Oil & Gas - 4QCY23 Report Card: Upstream Well Oiled

We upgrade our sector call to OVERWEIGHT from NEUTRAL. There was a significant improvement in the upstream services segment’s earnings delivery (against our expectations) in 4QCY23 sequentially, while that of the petrochemical and shipping segments only matches our expectations. With Brent crude prices expected to remain stable at USD84/bbl, we anticipate an increase in Petronas's upstream spending in 2024, aligning more closely with its RM60b annual capex goal. The upstream services segment appears to be entering the initial stages of a potential upcycle which will usher in an influx of job opportunities in 2024 and potentially more favourable contract terms as the supply of both upstream services and vessels tightens.

There was a significant improvement in the upstream services segment’s earnings delivery (against our expectations) in 4QCY23 sequentially as 44%, 44% and 12% of companies under our coverage beating, meeting and missing our forecasts, vs. 33%, 11% and 56% three months ago. Upstream services providers including UZMA (OP; TP: RM1.45), VELESTO (OP; TP: RM0.31), and WASCO (OP; TP: RM1.48) stood out, pointing towards a significant uptick in local upstream investment by Petronas, which will pave the way for a potential upcycle in the upstream services sector in Malaysian waters. On a more muted note, larger-cap players in the petrochemical and shipping segments such as MISC (MP; TP: RM7.51) and PCHEM (MP; TP: RM6.88) posted financial outcomes that only met expectations.

Brent prices to remain stable, conducive for upstream spending. The overall outlook for the Brent crude market remains largely unchanged since 4QCY23, prompting us to maintain our Brent crude price target at USD84/bbl for CY24. Our projections are based on the assumption that OPEC+ will continue its production cut throughout 2024, leading to a global crude production increase of 0.6m barrels per day (bbls/day). This increment falls short of the 1.4m bbls/day rise in global demand forecasted by the US Energy Information Administration (EIA). Consequently, the stability in Brent crude prices is expected to create a favourable scenario for Petronas to escalate its upstream capital expenditures, buoyed by the advantageous economics of crude production within the current price range.

Petronas to ramp up upstream spending. In 2024, we expect Petronas to fulfil its RM60b annual capex budget, with a greater emphasis on upstream investments to address the urgent need for mitigating natural production declines. To put this in perspective, during the first nine months of CY23, Petronas expended RM34.3b, substantially below its annual target. Given the positive outlook on Brent crude prices, it is likely that Petronas will strive to meet or exceed this yearly capex moving forward. This intention aligns with the details shared in the Petronas Activity Outlook 2024-2026, which forecasts a need for 14 jack-up rigs in 2024 (an increase from 12 in 2023) and 249 offshore support vessels (OSV) for drilling and projects in 2024 (up from 193 in 2023), underscoring a strategic pivot towards bolstering its upstream activities.

We upgrade our sector call to OVERWEIGHT from NEUTRAL as we upgrade VELESTO and WASCO to OUTPERFORM from MARKET PERFORM during the latest 4QCY23 results review after the companies posted strong sets of results. In our view, the upstream services industry is on the cusp of a potential upcycle with job flows expected to ramp up throughout 2024 and contract terms for the new potential job wins could be more favourable to the service providers due to the persistent supply shortages of providers and assets (vessels and rigs). Downstream outlook remains tepid due to overcapacity globally and slow recovery in global demand.

Our sector top picks are:-

i. DIALOG given the recovery in the spot tank terminal markets and gradually improving prospects of further expansion in capacities under Pengerang Phase 3,

ii. YINSON (OP; TP: RM3.47) due to its multiple FPSO projects scheduled for delivery in the next two years, offering a growth trajectory to its earnings base. We are also confident in Yinson's project execution capabilities, which should enable the timely delivery of upcoming projects, and

iii. UZMA as a mid-cap proxy to the expected surge in upstream services activities in Malaysia, which is likely to lead to increased order book replenishment for the group in FY25.