• Brent crude oil price weaker amid demand concerns.
• US-China trade war remains a prolonged uncertainty.
• Geopolitical tensions in Middle East and potential OPEC cut extension lend support to oil price.
• O&G stocks seem to have priced in further decline in oil price towards US$60/bbl; Petrochina and SEMBCORP MARINE LTD (SGX:S51) slip below Dec-2018 lows, further downside looks limited.

Oil Price on a Roller Coaster Ride

• Brent crude oil prices plummeted 4.6% on Thursday to US$67.8/bbl, on growing fears of an escalation in the US-China trade war, dampening the outlook for economic growth and consequently, oil demand. In addition, recent economic data from Japan, Germany and the European Union pointed to weakness in the energy-intensive manufacturing industry, and the recent US crude oil inventory report from EIA, which showed a crude oil inventory build of 4.7mmbbl in the week to May 17, also took a toll on sentiment.
• Oil prices have of late been stuck between the pulls of two competing forces –
  1. Tighter supply on the back of more stringent Iran sanctions filtering into the market, and Middle East geopolitical tensions leading to fears of supply disruption, and
  2. Demand concerns on the back of escalating US-China trade war and other grim economic data. Thus oil prices can move either way depending on the timing of which concern seems more pressing on the day.

US-China Trade War Is the Key Downside Risk for Oil Price

• Despite tight fundamentals, oil price sentiment unfortunately hinges very much on the development of trade talks between the US and China. While chances of an amicable resolution seemed reasonably high earlier in the year, pessimism has returned to the market owing to more hawkish rhetoric from both sides in the last few days.
• The trade war has also spilled into a “tech war” with US sanctions on Huawei Technologies, and China also taking a more hardline stance lately. Thus, the risk of a long-drawn full-fledged trade war with multiple rounds of tariffs on a bigger basket of imports seems more probable now than earlier, and that is bad news for global demand.
• For now, we maintain our base case scenario for saner heads to prevail, and still expect some form of trade resolution to be achieved in the coming months, with moderate oil demand growth hovering around 1.2mmbpd for these two years (vs 1.3-1.4mmbpd in 2014-2018). We maintain our Brent crude oil forecast of US$70-75/bbl for 2019/20 under this base case scenario.

All Eyes Will Also be on the G20 Summit at End June

• The drastic and aggressive shift in the US’s stance on trade negotiations has dampened the mood for meaningful trade discussions between the two countries.
• While we are hopeful on a formal bilateral meeting taking place between the two leaders during the G20 summit next month, the absence of a meeting will likely be construed negatively by the market and have negative ramifications on demand expectations. And should trade negotiations go nowhere over the next couple of months and all tariffs head toward 25%, our economists expect that in 2020:
  • China’s real GDP growth would to fall to 5%
  • US GDP growth would ease to 1%
  • Global growth to weaken by 0.5ppt to 0.75ppt
  • DXY (Dollar index) to soar past 100
• In the worst case scenario of an ever intensifying trade war with no resolution, this could result in Brent crude oil prices falling back to US$55-60/bbl in late-2019/ 2020 owing to the slowdown in global growth.

Supply Factors Remain Oil Price Supportive Though

• The potential supply disruptions should not be overlooked as well given the growing geopolitical tensions in the Middle East.
• Proxy wars between Saudi and Iran have intensified, and there have been reports of potential military conflict between Iran and the US as well. Saudi Arabia has seen an escalation of attacks on its oil export infrastructure and shipping - sabotage of two oil tankers carrying Saudi oil near the UAE in mid-May and two oil pumping stations attacked by armed drones two days later.
• In addition to Middle East tensions and tighter Iran sanctions, declines from Venezuela have continued as well.

OPEC Will Not Repeat Its Mistake

• OPEC and non-OPEC allies will meet likely in early July to decide the future of the 6- month production cuts that came into place from the beginning of 2019. While the US administration previously appeared confident that their allies like Saudi and UAE would increase production to ensure there is no supply shock for the market, we believe these countries learnt their lesson back in late 2018, when they pre-emptively increased production only for oil prices to crash following Trump’s surprise decision to provide waivers to importers of Iranian oil.
• This time around, we expect any increase in production from OPEC to be moderate at best and only after the full impact of Iran sanction waivers’ expiration and other ongoing factors like Middle East tensions and trade war negotiations have been assessed. In a recent OPEC Joint Ministerial Monitoring Committee meeting last weekend, oil ministers commented that they were inclined to extend the production cuts into the second half of 2019, which will keep the market relatively tight and hopefully accelerate inventory drawdowns.

Recommendations

O&G stocks have priced in further oil price declines.

• While oil prices have risen 23% YTD, O&G stocks have only seen a low teen increase. Most of the O&G names had hit YTD highs in mid-April, having risen by 30-40% from early Jan-2019, in tandem with oil price rebound of 36%.
• However, 70-80% of these gains were given back over the past 1-month as market sentiment took a sharp turn south. This were much steeper than the oil price decline of ~9% from YTD high of US$74.6/bbl, suggesting that market is pricing in further weakness in oil prices towards the US$60/bbl level, which is our bear case scenario of a full-fledged trade war.

Value emerging.

• Recall that the O&G sector hit a recent low at end Dec-2018 when oil price drifted below US$55/bbl. At current levels following the recent share price correction, the key O&G proxies under our coverage are barely up by~10% from the lows despite oil price increase of 23%. Hence, we believe further downside should be relatively more contained as market has priced in any potential oil price decline.
• Nonetheless, weak broad market sentiment and global demand jitters might continue to suppress stock performance in the near term till positive news comes about, for instance, progress of US-China trade talks, OPEC cuts, geopolitics-led oil supply disruption, optimism in equity market sentiment etc.
• We observed that Petrochina and SEMBCORP MARINE LTD (SGX:S51) are among the worst hit O&G names with YTD loss of 3-5%, and we think further downside might be relatively lower than peers.
• We continue to favour oilfield services providers (refer to valuation table in attached PDF report), as their earnings are less sensitive to oil prices, to ride on the capex recovery.

Source: DBS Research - 27 May 2019