Brent prices likely to rise, but not enough to hasten O&M recovery

Singapore

OUTPUT cuts by the Organisation of the Petroleum Exporting Countries (Opec) and its allies may have fuelled expectations of oil prices rebounding to between US$65 and US$80 a barrel this year, but the recovery of the moribund Singapore offshore and marine (O&M) sector is unlikely to kick into high gear.

Ang Ding Li, Asia-Pacific head of research at IHS Markit, told The Business Times that the marine sector will likely remain weak, especially in terms of charter day rates, because of the massive oversupply of vessels.

Singapore's offshore sector will do better, he predicted. He cited Sembcorp Marine as a positive example of a company that has used automation and low labour costs to land its building projects, and said strong competition could come from China, especially for conversion projects.

He noted that offshore costs have fallen significantly since 2014, with most projects being sanctioned at the Brent price of between US$55 and US$65 a barrel.

"In many instances, even US$45 is a good-enough price for sanction due to lower costs... How many of these projects will follow to Singapore depends on Singapore's competitiveness and market dynamics."

Foo Zhiwei, analyst at UOB Kay Hian, noted that day rates and activity levels in the local O&M sector have improved, but are still off the levels hit at the peak.

He said O&M players may be close to break even at the operating level, but many are unprofitable after taking into account interest expense. Debt burdens remain high among these companies. This may take a few more years to resolve.

"Even though the price of oil surged above US$60 a barrel last year, many O&M companies did not feel the benefit of this higher oil price, because oil majors are maintaining their project break-even prices at US$40 a barrel. Until this improves, profitability will remain challenged. As reference, project break-evens were well above US$80 a barrel in the good years of 2010-2014."

However, it seems that Brent prices are unlikely to surpass the more-than-US$80-a-barrel level achieved last October.

Analysts who spoke to BT are predicting that black gold will trade at US$65-US$80 a barrel.

Morgan Stanley equity analyst and commodities strategist Martijn Rats is expecting that the production cuts of 1.2 million barrels a day (mb/d) by Opec and its allies (collectively Opec+) from this month for an initial period of six months will be likely to be enough to balance the market in the first half of 2019 and prevent inventories from building.

The UK-based analyst predicts Brent prices to average US$65 a barrel in the first quarter of this year and to inch up to US$67.50 in the second quarter, followed by US$70 and US$72.50 in the third and fourth quarters respectively.

There are a few factors that might put the brakes on the climb in oil prices though, said Mr Rats, who was in town for Morgan Stanley's 17th Asia-Pacific Summit.

One is that non-Opec oil producers are unlikely to slow output. Non-Opec supply is estimated to grow by 2 to 2.4 mb/d this year, far outstripping demand, which Morgan Stanley expects to grow only at 1.3 mb/d.

Indeed, OCBC Investment Research's senior investment analyst Low Pei Han noted that the US is now the world's top crude producer with a supply of 11.3 mb/d as at last August - more than the Russian Ministry of Energy's estimated production of 11.2 mb/d in the same period.

The US' Energy Information Administration forecasts the country's crude oil output to rise by 1.2 mb/d to 12.1 mb/d this year, which is why OCBC sees upside supply risks that may cap the upward trajectory on oil prices.

OCBC is forecasting crude oil to average US$73.80 in the first quarter of this year; in the remaining three quarters, the averages will be US$72.50, US$71.30 and US$70.

The downward trajectory forecast is rooted in weak fundamentals - global oil supply remains flush while demands have slowed.

DBS Bank analysts Ho Pei Hwa and Suvro Sarkar said that the OPEC+ reduction will largely mitigate the projected increase in US supply for this year.

DBS expects Brent price to stage a subdued rebound to between US$70 and US$75 a barrel, restrained by the wider-than-expected supply/demand gap, given Iran sanction waivers, weaker global economic growth expectations, trade wars and emerging market weakness.

Liaw Thong Jung, regional oil and gas services analyst at Maybank Kim Eng, expects Brent to trade at US$65 a barrel with much volatility expected.

He said: "Cooperation and compliance among supporting members is key to this exercise ... Based on observation, Opec's grip on the oil market is slipping. It could not make a unilateral decision to cut output without the key support of its key non-Opec ally, Russia... Its role as a swing producer is being challenged by the US, a disruptive force now."

UBS Global Wealth Management's commodities strategist Giovanni Staunovo is more optimistic about Brent prices: his forecast is between US$70 and US$80 a barrel. The UBS chief investment office reiterates its recommendations to "sell the downside risks in crude prices or add long oil exposure".

Despite the rosier picture for oil prices, OCBC's Ms Low echoed other analysts assessment that a quick turnaround is not expected for Singapore's O&M sector, which has been in the doldrums due to a glut overhang.

She predicts a gradual recovery, underpinned by cost deflation across the industry and lower break-evens.

"Orders are still mainly expected from the non-drilling segment as recovery in the drilling market will take time. However, should there be significant contract wins this year for Keppel Corp and Sembcorp Marine, we'd see chances for trading opportunities especially for the latter.

"A sustained recovery, however, will only ensue with a continued flow of contract wins, which will drive a re-rating of related stocks in the sector."

The fair value for Keppel Corp, in her view, is S$7.97, and that for Sembcorp Marine, S$1.73.

Lee Wen Ching, an equities analyst at UBS Global Wealth Management, believes that the O&M sector is close to its trough in this cycle but that its recovery process could be protracted.

"We believe that the utilisation rates of drilling rigs globally appear to show signs of recovery. This suggests improving profitability and cash flow for the shipyards' customers," she said.

Despite this, she does not expect a sharp recovery of new orders in 2019.

DBS predicts better prospects for oil and gas (O&G) stocks, particularly the upstream exploration and production (E&P) players, as the oil price recovers. "O&G service providers are likely to get an uplift as well, as upstream E&P players will likely be more confident and comfortable when finalising their capital expenditure budgets for 2019."

Recovery of the offshore support vessels (OSV) providers will remain long drawn out though, DBS said. "The oversupply situation remains a primary overhang in the sector, as there is no clear answer to when and which of the significant number and type of laid-up OSVs will return to the market. We believe this will continue to weigh on sector sentiment in 2019."