the time of writing) as Saudi Arabia cut the price of supply to Asia.

The West Texas Intermediate (WTI) contract for October delivery skidded 69 cents or 1.76%, to US$39 a barrel on fears of loosening OPEC+ compliance, the end of the US driving season and stale long positioning combined to erode confidence in oil.

Bank Islam Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid believes the price cut reflects the prevailing condition whereby the oil supplies continue to exceed demand.

“The OPEC+ remains committed to the supply cut of 7.7 million barrels per day (bpd) by the end of the year and thereafter, another 5.8 million bpd from 2021 to mid-2022.

“It makes sense for them (oil producers) to cut prices to clear their inventories. Going forward, the oil majors’ capital expenditure (capex) would be very scanty. They are unlikely to ramp up production as industries are undergoing structural changes,” he told The Malaysian Reserve (TMR).

With earnings visibility under dark cloud cover, oil and gas (O&G) related stocks, as measured by the Bursa Malaysia Energy Index, are down by some 34% year-to-date with new contracts awarded to local operators falling 62% year-on-year to RM2.2 billion, with the worst fallout to come in the second half of the year (2H20).

AmInvestment Bank Bhd (AmInvest) maintains its ‘Neutral’ view on the sector, with a mixed number of ‘Buy’ and ‘Sell’ calls on local players.

It recommends ‘Buy’ on Dialog Group Bhd and Serba Dinamik Holdings Bhd for their resilient non-cyclical tank terminal and maintenance-based operations and Petronas Chemicals Group Bhd (PetChem) due to its high correlation to the oil price upturn.

“We continue to view the still-low oil prices and earnings of upstream service companies to be worse than the previous 2015-2017 downcycle, which led to multiple financial distress to O&G corporations, we retain our ‘Sell’ call on Bumi Armada Bhd, Sapura Energy Bhd and Velesto Energy Bhd,” AmInvest stated.

MIDF Amanah Investment Bank Bhd’s (MIDF Research) analyst Noor Athila Mohd Razali expects the crude price to trade rangebound for the year, as it remains capped by negative coronavirus news and slow demand recovery.

“The negative development on the Covid-19 front continues to plague price given new cases remain elevated in 16 countries that account for 70% of the global crude consumption,” she said.

MIDF Research expects the continued decline in worldwide crude inventory levels will assist in supporting oil prices going forward.

“Crude inventory will gradually decline until the third quarter of 2020 (3Q20) before demand finally catches up in the 4Q after two quarters of suppressed consumption and the production cut by US shale producers,” she said.

Production often lags by six-months from the change in oil price resulting in the full-impact of a production cut to be felt only towards the end of 2H20.

Noor Athila added that a “second wave” of Covid-19 infections could result in a prolonged pullback in demand that could stunt the recovery of the industry.

Low prices and volatility will make it hard to induce oil majors including Petroliam Nasional Bhd (Petronas) to increase their capex.

Petronas will cut its capex by 21% to RM39 billion (from RM50 billion previously) to account for the current low oil price environment and expected slowdown in offshore activities.

It announced a cut in its operational expenditure spending this year by 12% this year which is estimated to be about RM2 billion.

MIDF Research believes this would lead to potential termination of soon-to-be-renewed contracts and margin compression for O&G service providers that are dependent on Petronas-related contracts.

The move is similar to the 20%-30% capex reductions announced by oil majors like Exxon Mobil Corp, Royal Dutch Shell plc, Saudi Arabian Oil Co and Petrobras SA.

The weak crude oil price environment will also hit upstream exploration and production (E&P) players like Hibiscus Petroleum Bhd, Reach Energy Bhd and Sapura Energy.

MIDF Research noted that Sapura Energy, due to 50% of its E&P arm was sold to OMV AG, is less exposed to the sharp drop in oil price. However, it might endure a delay in the recovery of its drilling segment which remains at a loss-making position.

“As for the local O&G support services players, we remain favourable towards companies that are involved in maintenance, construction and modification (MCM) services,” Noor Athila said.

This, she added, is because Malaysia is an oil-exporting nation and oil-related income constitutes 30.9% of the total government revenue in 2019.

MIDF Research’s top pick for the sector is Dialog due to its stable recurring income from its tank farm business and due to it being one of the main beneficiaries of the soon-to-be-operational Pengerang Integrated Complex’s MCM contract awards. The research outfit also likes Serba Dinamik for its diversified revenue stream and geographical exposure to the global O&G network.

“It is worth noting both companies are involved in MCM services for the industry which has seen minimal interruption from the Covid-19 pandemic and low oil price environment,” she added.

For the downstream subsector, MIDF Research favours Gas Malaysia Bhd as the decline in energy prices has a neutral impact on its cost due to the offtake arrangement it has with Petronas Gas Bhd.

The outlook, however, remains lacklustre for PetChem and Petronas Dagangan Bhd.

For PetChem, even though the low oil price environment is favourable in terms of feedstock price, MIDF Research said the weaker price would result in low average selling prices of its products that will reduce its margins.

The near future of the O&G industry, according to analysts, will remain volatile until the end of 2021, as supply and demand face an ongoing rebalancing act following the economic and market fallout caused by the Covid-19 pandemic.

Experts reckon oil prices will continue to be susceptible to major socio and geopolitical developments in the world throughout the year.

Moody’s Investors Service Inc in a recent sectorial report expects the crude price to remain highly volatile with a possibility of recovery towards its medium-term price range of US$45-US$65 per barrel.

The credit rating agency stated that growth would be slow for the industry, which now faces more uncertainty about future demand and the evolving regulatory environment.

“We expect an uneven, extended recovery that depends on a gradual improvement in oil and gas demand, backed by the rebuilding of global economic activity, especially in the key consumer markets of China, South-East Asia and the US,” it said.

Moody’s expects WTI crude prices to average US$30 a barrel in 2020 and US$40 in 2021 and Brent crude oil to average US$35 per barrel this year and US$45 in 2021.