• Limited impact from attacks for now
• But higher geopolitical risk premium
• Value play; benefiting under sector rotation

Limited Impact From Attacks for Now…

Following an attack on Saudi Arabia’s production facilities that has taken out 5.7m bbl/day of supply, or about half of the kingdom’s output and about 5% of the global supply, the kingdom has just issued an update that it has recovered more than half of the production that it had lost during the attack.

The Abqaiq facility is now processing about 2m bbl/day, and should return to pre-attack levels by end Sep. This suggests that Saturday’s attacks should only have a limited impact on production and exports, a smaller shock than feared by Monday’s media reports. Still, this incident is worthy of attention because it is not like any other supply disruption involving pipelines or other peripheral infrastructure, but one that damages the heart of Saudi Arabia’s oil complex.

… But Higher Geopolitical Risk Premium

Saudi Arabia has for decades been a stable oil producer that markets turn to in times of crude oil crisis, but now the view that its key production facilities are also vulnerable to attacks and sabotage may lead to a higher geopolitical risk premium in oil prices, given the apparent ease with which a significant chunk of productive capacity was put out of action. It is not clear whether Saudi Arabia or the US will try to respond militarily. In addition, there is also the risk of more attacks later.

Recapping Our Earlier Stance

In our 23 July sector report, we highlighted preferred picks for key sub-sectors of the oil and gas value chain, noting that selective opportunities exist over the medium term. Depending on movements in oil prices as well as demand and supply dynamics, the performance of each subsector will vary accordingly.

For instance, under a weak oil price environment, higher beta names such as exploration & production (E&P) companies as well as drillers are likely to underperform, and as mentioned in our sector report, there did not seem to be a compelling reason to be heavily invested in this segment at that time.

Favour E&P and High Beta Names When Oil Prices Rally…

However, this has changed since the Saudi attacks and spike in oil prices. When oil prices rally, these higher beta names typically outperform. As mentioned in our earlier internal flash note on 16 Sep, higher beta and previously high short-interest stocks should lead the way higher on a trading basis post the attack, and this was seen after markets opened on Monday. Refiners, on the other hand, would generally underperform due to the higher input costs with higher crude oil prices.

… But Stick to Oil Majors After the Dust Settles

Fundamentally, we would stick to our preference for the oil majors (relatively defensive, attractive yields) after the move fades, barring an escalation in geopolitical tensions. The oil majors are still relatively more defensive compared to other subsectors, and we expect the dividends of companies BP, Total and Royal Dutch Shell to be sustained with the strong free cash flow yields, backed by improving returns.

Source: OCBC Research - 18 Sept 2019