Regional Market Strategy
Strong oil outlook for 2011 and beyond
• Strong oil outlook for 2011 and beyond. We raise our oil price forecasts for 2011- 13 and beyond. This brings us to $110/bbl oil price forecasts for 2012-13 and $90/bbl for the long term with our new forecasts now 10% above market consensus. We examine the impact on key sectors and raise our earnings estimates and target prices for energy and petrochemical stocks accordingly. Transportation is the other key sector where we cut our earnings forecasts on higher fuel cost assumptions. The growth impact is marginally negative with our macro team revising Sino-Asean GDP for 2011-12 down by 0.2-0.8%. Our recommended picks to ride the strong oil theme are PTTEP, TOP, IVL, PChem, Keppel Corp, Sembmarine, Kencana, Sapura Crest and Ezra.
• Oil demand likely to outpace supply from 2012. We expect oil prices to continue to rise as the sector moves from a cyclical recovery in 2011 to a structural bull market starting 2012. We believe market fundamentals will remain structurally bullish in the long term due to demand growth outpacing supply growth. We raise our oil price assumptions from US$95/bbl to US$105/bbl for 2011 and from US$100/bbl to US$110/bbl for 2012-13 and lift our long-term estimate from US$85/bbl to US$90/bbl based on higher demand, cost inflation and premiums driven by the risk of supply disruptions.
• Earnings boost for energy and petrochemicals, hit on transport stocks. On the heels of our oil price upgrade, we raise earnings and target prices for energy and petrochemical stocks within our coverage with the largest upgrades seen for PChem and PTTEP. On the other hand, higher fuel cost expectations have translated into earnings cuts for our transport stocks. Companies with low profit margins, higher fuel costs-to-sales ratios and slower expected pass-through bear the brunt of our earnings cuts with a more significant impact for MAS, BLTA and CSCL. We remain selective on aviation picks with SIA as the sector top pick and maintain our Underweight position on tanker and dry bulk shipping, but Overweight on container shipping.
• Recommended picks to ride strong oil theme. We like PTTEP for its high leverage to higher oil prices; TOP for its wider margins and strong earnings growth as the largest refiner in Thailand; IVL for its strong earnings momentum on an acquisition and polyester boom; PChem for its highest leverage to oil prices and solid earnings growth; Keppel Corp and Sembmarine as proxies for the rig replacement cycle; Kencana, Sapura Crest and Ezra as offshore service providers that we expect to benefit from increased E&P and marginal field development.
Oil: from cyclical recovery to structural bull
We believe the oil market is entering a transitional phase between a cyclical recovery in 2011, precipitated by the drawdown of high inventory levels, and a structural bull market given the reduction of spare OPEC capacity to satisfy demand growth. This could shift the demand-supply balance from a situation of oversupply into an undersupply-driven bull market, which had taken place in 2006-08.
Even before crude oil prices spiked due to geopolitical concerns in Feb 11, oil prices were high at above US$90/bbl for Brent and Dubai while WTI stayed weaker at slightly below US$90/bbl due to poorer demand and a higher inventory level. We believe high sustained oil prices reflected the inflation in the cost of oil production and a long-term structural undersupply in the market, resulting in a contango oil curve
We raise our oil price assumptions by 10-11% for 2011-13. Hence, our estimates are lifted from US$95/bbl to US$105/bbl for 2011 and from US$100/bbl to US$110/bbl for 2012-13. Meanwhile, we increase our long-term oil price from US$85/bbl to US$90/bbl. As a result, our oil forecasts are now 10% above market consensus. We use Brent oil price forecasts rather than WTI as we think the Brent market has a higher correlation with Dubai oil prices, which is the most relevant benchmark for oil and gas companies in Asia.
2011: We believe higher oil prices in 2011 will be driven by high premiums arising from geopolitical tensions and greater demand in the medium term as a result of the earthquake-tsunami and subsequent nuclear threat in Japan.
2012-13: We see higher oil prices driven by tighter demand-supply as spare OPEC capacity will be used to satisfy rising demand growth.
Long-term oil prices post-2013: We raise our long-term oil price assumption by US$5/bbl to US$90/bbl as we think the higher cost of the global marginal production unit of oil sand of US$80-90/bbl will become the oil price floor average as demand for oil will start to outpace supply by 2012. Hence, certain cost premiums are likely.
