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Oil and Gas: Exploration & Production
Oil Prices: Increased volatility on geo‐political risks
Oil & Gas Sector Performance 1M 3M 12M Absolute % ‐12%
‐13%
‐29%
‐7%
‐10%
‐40%
Relative to KSE % Relative Chart KSE100 vs Oil & Gas sector
30%
Oil and Gas KSE100 Index
20%
10%
0%
‐10%
Apr‐15
Feb‐15
Mar‐15
Jan‐15
Dec‐14
Oct‐14
Nov‐14
Sep‐14
Jul‐14
Aug‐14
Jun‐14
Apr‐14
‐30%
May‐14
‐20%
‐40%
Source: BMA Research
Tuesday April 7, 2015 After peaking to USD62/bbl (Brent) and USD54/bbl (Nymex) in Feb’15, oil prices have retreated by 4%‐5% as weak fundamentals continue to depress oil market sentiments. Last two weeks remained volatile as oil prices witnessed swings of +/‐5% on re‐
emergence of political uncertainty in the Middle East given i) armed conflict in Yemen and ii) Iran Nuclear deal negotiations. During the last one month, average oil prices stood lower by 7%MoM where the bearish sentiment in oil prices was driven by i) hefty build‐up in US inventory, ii) 2.0xYoY increase in Libyan output, iii) sizeable uptick in Saudi output to ~10mnbpd and iv) concerns on additional exports from Iran following the Iran Nuclear deal. However, i) continued downtick is US rig count and ii) 4% weakening in USD index contained the downward slide in oil prices. Declining trend in oil prices coupled with bearish sentiment in benchmark index kept BMA E&P Universe under pressure as it underperformed KSE‐100 by 7% during the last one month. Near term upside in the E&P sector will remain restricted due to depressed earnings outlook in FY15F (down 30%YoY). However, long term prospects remain convincing on account of i) aggressive development and exploration activity, ii) strong cash balance and iii) gradual recovery in prices as shale production eases off in late 2015. We believe the sector has priced in the negatives as it is currently trading at FY15F P/E of 8.5x (inline with KSE100 P/E) compared to 10.5x (8% premium over KSE100) on Feb3’16 when market multiple peaked at 9.7x. Assessing the impact of Saudi‐Yemen conflict: The geo‐political situation crisis in the Middle East intensified when a Saudi led coalition launched airstrikes on Yemen against the rebel forces ‘Houthis’ on Mar26’15. Consequently, oil prices across the globe posted gains of 7%‐9% in the following two days due to fears of a large scale regional conflict leading to sizeable disruption in crude supplies. An estimated 3.8mnbpd of oil pass through the narrow shipping channel ‘Bab el‐Mandeb’ along the coastline of Yemen. However, given i) the presence of US/Allied and Egyptian naval forces in the region, ii) absence of maritime attack capabilities of the rebels and iii) 130kbpd oil production of Yemen (a mere 0.15% of global production), we believe the armed conflict in the region will have negligible influence on the oil prices. That said, any escalation in the tensions leading into a sectarian stand‐off, thereby potentially bringing other nations (Libya, Syria, Iraq) into the conflict as well, will remain a key upside risk to prevailing oil prices. Iran Nuclear deal to expand supply surplus: After 18 months of intensive bargaining, the negotiating teams of Western powers and Iran finally took a decisive step on Apr2’15 as they managed to formulate a framework agreement, being regarded as a stepping stone towards reaching a final accord (expected: Jun30’15). As per the agreement, Iran will have to comply with all conditions set forth in the tentative agreement before pumping oil into the global market. Muhammad Affan Ismail, CFA muhammad.affan@bmacapital.com +92 111 262 111 Ext: 2058 Despite being a tentative agreement, the market overreacted as it hammered down oil prices by ~4% during the next trading session. The successful implementation of the full accord by Jun’15 will potentially add ~1.0mnbpd of crude in a phased manner over the next six months from the final deal, thus diluting the significance of upcoming OPEC meeting in Jun’15. Given the fact that the sanctions have severely crippled the Iranian economy, we believe it is highly likely that Iran will display more flexibility and agree to the conditions. At the same time, with increasing preference towards a diplomatic solution, the West (six major powers) may also ignore the pressure from Israel and Saudi Arabia and finally seal the deal. BMA Capital Management Ltd. 801 Unitower, I.I.Chundrigar Road, Karachi, 74000, Pakistan For further queries, please contact: bmaresearch@bmacapital.com or call UAN: 111‐262‐111 This memorandum is produced by BMA Capital Management Limited and is only for the use of their clients. While the information contained herein is from sources believed reliable, we do not represent that it is accurate or complete and should not be relied upon as such. Opinions expressed may be revised at any time. This memorandum is for information only and is not an offer to buy or sell, or solicitation of any offer to buy or sell the securities mentioned.
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Outlook remains bleak on weak fundamentals: Given i) limited dent in expected US shale production during 4QFY15 despite falling rig count and ii) record production levels in Africa, Saudi Arabia and Iraq, we expect upside in oil prices to remain limited. Our 4QFY15 and FY16 average oil price assumption remains intact at USD50/bbl and USD60/bbl, respectively where any escalation in Saudi‐Houthis battle into a regional conflict will remain upside trigger to our base case oil price assumption. On the flip side, successful completion of final accord between West and Iran will remain a key downside risk Investment Perspective: With uncertain outlook on prices coupled with an estimated 30%YoY decline in FY15F earnings, we expect near term upside in the E&P sector to remain restricted. However, long term prospects of the sector remains convincing on i) aggressive development and exploration activity, ii) strong cash balance and iii) gradual recovery in prices as shale production eases off in late 2015. We re‐iterate POL as our top pick in the E&P sector with a TP of PKR490/sh (total return of 54%) where our conviction on the stock is based on i) 3 year CAGR of 11% in oil production and ii) 12% D/Y, both being highest in the sector. However, potential dry well write‐off at Pindori‐9 will remain a downside risk to our earnings estimate. BMA Capital Management Ltd. 801 Unitower, I.I.Chundrigar Road, Karachi, 74000, Pakistan For further queries, please contact: bmaresearch@bmacapital.com or call UAN: 111‐262‐111 This memorandum is produced by BMA Capital Management Limited and is only for the use of their clients. While the information contained herein is from sources believed reliable, we do not represent that it is accurate or complete and should not be relied upon as such. Opinions expressed may be revised at any time. This memorandum is for information only and is not an offer to buy or sell, or solicitation of any offer to buy or sell the securities mentioned.
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