This article first appeared in Capital, The Edge Malaysia Weekly on August 26, 2024 - September 1, 2024

While Brent crude oil prices have been holding steady above the US$75 per barrel level this year, other uncertainties are looming, casting a dark cloud over the local oil and gas (O&G) sector.

For one thing, the ongoing negotiations for Petroleum Sarawak Bhd (Petros), which is looking to take control of national oil company Petroliam Nasional Bhd’s (Petronas) activities — related to the acquisition, supply, distribution and sale of natural gas in Sarawak — have created quite a stir, with the policy shift raising concerns about the impact on Petronas’ earnings and its annual capital expenditure (capex). In a nutshell, if Petronas slashes its capex, there will be a dearth of jobs for O&G players.

Then, in mid-August, the Organization of the Petroleum Exporting Countries (Opec) slightly revised down its global crude oil demand forecast for 2024, citing softer intake by China.

The world oil demand growth forecast for 2024 was revised down slightly by 135,000 barrels per day (bpd) from the previous month’s assessment. It now stands at 2.1 million bpd, which is nevertheless well above the historical average of 1.4 million bpd seen prior to the Covid-19 pandemic.

Several local O&G companies on Bursa Malaysia have seen a good run since the beginning of the year, buoyed by new contract awards from Petronas, higher charter rates and new field discoveries.

To put things in perspective, last year, Petronas and its petroleum arrangement contractors (PACs) recorded 19 exploration discoveries, compared with 10 in 2022 and eight in 2021.

“It’s simple, the new findings are great for the local O&G ecosystem as they could likely translate to higher activities in the sector in the coming years, which in turn could possibly lead to better earnings for the companies,” says an analyst.

Nonetheless, the recent development in the local O&G landscape involving Petros becoming the sole gas aggregator in Sarawak cast a shadow on Petronas’ ability to sustain its annual capex spending. This is especially because Sarawak is the largest gas exporting state in Malaysia, with 90% of all Petronas liquefied natural gas (LNG) cargoes in the country being sourced from or through the state.

While there has not been any formal announcement of a definitive agreement on the transition from Petronas to Petros, Sarawak’s Minister for Utility and Telecommunication Datuk Seri Julaihi Narawi has reportedly said the parties had agreed to sign a definitive agreement by July 1. Sarawak Premier Tan Sri Abang Johari Tun Openg has insisted on concluding the negotiations by this Oct 1.

Given the size of Sarawak’s business, several research houses believe that Petronas’ annual capex could be significantly impacted by the policy shift. This, in turn, could affect contracts flow to local service providers.

“Marking a significant shift in the control of Sarawak’s natural resources and potentially impacting Petronas’ cash flow, Petros will be responsible for buying gas from all upstream producers in Sarawak, selling gas to all downstream buyers, including LNG processing plants, and managing the distribution and supply of natural gas within Sarawak.

“Negotiations are ongoing between Petros and Petronas, with exploration and production (E&P) works and developing projects potentially deferred pending a final resolution,” Maybank IB Research said in an Aug 19 note to clients.

Under a capex deferral scenario, the research house expects the O&G service providers that are highly reliant on local contracts — especially in the offshore support vessel (OSV), hook-up and commissioning (HUC), and offshore fabrication services — to be the first to be adversely affected.

“This would potentially impact Dayang Enterprise Holdings Bhd (KL:DAYANG), Perdana Petroleum Bhd (KL:PERDANA), Icon Offshore Bhd (KL:ICON), Sealink International Bhd (KL:SEALINK), Marine & General Bhd (KL:M&G), Carimin Petroleum Bhd (KL:CARIMIN), Malaysia Marine and Heavy Engineering Holdings Bhd (KL:MHB) and Petra Energy Bhd (KL:PENERGY),” Maybank IB says, adding that it expected slower growth in the local O&G sector. Nonetheless, it maintains a positive rating on the sector with a changed shift to defensive midstream companies and companies with regional exposure and capabilities such as Dialog Group Bhd (KL:DIALOG) and Wasco Bhd (KL:WASCO).

On the other hand, CGS International expects exploration drilling to be affected first by the shift in Petronas’ role in Sarawak, followed by certain development drilling work, which may reduce demand for rigs and the accompanying OSV.

“We think Velesto (KL:VELESTO) could see domestic demand for its jack-up rigs wobble in 2025. Some maintenance spending could also be deferred, though maintenance could be the last to see Petronas spending cuts; hence, Dayang could be more resilient,” it said in a July 29 report.

CGS estimates that Sarawak gas accounted for more than 40% of the volume and value of the total O&G resources extracted in Malaysia in 2021.