First stage: cyclical recovery in 2009-11
Since 2008 when the global financial crisis hit the oil market, oil inventory drawdown has improved, growing from only 0.01mbpd in 2009 to 0.38mbpd in 2010. This resulted in a marginal drawdown of inventory of 0.4mbpd in 2009-10, compared with 1.76mbpd in 2007. However, on a seasonal basis, there was a clear gradual improvement in the inventory amount drawn now and we expect this trend to continue in 2011-12 on the back of demand growth, which we expect to outpace that of supply.
Second stage: structural bull market from 2012
We expect the oil market to enter a structural bull phase by 1H12 as spare OPEC capacity could flood the oil market after the global oil inventory normalises. Historically, spare OPEC capacity has an inverse relationship with world oil prices with oil prices rising as spare capacity declines. In 2008, when spare OPEC capacity dipped below 2mbpd, Brent oil prices hit a record high of over US$140/bbl. In 2012, we believe demand growth will outpace non-OPEC supply growth, necessitating the entrance of spare capacity from OPEC into the oil market to fill the gap.
We expect average oil prices to hit a record high of US$110/bbl in 2012, surpassing the US$98/bbl posted in 2008. Spot Brent oil prices, on the other hand, may or may not exceed its record high of US$146/bbl on 3 Jul 08.
Rising long-term oil trends
In the short term, oil price volatility is influenced more by hedging transactions and geopolitical concerns while long-term oil price levels are inflated by rising production costs and demand-supply imbalances. Higher demand growth is expected to outpace supply growth, which is constrained by limited new discoveries and operational difficulties in unstable oil production areas.
Roaring demand, waning supply
In 2010, oil demand grew 2.4mbpd, exceeding consensus expectations and marking one of the highest levels on record. Assuming that oil prices will average US$110/bbl, we expect demand to grow at a solid pace by 1.5mbpd in 2011 and 1.7mbpd in 2012. Supply will be more challenging as insufficient non-OPEC supply growth will necessitate the drawdown of spare OPEC capacity, leading to higher oil prices.
Demand growth. World oil demand is expected to grow 1.5mbpd in 2011 and 1.7mbpd in 2012, following a strong increase of 2.4mbpd in 2010. Despite being weaker than in 2010, the growth pace exceeded the increase of 1.0mbpd in 2007, which pushed oil prices to record highs. Unless oil prices exceed US$130/bbl, which we believe is the level oil demand will be extinguished, we expect demand to continue to grow and drive oil prices higher above US$100/bbl by 2012.
Non-OECD growth a key driver. We continue to expect growth from non-OECD countries over the next few years. China remains the key oil-consuming country and is expected to absorb 0.5mbpd more in 2011-12 following solid demand growth of 0.85mbpd in 2010. Despite improvements, US demand is expected to grow only 0.1mbpd in 2011, a decline from 0.3mbpd in 2010.
Strong car sales to be sustained. We believe China will see strong car sales growth of above 15% p.a. despite higher oil prices. This is supported by China’s growing personal wealth, which should allow its emerging middle class to absorb high oil prices. We believe that as long as oil prices do not surpass US$130/bbl, car sales will maintain their solid growth pace.
In the US, car sales turned positive in Sep-Nov 10 and grew marginally. We believe the growth rate will remain positive though small, leading to a gradual improvement in oil demand in 2011.
Supply growth constraints. As demand growth is expected to remain strong, we expect global demand-supply to hit an equilibrium in 2011. However, we see the balance upset in 2012 as non-OPEC supply growth is expected to decline sharply, forcing additional supply to come mainly from OPEC to fill the gap in demand. This should lead to a decline in spare OPEC capacity from 5mbpd currently to below 3mbpd by 2013.
Cost inflation provides a floor for oil prices
Oil prices have been volatile in the short term, driven by market concerns over supply disruptions caused by geopolitical tensions. The volatility is further exacerbated by financial hedging. However, in the long term, we believe oil prices will see a higher “price floor”, supported by rising production costs mainly for the production of Canadian oil sand, which has been the new key oil supply over the past few years. We believe the cost of Canadian oil sand of US$85/bbl will become the floor for global oil prices, given its importance as one of the largest marginal production units of global oil. Oil sand currently accounts for 3% of global oil production and over 70% of Canadian oil production.
