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Oil and gas sector in for another blazing year [23-01-2013]  
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OUR oil and gas (O&G) portfolio ended 2012 was all fired-up with a weighted return of 21% versus the FBM KLCI's 10% gain.

It is in for another blazing year given Petronas' record capital expenditure and various development initiatives as well as a splashy comeback by the marine support providers.

The sector remains a high-conviction “overweight”. Also intact are all our stock recommendations, earnings forecasts and target prices. Our top picks are Petronas Dagangan for the big caps and Perisai Petroleum for the small caps.

Last year was a busy one for bigger service providers as more Economic Transformation Programme (ETP) works such as marginal field developments and enhanced oil recovery (EOR) got underway.

This year, we continue to have positive expectations of the sector, which is already off to a strong start. Year-to-date, Perdana Petroleum and Alam Maritim have clinched a combined RM1.1bil worth of contracts as they ride the wave of recovery in the marine support segment after a few washout years.

High oil price backs Petronas' exploration and production (E&P) works, and gives it and other producers more confidence to spend. The Brent crude oil price is currently hovering at US$112 per barrel and is expected to stay at elevated levels on the back of optimism that global economic growth will accelerate. We understand that oil price of around US$60 per barrel is needed to support marginal field exploration.

We expect all-time high net profits in calendar year 2013 to 2014 for Bumi Armada, Dialog Group, Perisai, Petronas Dagangan and a new merged entity, which make up 56% of our Malaysian oil and gas portfolio. This collective record performance supports our robust three-year earnings per share (EPS) compounded annual growth rate (CAGR) of 19.1%.

Reflecting the sector's bright prospects, our O&G portfolio has outpaced the benchmark index by 4.3% year-to-date, shored up by Alam, Perdana and Wah Seong. Given the high oil price, expect E&P activities to continue, especially in countries which are fuelled by petrodollars including Malaysia.

In 2011, the O&G sector contributed 36% to the Government's revenue in the form of taxes, dividends, royalties and export duties. With the right expertise and incentives, the development of a marginal field can take less than 24 months. As a deepwater field may take up to five years to be developed and the establishment of marginal fields is aimed at arresting the projected long-term decline in domestic O&G production and enhancing reserves. Malaysia's reserves of crude oil, condensate and natural gas have been somewhat stagnant.

Petronas targets to extract 1.7 billion barrels of oil and oil equivalent through various initiatives that include marginal field and deepwater field developments. The O&G sector put up a strong showing in 2012, mirroring its performance in 2011. On a weighted average basis, the sector provided a robust return of 20%, doubling the gain for the FBM KLCI, thanks to the surge in the share prices of bigger caps, namely Petronas Dagangan and a new merged entity, which ended the year 41% above its reference price following its listing on May 17, 2012. Smaller caps Perisai and Dayang Enterprise also pulled their weight, helping the sector to close the year on a high note.

The year 2012 was also the year of recovery for marine support players, namely Perdana and Alam, thanks to the improvement in vessel utilisation and charter rates. In second half of 2012, Perdana and Alam rallied by a scorching 70% and 27%, respectively.

At the other end of the spectrum, Malaysia Marine & Heavy Engineering, on which we initiated coverage with an “underperform” call on Jan 16, 2012, performed to our expectation with the share price falling by 21% in 2012.

Solid return

Overall, the O&G stocks that we cover tracked the sector. On a weighted average basis, our portfolio gave a solid return of 20.5%. The share prices of stocks in our O&G coverage advanced by an average 12.4% in 2012, higher than the FBM KLCI's 10.3%. After the announcements and awards of sizeable ETP projects in 2011, O&G players rolled up their sleeves and got down to work in 2012, which was an overall busy year for bigger service providers.

To recap, the ETP, which was unveiled on Sept 21, 2010, has provided a substantial boost to Malaysia's O&G and energy sector, which is one of the 12 national key economic areas. Commanding 44% of the RM212bil committed investments so far, the O&G and energy sector is the single largest beneficiary of the ETP.

Several initiatives under the ETP have shown significant progress, especially in the upstream segment, in particular the development of marginal fields. In Jan 2012, UK-based Petrofac confirmed that first oil had flowed at the Sepat field located in offshore Trengganu, slightly more than a year after the company was entrusted with the task of fast-tracking first oil from the field through a project worth an estimated US$250mil to US$280mil (RM750mil to RM840mil). The first oil paved the way for commercial production to start.

Sepat follows the production sharing contract (PSC) model, not risk service contract (RSC), as it is a Petrofac project with no local equity. However, Petrofac was joined at the field by pre-merger Kencana, which added processing equipment to the mobile offshore production unit, and Bumi Armada, which supplied and installed the floating storage and offloading (FSO) facility for the project.

The FSO was designed for an early production of about 20,000 barrels of oil daily. After Sepat, Petrofac hit another marginal field milestone. In Dec 2012, the company and its 50:50 JV partner the new merged entity celebrated its first gas at the Berantai field, also in Terengganu waters. The first gas was hit slightly less than two years after Petronas awarded a nine-year, US$800mil development and production project to the JV in Jan 2011.

Berantai is Malaysia's first RSC and is expected to set the benchmark for future marginal field contracts. Sarawak's Balai marginal cluster is Malaysia's second RSC. Up to 14 reservoir sections were identified as at November 2012 as the contractor group consisting of Australia-based Roc Oil (48%), Dialog (32%) and Petronas Carigali (20%) continued its extensive testing in the pre-development phase.

