Short-term gain, long-term pain for Malaysia’s O&G sector

Pic by TMR FILE 

THE past two years have been turbulent times for the local oil and gas (O&G) sector amid the wild swings in global oil prices

In 2020, the unprecedented Covid-19 pandemic led to worldwide lockdowns and economic recession, crushing global oil demand and crashing crude oil prices along the way. West Texas Intermediate (WTI) hit an unprecedented record low of minus US$37.63 (RM170.46) per barrel while Brent hit a low of US$19.33 — a level not seen since 2001.

Then in 2021, amid the worldwide inoculation, economies reopened and activities resumed, subsequently boosting oil demand and prices.

Early 2022 saw the Russia-Ukraine war throw a spanner in the works, as sanctions on Russia led to supply disruptions and caused oil prices to spike to multi-year highs. WTI hit a high of US$123.70 per barrel while Brent hit a high of US$127.98 — the highest levels since 2008.

Fast forward to today, amid fears of recession and normalisation of supply, crude oil prices have softened, with WTI and Brent trading at around US$85 and US$91 per barrel respectively as of Sept 9, 2022, around -30% down from its recent peak.

While the global O&G players have seen a better than expected recovery (MSCI World Energy Sector Index is up 28%) amid elevated crude oil prices, local O&G players have had very different fortunes, with the Bursa Energy Index only slightly up by 0.8%.

One of the main reasons for the diverging performance is that most of the top 10 players in the Bursa Energy Index are primarily service providers which may not directly benefit from the higher crude oil prices, and hence, are less correlated with crude oil prices compared to exploration and production players.

Investors unperturbed by Petroliam Nasional Bhd’s (Petronas) upsized capital expenditure (capex) as headwinds remain prevalent in the energy sector over the long term.

On June 9, 2022, Petronas announced that it would upsize its 2022 capex from the initial RM40 billion to RM60 billion, which would be the highest capex since 2015.

Since Petronas is the largest O&G state-owned enterprise in Malaysia and the largest client for the local O&G sector, the doubling of capex by Petronas (from RM30 billion in 2021 to RM60 billion in 2022) should be a major catalyst for Malaysia’s O&G sector in the near term as most of the local names in this sector are service providers for Petronas.

However, since the Petronas announcement, the Bursa Energy Index is down -13.2%, a far cry from the positive outcome that should have ensued.

We think that there are a few reasons for the lackadaisical performance.

Firstly, weaker oil prices amid demand concerns.

Overheating inflation among developed markets (the US, UK and European Union) forced central banks to hike interest rates aggressively in order to fight against the higher price levels. Consequently, global growth has slowed, leading to lower demand for oil and triggering a downtrend in oil prices.

Meanwhile, China, the second largest oil consumption country, has faced several Covid-19 outbreaks resulting in renewed lockdowns, dragging the market sentiment further.

Secondly, the rising rate environment.

Companies that have a weaker debt profile could face higher margin pressure during a monetary tightening environment due to higher interest rate payments. Generally, the O&G sector is a capital-intensive sector. Rising interest rates would lead to a higher cost of debt capital and potentially impede the ability of the company to cover its operating expenses and erode earnings further.

Thirdly, increasing environmental, social, and governance (ESG) awareness among investors.

Since the rising awareness of ESG years ago, investors have been moving towards decarbonisation. The O&G industry, due to its high carbon emitting nature, has been experiencing underinvestment. Based on the statistic, upstream spending is still expected to be well below pre-Covid levels in 2022 since its peak in 2014.

With the vast majority of market participants starting to join in sustainable investing, ESG’s influence on capital access is here to stay and capital flows into non-ESG investments could take a hit going forward as investors continue to shift towards ESG-compliant investments and stay away from carbon-intensive industries.

Do not fall into the value trap.

Despite soaring crude oil prices, stock prices of O&G companies in Malaysia, as represented by the Bursa Energy Index, continue to be lacklustre. The Bursa Energy Index is now trading at 707.16 points as of Sept 9, 2022 and its 2024F forward PE is at 8.96x, far below its five-year historical PE of 17.6x.

With the extremely cheap valuation of Bursa Energy Index, the upside potential seems compelling, however given the global macro uncertainty and structural transformation trend to sustainable energy in the long term, we think investors should take note that the long-term headwinds could offset the short-term catalysts.

Given the rising geopolitical tension and tight supply situation, we reckon oil prices are poised to stay at an elevated level in the near term, nevertheless the headwinds such as rising awareness of environmental aspects and softening demand do persist. As such, we hold a ‘Negative’ view on the Malaysian O&G sector in the long term and advise investors not to fall into the value trap.

The views expressed are of the research team and do not necessarily reflect the stand of the newspaper’s owners and editorial board.


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