“A margin squeeze on Petronas from its Sarawak gas business could have consequences on Petronas’ operating cash flows and may affect its ability to spend on capex,” it adds.

To recap, in March this year, Petronas announced a capex allocation of between RM50 billion and RM60 billion for this year, which is part of its RM300 billion capex over the next five years. About 80% of the capex will still focus on its core hydrocarbon business.

However, in stark contrast, BIMB Securities is of the view that Petros taking over the role as sole gas aggregator in Sarawak is unlikely to disrupt upstream capex, which is detrimental to the sector.

“Sarawak government will require sustainable investment in the upstream segment (particularly in the greenfield projects) in order to ensure gas supply security in the long term. From the capital allocation point of view, we think that it is a bad decision, for Petronas will cut its greenfield upstream capex merely due to lower income from other segments,” it said in an Aug 9 report.

BIMB points out that the economics of greenfield projects remain viable, driven by a higher O&G price environment. The bank-backed research house expects offshore projects to remain viable as long as oil prices remain above the US$60 to US$70 per barrel band.

“Hence, we view the idea (Petronas will cut its upstream capex amid lower revenue) as a gross oversimplification,” it reckons.

Since the beginning of the year, 19 out of 30 O&G companies on Bursa Malaysia have seen a good run in their share prices. The top performers are mainly OSV players, namely Sealink, Dayang, TAS Offshore Bhd (KL:TAS), Icon Offshore, Marine & General, Barakah Offshore Bhd (KL:BARAKAH) and Perdana Petroleum.

The robust share price performances were also backed by improving earnings this year following better charter rates and higher utilisation of their vessels.

As a matter of fact, vessel operators saw better valuations than other segments in the sector, fetching an average of historical price-earnings ratio (PER) of about 14 times.

However, it should be noted that while OSV players such as Perdana Petroleum and Dayang have turned the corner, there are others that are still in financial distress. For instance, Alam Maritim Resources Bhd (KL:ALAM) submitted its regularisation plan to Bursa Malaysia last month, almost two years after it fell into cash-strapped Practice Note 17 (PN17) status. O&G company Barakah Offshore, which has been categorised as PN17 since May 2017, is still formulating a regularisation plan. It has until Oct 31 to submit its plan or risk being delisted from the local bourse.

In comparison to the ailing outfits and those trading at high multiples, E&P companies such as Hibiscus Petroleum Bhd (KL:HIBISCS), which is trading at a historical PER 3.77 times, seem cheap. Meanwhile, floating, production, storage and offloading (FPSO) companies such as Bumi Armada Bhd (KL:ARMADA), MISC Bhd (KL:MISC) and Yinson Holdings Bhd (KL:YINSON) are trading at historical PERs of 8.13, 17.01 and 9.75 times respectively.

However, O&G companies mainly in the downstream sector are the underperformers this year. 

For instance, Petronas Dagangan Bhd (KL:PETDAG), which is the retail arm of Petronas, saw its share price falling more than 7% this year to RM19.74 last Wednesday, while its sister company Petronas Chemicals Bhd’s (KL:PCHEM) share price declined 22% to RM5.56. Its competitor Lotte Chemical Titan Holding Bhd (KL:LCTITAN) fell 21.5% this year on the back of continuous losses. Dialog Group Bhd (KL:DIALOG) fared better than other downstream players, gaining 21.5% this year to reach RM2.50 a share.

The elevated global Brent crude oil prices over the last two years have spurred interest in the sector, leading to several changes in ownership in the local O&G players.

For instance, Icon Offshore saw the emergence of Yinson Holdings Bhd as a major shareholder through Liannex Corporation (S) Pte Ltd, which now has 56.67% equity interest in Icon Offshore. Liannex, which serves as a private vehicle for Lim Han Weng and his spouse Bah Kim Lian, bought a 50.2% stake in Icon Offshore from Ekuiti Nasional Bhd in March.

There is also talk that MISC Bhd (KL:MISC) is in discussions with the shareholders of Bumi Armada Bhd (KL:ARMADA) to take up a substantial stake in the FPSO player.

In 2023, Deleum Bhd (KL:DELEUM), which provides specialised products and services to the E&P sector, saw Ramanrao Abdullah, its CEO since July 2021, buying into Lantas Mutiara Sdn Bhd, a private company that holds a 20.36% stake in Deleum. Ramanrao had previously been with Halliburton for 26 years.

Overall, while the local O&G sector has had a good run thus far this year, volatility and uncertainty persist with the possibility of changes in the operating environment. 

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