The contractor group scored a 15-year Petronas contract worth up to US$950mil (RM2.85bil) in August 2011. The third RSC was awarded in July 2012 to Thailand-based Coastal Energy, which signed a small-field RSC with Petronas for the development of the Kapal, Banang and Meranti (KBM) cluster of small fields located offshore Peninsular Malaysia. The contract value has not been disclosed. On Sept 19, 2012, Petra Energy inked an agreement with Coastal to subscribe for a 30% stake in the KBM RSC.

In the downstream segment, Dialog has commenced the construction of tank terminals in Pengerang, Johor after spending much of 2012 working on land reclamation and engineering works. Having secured the Pengerang and Balai projects, Dialog is by far the biggest winner of the ETP.

Despite the flurry of ETP works which have benefited mostly the bigger caps, it was small cap Perisai that stole the show in 2012. Perisai's share price shot up by 45.9% and outpaced the FBM KLCI by an impressive 31.9% as investors rushed to buy into the stock that offered an attractive combination of transformational growth and cheap valuations.

Top performers

Within our portfolio, the top performers after Perisai were Perdana, Petronas Dagangan and the new merged entity, which beat the benchmark by 30.0%, 28.7% and 28.5%, respectively. Perdana had a massive rebound, from the biggest letdown in 2011 to the second best performer in 2012 as an improved operating environment in the marine support segment helped the company turn the corner.

Also barrelling their way to the top of the league table were Deleum, Pantech and TH Heavy Engineering (formerly Ramunia) with share price jumps of 89.4%, 54.8% and 52.2% respectively. The biggest loser was SAAG, which share price crashed by 92.3%. Also at the bottom of the barrel were KNM and MMHE, which share prices plunged by 46.5% and 20.7%, respectively.

The Malaysian O&G sector is expected to see a further increase in activities in 2013 as Petronas boosts its E&P activities with local and overseas partners. Billions of dollars are being committed to new projects as the national oil company aims to exploit new reserves and strives to get the most from mature and marginal field assets.

The sector started 2013 on a very optimistic note, with an onshore oil discovery in Sarawak and goodies for the marine support players which 0are enjoying an operational revival. In the first two weeks of 2013, Perdana and Alam bagged five contracts worth a cumulative RM1.1bil with more in the pipeline.

In addition to more works for the marine support players, key projects to watch for this year are: EOR, marginal field development, and hook-up and commissioning.

A high oil price backs Petronas' E&P works, and gives it and other producers more confidence to open their wallets. Brent crude oil price is currently hovering at US$112 per barrel and is expected to stay at elevated levels on optimism that global economic growth will accelerate. We understand that an oil price of around US$60 per barrel is needed to support marginal field exploration. Last year, Petronas and Shell agreed to invest US$12bil (RM36bil) over 30 years in an EOR collaboration. The duo will recover oil off Sarawak and Sabah coasts as Malaysia seeks to arrest its production decline. As at September 2012, the country's production stood at 537,000 barrels per day (bpd), 30% lower than the peak of 762,000 bpd recorded in 2004.

Malaysia also targets to extend the life of its stagnant reserves, which could run out in 15 years. The production-sharing partners aim to extract 750m barrels oil in the northern Sabah fields and Sarawak's Baram Delta by increasing recovery rates. The average recovery factor is projected to increase from 36% to 50%. This should extend the fields' lives beyond 2040, said Petronas's CEO Tan Sri Shamsul Azhar Abbas.

Petronas holds a 50% stake in northern Sabah and a 60% stake in Baram Delta. Petronas and Shell first announced the tie-up in November 2011 and has started the ball rolling at the Bayan field in Sarawak.

More EOR projects

In November 2012, Dialog and US-based Halliburton formed a 50:50 JV, Halliburton Bayan Petroleum, which will provide services required by Petronas to enhance recoverable reserves from Bayan. The estimated value for the EOR project is US$1.2bil (RM3.6bil) for a term of 24 years. We understand that more EOR projects will be rolled out this year. The introduction of the RSCs is to encourage the uptake of marginal field developments.

Under the RSC structure, Petronas retains field ownership while the contractors, which are local and foreign service providers, stand to receive a fee on top of the upfront investment in the field. The reserve size of each of the marginal fields is at most 30 million barrels of oil equivalent and, therefore, may not appeal to super majors but for smaller companies, it could double their reserves overnight.

First oil from Kapal which is part of the KBM cluster of small fields is due in July this year, a year after Coastal bagged the RSC. Kapal's first oil will be followed by production at Banang in July 2014. No production date has been set for Meranti, the third field in the KBM cluster.

After Berantai, Balai and KBM, the company that will get the next RSC is anybody's guess but Tembikai and Cenang are believed to be up for grabs again after talks between Scomi and Australia's Cue Energy appeared to have stalled late last year. Dialog and the new merged entity have made it clear that they are not stopping at their respective Balai and Berantai fields.

Meanwhile, Bumi Armada, which is involved in Sepat through the supply of an FSO facility, aspires to have direct involvement in the marginal field development and is believed to have set its sights on Tembikai and Cenang. Daya Materials is also understood to be eyeing marginal field opportunities.

Petronas and PSC partners are holding an open tender for jobs worth RM8bil to RM10bil. The jobs are for hook-up and commissioning (HUCC) projects in local waters, known as the Pan Malaysian cluster. HUCC entails the connecting and testing of the various systems on the offshore structures.

We believe potential winners for the HUCC jobs will mostly be companies with vessels, as marine support makes up an estimated 60% of the required works.

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