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Oil price surges after Opec action but shale could spoil the party
Dec 02, 2016

The Business Times

OIL-AND-GAS stocks on the Singapore Exchange (SGX) rallied on Thursday, after oil cartel Opec beat expectations by agreeing to cut output by 1.2 million barrels a day for the first six months of 2017. Non-Opec countries are expected to join in with another 0.6 million-barrel cut.

Rig builders Keppel and SembMarine, liftboat provider Ezion and other struggling names like contractor Ezra, explorers KrisEnergy and Rex International, and offshore-support vessel builder Nam Cheong all notched sizeable gains of 3 to 10 per cent.

Brent crude oil for January delivery surged 9 per cent past US$50 a barrel. But analysts were sceptical about how far the bounce will go towards helping local offshore and marine counters, which are struggling from oil majors scaling back expenditures.

They also noted the agreement by Opec (Organization of the Petroleum Exporting Countries) was just for six months, and it is unclear whether all parties can commit to the cuts.

A 60-70 per cent compliance rate is being factored into the forecasts. Meanwhile, analysts say, shale production in the US is picking up, limiting any oil price upside.

Maybank Kim Eng Research kept its "neutral" rating on the regional oil-and-gas services sector in a Thursday note. It said there are neither clear signs of higher global capital expenditures nor a quicker rebalancing of the demand-supply situation to support a stronger oil price recovery.

The broker's preferred buys are Ezion, China oil giant CNOOC, Thai oil firm PTT and Malaysian offshore support services firm Yinson.

OCBC credit analyst Nick Wong said offshore companies supporting the oil-and-gas sector will still face a challenging year ahead. They depend on investment plans for oil and gas, which are already fixed for the coming year. Explorers and producers do not have healthy balance sheets and will spend less, he said.

Suresh Tantia, an investment strategist at Credit Suisse, said he prefers banks to oil-and-gas names. Banks have diversified away from the oil-and-gas sector, and also stand to benefit from higher interest rates.

"There would be a short-term relief for service providers but ... for these companies to survive, they need the capital expenditure investments from oil producers. And as long as oil is below US$60 a barrel, we won't see the investments coming."

Analysts do not expect oil to rise above US$60 a barrel.

Richard Jerram, chief economist at Bank of Singapore, pointed out that the numbers of US rigs drilling for oil are already up nearly 50 per cent from May's lows.

"This will limit the upside to prices. So we see prices settling in a range around the US$50 level, limited by Opec cuts on the downside and the potential for higher US output on the upside," he said.

The US has undergone a revolution in energy production in recent years. Oil and gas can be extracted from shale-rock formations by pumping in a high-pressure water mixture in a process known as fracking.

Shale production has enabled the US to dramatically lower its dependence on imported crude oil, weakening the pricing power of the Opec cartel.

As oil prices started falling in mid-2014, Saudi Arabia, the world's largest oil exporter, made a fateful decision not to cut output in the November Opec meeting that year. The country was thought to be pursuing a strategy of oversupplying the market, partly to force the American shale firms out of business. Shale producers need to sell oil at around US$50 to US$60 a barrel to break even.

Oil prices halved to around US$50 in 2015 and went under US$30 a barrel in January this year. The shale producers went bust, but then Opec's oil revenues also fell drastically.

With Opec's agreement to cut production by around 1.2 million barrels a day, at the top end of expectations, it will produce 32.5 million barrels a day from next year, from almost 34 million barrels previously.

What also surprised the market was the promised reduction by another 600,000 barrels a day from non-Opec countries, with half the reduction contributed by Russia.

Estimates peg global demand at around 95 million barrels a day, and global supply exceeded that by one to two million barrels a day in recent quarters. Stockpiles had thus grown significantly.

With the cut, Anthony Starkey of S&P Global Platts Analytics said a deficit could arise next year if the oversupply is lower than previously assumed. Others have urged caution. Goldman Sachs estimates show that, assuming an Opec cut, daily demand and supply will be just brought into balance for the coming quarters.

It emphasised that the cut mainly targeted excess inventories and was not meant to cause high prices. "We do not believe that oil prices can sustainably remain above US$55 a barrel." Substantial US shale growth can bring prices down to US$50 a barrel by the second half of 2017, it said.

Norbert Rucker, head commodities research at Julius Baer, alluded to issues in the details of the Opec deal that can limit its effectiveness.

He said: "Historically, Opec has a poor track record of complying with quotas. It must be a bitter pill for war-torn Iraq to cut (output) while neighbouring Iran gets the wildcard to grow supplies."