Not Just About Crude Oil Price

Not Just About Crude Oil Price: "♦ Crude oil price. Crude oil prices hovered in the US$65-74/barrel range in Aug-Sep period as expectations of an economic recovery and higher oil consumption in the future were weighed against weak current demand and high inventories. We believe the cushion (i.e. level of spare capacity) would remain at around 8% of global consumption in 4Q09 before narrowing marginally to 7% in 2010 given: 1) still weak demand from US and Europe; 2) gradual increase in supply due to stronger-than-expected Russian output; and 3) still high floating storage level. Hence, we believe crude oil price would likely hover around US$60-70/barrel in 4Q 2009 before rising to US$60-80 and US$80-100 in 2010-11 respectively.

♦ Sector outlook. With crude oil price remaining volatile, we believe E&P players may continue to defer lumpy capex for greenfield upstream projects. Furthermore, we believe there could be pressure on contract pricing as competition for regional and domestic jobs are likely to remain intense amidst still low contract flows from North America and Europe.

♦ Survival of the fittest. While we have highlighted that sizeable projects would be scarce and contracts would be priced at more competitive rates, we believe local players with strong recurrent earnings and conservative management (i.e. Dialog) as well as strong market position (i.e. Wah Seong) would fare better than others. We also favour companies with improving cost management (i.e. SapuraCrest after delivery of two new India jv vessels) and ability to move up the value-chain (i.e. fabrication of tender rigs for Kencana).

♦ Reiterate Overweight. We expect sustainable contract flows ahead as most of the conventional production-stage projects are able to proceed again at current oil price of above US$60/barrel. However, in the near term, we believe investors should focus on companies with stronger orderbook replenishment and good earnings visibility. As highlighted above, these include Wah Seong, Kencana and Dialog. Longer term, we reiterate our view that the continued shortage of offshore E&P assets (exacerbated by delays in E&P spending) will underpin the growth in E&P activity. Hence we maintain our Overweight stance on the sector. Our
top pick for the sector is Wah Seong.

By RHBinvest
Analyst: Wong Chin Wai

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