Overweight
IEA releases emergency supplies. The International Energy Agency (IEA) announced last Thursday that its 28-member countries will be releasing 60m extra barrels of oil in the coming month in response to the ongoing disruption of oil supplies from Libya. This is the third time that IEA member-country stocks have been used - the first was in 2005 after Hurricane Katrina damaged offshore rigs, pipelines and gas refineries and the second was during Iraq's invasion of Kuwait in 1990/1991. The oil supplies, which should begin hitting the market around the end of next week, caused a knee-jerk reaction in markets following the announcement - prices of Brent crude futures for August delivery have fallen about 9% ever since to US$103/bbl, while WTI prices have dropped about 5% to US$90/bbl.
Merely a stopgap measure. This development comes as little surprise to us, considering that oil consuming markets have been bemoaning the continued rise in energy prices and the detrimental impact on economies. The US will also be ending its QE2 program at the end of this month amid stillweak economic growth and disappointing data. However, we expect this recent announcement to only have a short-term impact on the oil markets. As developed markets continue their fragile economic recoveries, oil demand from emerging nations such as China and India is expected to remain strong. In addition, as most of the easy oil has been exploited, extraction costs are also expected to rise in the future. Indeed, the IEA has forewarned that it does not exclude another decision to make additional supplies available to the market subsequently, should markets continue to remain tight.
Maintain Overweight. Hence, as much as share prices of oil and gas related stocks are correlated to movements in the oil price, we are not overly concerned about this latest development. In fact, we see it as a positive to keep oil prices in check so that economic recoveries do not get derailed; we would be comfortable with oil prices above US$80 as this level should still sustain capital expenditure in the sector. Meanwhile, we maintain our Overweight rating on the broader sector. Keppel Corporation [BUY, FV: S$13.00] and Sembcorp Marine [BUY, FV: S$6.30] remain as our preferred picks, given the positive outlook for the segments of the oil and gas value chain that they operate in, and their established market positions to capitalize on opportunities within the sector.
Rationale behind decision. The move, which is expected to increase oil supply by about 2m bbl/day, actually more than offsets the 1.5m bbl/day cut in Libyan supply since a civil war started in Feb. This development also comes closely on the heels of a promise by Saudi Arabia to boost production after an OPEC meeting on 8 Jun failed to persuade its members to increase output collectively. In its explanation, the IEA mentioned that crude demand peaks in the summer driving season in the Northern hemisphere and thus markets are expected to tighten further. Meanwhile, although Saudi Arabia intends to increase production, it takes time for the incremental barrels to be produced and shipped to consuming markets.
Tension with oil producing countries. Inevitably, the IEA's decision to release supplies to the market may result in the ire of oil producing countries. Indeed, certain OPEC officials have warned of possible retaliatory measures should oil prices fall too sharply. The IEA, on its part, said that it has been in close contact with key oil producing countries, in particular Saudi Arabia, and only wishes to stabilize oil markets. In our view, given the inflationary situation in emerging nations and the fragile economic trajectories of several developed economies, we believe there is still sufficient room for oil consumers to bargain for lower oil prices, as it will be to no one's benefit should the global economic recovery stall.
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