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Oil and Gas: Exploration & Production
Price to remain weak; Production gains remain the key
Oil & Gas Sector Performance 1M 3M 12M Absolute % ‐6%
‐3%
‐25%
Relative to KSE % ‐2%
‐8%
‐44%
Pakistan E&P Estimates FY15F Arab Light FY16F FY17F 70 60 70 OGDC 19.9 19.5 25.0 PPL 19.2 19.0 23.4 POL 38.7 43.4 57.7 TP Upside DY OGDC 240 22% 6% PPL 201 26% 7% POL 490 39% 11% Relative Chart KSE100 vs Oil & Gas sector
Oil and Gas 40%
KSE100 Index
30%
20%
10%
0%
‐10%
Mar‐15
Jan‐15
Feb‐15
Dec‐14
Oct‐14
Nov‐14
Sep‐14
Jul‐14
Aug‐14
Jun‐14
Apr‐14
May‐14
‐30%
Mar‐14
‐20%
Source: BMA Research
Muhammad Affan Ismail, CFA muhammad.affan@bmacapital.com +92 111 262 111 Ext: 2058 Wednesday March 18, 2015 After witnessing a short bull run in Feb’15, oil prices have again started to send bearish signals with 10% and 11% decline in Brent and Nymex, respectively in just last one week. The sharp decline in prices can be attributed to i) hefty buildup in crude inventory levels in the US (highest level in last 80 years), ii) resumption in supplies from Libya, iii) possible nuclear deal between Iran and the West and iv) strengthening of the dollar index by 6%MoM. Going forward, the near term outlook remains bleak due to weak fundamentals owing to i) ample supplies, ii) weak global demand and iii) easing geopolitical situation (Iraq and Libya). Also, further strengthening of the dollar coupled with possible rate hike by the US Federal Reserve will further dent the sentiment in crude oil market. From the vantage of Pak E&Ps, we believe price performance of sector will remain muted given i) weak oil prices and ii) an estimated 30%YoY‐35%YoY decline in 2HFY15F earnings of the sector. With a lackluster pricing scenario, we believe the E&P company with highest production gains to outshine in the sector. In this regard, we maintain our long term conviction on POL with i) 3 year CAGR of 11% in oil production and ii) a healthy yield of 11%. PPL, currently exposed to exploration drilling in 3 high impact areas, can also attract investor’s attention in case of a successful attempt. Oil prices rebound short lived: After witnessing a sharp deterioration of ~50% during 7MFY15, oil prices rebounded sharply in Feb’15 as both Brent and Nymex posted significant gains of 37% and 20%, respectively from lows of USD45/bbl in Jan’15. The sharp decline in US rig counts to 866 started the bullish momentum in oil prices. This coupled with i) temporary shortfall in supplies and ii) seasonal uptick in demand remained the prime reasons behind recovery in oil prices. However, the bullish momentum was short‐
lived as i) hefty build‐up in US inventories, ii) strengthening of dollar index by 11%CYTD, iii) resumption in supplies from Libya and iv) anticipation of additional supplies from Iran resulted in a significant decline of 10%‐11% in oil prices during just last one week. Outlook remains bleak on ample supplies + muted demand: Going forward, the fundamental backdrop is still bearish given huge over supply in the market. Limited demand from refineries as winter season concludes coupled with gradual resumption in supplies from Libya and Iraq will keep oil prices upward sticky. The market will continue to eagerly await the stance of OPEC members in their upcoming meeting due in Jun’15. Limited growth in global consumption amid weak Eurozone economic state coupled with slowdown in pace of Chinese economic growth will also fail to provide any impetus to oil prices, we believe. The ongoing negotiations between West and Iran, if successful, will pump more crude in the already oversupplied market, thus remaining a key downside risk to our base case assumption of USD60/bbl and USD70/bbl in FY16F and FY17F, respectively. Brent‐Nymex parity – another concern for Brent’s sustainability: During the Feb’15 bull run, Nymex managed to rally by 20%, underperforming both Brent and OPEC basket by 12% and 9%, respectively. The i) ongoing refinery maintenance period, ii) considerable buildup in stockpiles and iii) labor strike at 15 US refining facilities due to safety related issues remained the prime reasons behind nominal gains in Nymex. Consequently, the discount of Nymex to Brent has now widened to ~USD10/bbl compared to average USD4/bbl during Sep’14‐Dec’14 period (months of free fall in oil prices). Given the fact that oil market still remains oversupplied, we believe there is a high risk for Brent to sustain at current levels. 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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Shale production will continue to influence oil prices: Despite the notable decline in rig count in US (down ~39% in last 3 months) coupled with cut in CAPEX plans by E&Ps, the forecast for US crude production remains upbeat. In this regard, the U.S. Energy Information Administration (EIA) have already upward revised their production forecast to 9.35mbpd (up 8%YoY). Shale production is also expected to head northwards depicting a growth of 0.59mbpd (up 15%YoY) to 4.5mbpd in 2015, as per OPEC’s Oil Report for Feb’15. However, the growth in shale production may start to lose steam in 4Q2015 due to continued decline in oil rigs given unattractive economic returns amid depressed oil prices. Can oil prices sustain at higher levels? Despite potential easing in shale production in late 2015, we foresee recovery in oil prices to remain limited (below USD70/bbl) as any significant uptick in prices may be followed by increase in shale drillings. It is pertinent to note that the share of horizontal drilling (a two step process) in US has increased significantly which has allowed the drillers to complete the drilling (first step) but not turn on the spigot (second step – fracking). As per Wood Mackenzie, almost 3,000 such wells in US have been drilled but not tapped, waiting to realize the production at higher price levels (probably at USD65/bbl‐USD70/bbl ‐ Nymex). This strategy by US E&P companies of responding to price increases by finishing more wells and adding new crude supply may delay the conditions needed for a rebound in oil prices. However, the key question here will be that for how long they can hold on to those wells? Considering that Saudi Arabia may continue to keep prices below USD60/bbl till 2015 end, we believe the prolonged suspension of these wells may start eating into the already depressed profitability of shale producers. Pak E&Ps – Volumetric gains remain the key: Our 2HFY15 assumption of oil price is intact at USD50/bbl while we foresee oil prices to average at USD60/bbl in FY16 based on gradual recovery in price as shale production start easing in late 2015. With upside in oil prices expected to remain restricted in near term, we believe E&Ps with highest volumetric gains to outshine in the sector. In this regard, we continue to prefer POL, expected to post 3 year CAGR of 11% in oil production, being highest in the sector. POL is exposed to drilling in 3 development wells (2 under progress + 1 planned), located in high impact TAL block. Investment Perspective: The near term price performance may remain muted given i) continued decline in earnings of the sector (2HFY15F NPAT down 30%YoY‐35%YoY) and ii) range bound oil prices. Beyond FY15, we believe production gains on completion of key development projects and gradual recovery in prices will improve the sentiments. POL remains our top pick in the E&P Universe with a TP of PKR490/sh, offering an upside of 39%. 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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