The cost of Canadian oil sand is one of the highest in oil production. However, we believe that on the back of the twin factors of limited non-OPEC supply growth and solid demand growth, the 3mbpd marginal supply unit of oil sand will need to enter the oil market as a supply crunch is inevitable over the next few years. Also, the transportation cost of oil sand from the Alberta province in Canada to the US market has declined as more pipelines have been built. Many more are scheduled over the next five years.
Near term, watchful on price volatility
Net positions of oil futures, both in terms of non-commercial net futures positions and open futures interests, have hit record highs, surpassing the peaks in 2007-08. We believe this could result in higher oil prices over the next 2-3 months, followed by a sharp plunge after the spike. Currently, oil prices remain at a high of US$115/bbl, still far from its previous peak of US$147/bbl.
The higher the price, the sharper the subsequent drop. We, however, believe that speculation over oil futures is likely to have only a short-term impact on oil prices. Long-term prices, in our view, are driven by costs and the demand-supply balance. In any case, we believe the annual average oil price is less likely to exceed US$110/bbl. Should oil prices spike over US$130/bbl over the course of 2-3 months in 1H11 on the back of excessive speculation, demand for oil could be threatened during the latter part of the year, similar to what happened in 2H08. This would effectively result in a lower-than-expected annual average oil price. However, if geopolitical tensions in MENA end within the next 2-3 months and if the unrest does not spread to the big five oil producing countries in the Middle East – Saudi Arabia, UAE, Qatar, Kuwait, and Iran, oil prices should decline to their normal fundamental cost-based level of US$90-100/bbl. This would also result in an annual average oil price of US$105/bbl in 2011, in our view.
Impact on oil price volatility and levels. Oil futures price curves have fluctuated following concerns that geopolitical risks may cause supply disruptions and that Japan’s temblor-tsunami could result in lower demand for oil in the short term. While oil prices have ranged wide in the short term, long-dated oil prices have moved in a much narrower band of US$102/bbl and US$107/bbl for Brent and between US$98/bbl and US$103/bbl for WTI. In our view, these data support our thesis of higher oil prices, which is based on the cost-plus basis of higher production costs given the marginal unit of oil sand and deepwater oil production of US$85-95/bbl plus future premiums on the back of a potential tight demand-supply situation when demand for oil starts to outpace supply by 2012.
Geopolitical risk a wild card
We maintain our base-case view that the impact of supply disruptions in Libya and Algeria will be limited and are unlikely to push short-term oil prices beyond US$130/bbl. Sufficient spare capacity from OPEC and a high global inventory should be enough to make up for supply disruptions in Libya and Algeria, assuming the unrest does not spread to five key OPEC oil producers, Saudi Arabia, Iran, UAE, Qatar, and Kuwait.
Currently, the global inventory is high at 3,750m bbl, equivalent to around 43 days of global consumption. Spare OPEC capacity is also expected to be sufficient to help make up for the shortfall in supply from Libya and Algeria, assuming that the disruptions in these two countries are not permanent. However, if Libya’s and Algeria’s entire oil production is halted, OPEC’s spare capacity is likely drop close to 2mbpd, as seen in Jul 08 when oil prices hit record highs due to market concerns over insufficient supply.
But risk hinges on the big five. While we believe OPEC’s spare capacity will sufficiently cushion the impact arising from the decline in oil production in Libya and Algeria, we highlight that risks will mount if the unrest spreads to any of the big five oil producing countries – Saudi Arabia, Iran, Kuwait, UAE and Qatar. Together, these five countries account for 80% of total OPEC capacity. Historically, OPEC members have complied strictly with their oil production quotas, effectively supporting oil prices when demand is depressed. Hence, we believe if oil prices rise too fast to over US$120- 130/bbl, OPEC will act aggressively to boost the group’s oil production to prevent oil prices from getting too high and threatening demand.
With almost all spare global oil capacity coming from the Middle East’s OPEC countries, we believe the recent uprising in Bahrain, Saudi Arabia’s neighbourhood, and future developments will play a critical role in oil price movements. While Bahrain, a non-OPEC Middle East country, has oil production of only 40kbpd, 0.05% of global oil production, with limited oil reserves, its strategic location smack in the middle of the Middle East oil-producing countries, renders oil supply vulnerable and increases the risk of supply disruptions. Hence, we believe oil price premiums can only get higher on the back of unrest in the MENA countries.
