This article first appeared in The Edge Malaysia Weekly on May 15, 2023 - May 21, 2023
BRENT crude oil has come off the peak over the past year. To put things in perspective, the benchmark had slipped almost 40% from above US$120 per barrel last June to a year low of US$72 per barrel on May 4.
The current price weakness was despite the surprise supply cut by Opec+ producers last month, showing that demand is waning. While the weaker oil prices have raised some eyebrows, in general, most analysts and market watchers say the commodity is likely to maintain or gain momentum, which will be good for consolidation in the oil and gas (O&G) sector. Assets that are up for sale would fetch more compelling offers in the face of strong oil prices.
In terms of the oil price forecast, Maybank Investment Bank Bhd’s O&G analyst T J Liaw expects the recent weakness in Brent crude to be temporary, owing to negative sentiment in the market.
“We reckon the concern over the softening demand from a recession-risk scenario had an adverse impact on sentiment and oil prices in recent weeks. This was despite Opec+ surprising the market with a higher-than-expected cut a month ago, which saw oil prices heading [past] US$80 per barrel,” he says.
“Prior to that, the weakness in oil price was due to the banking jitters in the US. That said, we believe the fundamentals of the oil market will see a quick recovery from these negative sentiments.”
Liaw remains bullish on global crude oil prices for this year with an estimate that Brent crude will return to US$100 per barrel levels. He points out that the O&G sector is still at the beginning of the up cycle and there are more opportunities ahead.
“We see value in O&G counters that offer visible earnings growth, new orders and project upside, and undemanding valuations to boot. That’s especially so for those less burdened by balance sheet issues. O&G counters that offer cash-flow certainty and a strong, focused management team will readily capitalise on this cycle,” he says.
Liaw’s top picks include Yinson Holdings Bhd, Hibiscus Petroleum Bhd and Dialog Group Bhd.
Bank Negara Malaysia and the Ministry of Finance (MoF) estimated lower Brent crude oil prices for this year at US$80 to US$90 per barrel, compared with the average of US$99 per barrel in 2022.
On the back of slowing global economic growth, Lee Heng Guie, executive director of the Associated Chinese Chambers of Commerce and Industry of Malaysia’s Socio-Economic Research Centre, expects oil demand to be affected by the challenging world economy, owing to the continuous tightening of monetary policy, the ongoing US-China trade war and banking turmoil in the US and Europe.
“Despite the Opec+ cut in production to prop up prices, crude oil prices are likely to be lower than last year, averaging between US$80 and US$85 per barrel as the global economy braces itself for a slowdown as the US Federal Reserve continues to increase interest rates,” he tells The Edge.
Some quarters see a heightened possibility of sector consolidation, given that many local O&G service providers are still trading at valuations far below historical levels in the heyday before the industry downturn in late 2014.
For instance, Hibiscus Petroleum Bhd, Uzma Bhd, Icon Offshore Bhd, Coastal Contracts Bhd, Deleum Bhd and Bumi Armada Bhd are trading at single-digit price-earnings multiples. The O&G stocks had price-earnings ratios of more than 30 times in the previous oil boom.
This could indicate that investors are treading cautiously as uncertainty looms. There are also troubled O&G companies such as TH Heavy Engineering Bhd, Serba Dinamik Holdings Bhd and Sapura Energy Bhd, which have had a variety of issues and are financially strained.
To put things in perspective, Malaysia has more than 4,000 O&G companies, including more than 2,000 small and medium enterprises. Many of these companies are highly reliant on local projects, especially from Petroliam Nasional Bhd (Petronas).
An O&G executive says consolidation among local service providers could help address the structural challenges faced by the industry. “There are too many small licensees and small operators in the market. Many of the companies, especially the offshore service providers (OSV), are still in debt, with limited capital injection to fund growth,” he tells The Edge.
He points out that many of the local players are also heavily reliant on local jobs and operate at compressed margins because of competition. “For instance, there are about six [large] fabrication yards in Malaysia, but we need only two to three players in the market. Consolidation among the players would increase their competitiveness and bargaining power when bidding for jobs.”
According to a report by Kenanga Research in March, the Malaysian O&G sector derived 68% of its revenue from local activities. Kenanga says that while activity levels of O&G service providers are rising, the industry still faces many structural challenges, including a lack of competitiveness in the international arena, which creates an over-reliance on locally derived revenue.
The research house notes that the industry’s heavy focus on local content boils down to several key reasons, including inadequate technology development, with R&D activities considered to be low relative to industry size. “This has resulted in local [oil and gas services and equipment] technology not widely regarded internationally in the field,” it adds.
UOB Kay Hian Research points out that there has been a global consolidation of fabrication yards, which could force a merger between Sapura Energy and Malaysia Marine and Heavy Engineering Holdings Bhd (MHB). “We believe the strongest justification may be to address the risk of potentially falling into a trap of ‘second-tier’ yard [overcapacity] over the long term, and to [form partnerships] to enhance pricing strategies, scale and technology,” the research house says in a May 9 report.
The annual capital expenditure (capex) of oil majors, including Petronas, hinges on crude oil prices. As such, the recent price weakness in Brent crude could force Petronas to slash its capex. The national oil company has announced a capex guidance of RM300 billion between 2023 and 2027, including 20% for green energy.
After the oil price crash in late 2014, Petronas undertook a cost-cutting programme that caused local O&G companies to operate on razor-thin margins as the global energy industry entered a prolonged downturn. The national oil company also tightened its belt and cut its capex as oil prices fell to a low years after the 2014 crash.
Nevertheless, consolidation in the O&G sector could be likely, considering that many of the players are in better shape now after recovering from the 2014 crash and Covid-19 pandemic. Still, a shift towards green energy globally, which will eventually see fewer jobs in the O&G sector, looms.
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