Macro impact
Based on our new oil price assumptions (from US$95/bbl to US$105/bbl for 2011 and from US$100/bbl to US$110/bbl for 2012-13), we have tweaked our macro variables for 2011-12, to reflect the first-round and second-round effects through trade and income channels.
We continue to expect the global recovery to remain on course albeit with some hiccups. While sustained high oil prices due to supply disruptions would short-circuit growth, the likely damage should be manageable for this year. Emerging economies may be hit harder due to their higher usage of oil per unit of output though the oil intensity in emerging economies has been falling in recent years. Manufacturing industries have become more fuel efficient amid the development of less-energyintensive service industries. Overall, the impact of higher oil prices will be spread over two years, with the effect felt more in 2012.
On GDP, we lower our growth estimates by 0.2-0.8% pt for China, Hong Kong, Indonesia, Malaysia, Singapore and Thailand in 2011-12. If oil prices reach US$150/bbl for a sustained period of six months or more, the economic impact would almost certainly be larger. Figure 24 shows the sensitivity impact for every US$10/bbl rise in oil prices.
On inflation, upward risks remain, not only due to supply factors but also to the risk of headline inflation feeding into a wage-price spiral. For those economies that have been operating at full capacity and experiencing tight labour market conditions, both headline and core inflation have risen, and some have stayed above the central bank’s comfort zone. China’s inflation rose to 4.9% yoy in Feb, Hong Kong (3.7% in Feb), Indonesia (6.8% in Feb), Singapore (5.0% in Feb). Thailand’s and Malaysia’s inflation remain relatively low at 2.9% in Feb and 2.4% in Jan respectively. As food (19.6-36.1% of total CPI basket) and transport (9.1-26.8% of total CPI basket) are core elements in Asian household budgets, sustained price increases not only erode consumers’ real purchasing power but would also spill over to general price increases for other goods and services. We tweak our headline inflation forecasts higher by 0.2- 0.9% pt for ASEAN-4, China and Hong Kong in 2011-12, reflecting the partial passthrough of higher energy costs. We think the government will absorb part of the impact through fuel subsidies to manage the effects of high oil prices on consumers and businesses.
On interest rates, we maintain our outlook except for Thailand. We believe policymakers will strike a balance between supporting growth and managing risks to inflation.
Earnings revisions: cuts to Transportation
Aviation
Jet fuel prices rise faster than Brent crude oil. On top of our hike in Brent crude oil price forecasts by US$10/bbl today, we have also raised our crack spread assumption by US$5/bbl. Consequently, our jet fuel price assumptions have been increased by 13-14% for all forecast years to average US$125/bbl in 2011, and US$130/bbl from 2012-13. This is because the refinery outages in Japan as a consequence of earthquake damage and shortage of electricity could reduce jet fuel supplies in the market. Japan produces 3-4% of the world’s jet fuel. This is expected to increase the crack spread between Singapore jet fuel and Brent crude oil. We had previously assumed a crack spread of US$15/bbl, but now raise it to US$20/bbl. Jet fuel averaged only US$90/bbl in 2010, and is now expected to average almost 40% higher at US$125/bbl in 2011. The price of jet fuel is currently US$133/bbl and averages US$119/bbl year-to-date.
AirAsia the least affected; MAS the most. The impact of the above revisions is to reduce the earnings estimates for airlines under coverage. Among the four stocks in our universe, MAS will bear the brunt of the deepest earnings cuts of 13-49% for CY11-13. This is followed by Tiger Airways with core EPS cuts of 15-28%, then SIA of 14-26% and finally AirAsia with the least cuts of only 3-12%. AirAsia and SIA are the two airlines with the lowest downward adjustments due to their strong profitability and relatively low proportion of fuel cost relative to revenue. Our EPS adjustments assume that each airline recovers 50% of the fuel price hike via higher base fares, surcharges or ancillary revenue.
Raising fares or fees. Since early December, SIA has increased its surcharges three times by 36-49% cumulative. MAS has also raised surcharges for international routes. AirAsia still does not have any fuel surcharges, but has increased the charges for certain ancillary services, while also raising base fares in February. Tiger Airways similarly does not have fuel surcharges, but it has also raised base fares and is pushing customer adoption of its ancillary products. We estimate that AirAsia can offset US$3.10/bbl of fuel price for every 1% rise in its average fare, against US$2.50/bbl for SIA, US$2.45/bbl for MAS, and US$2.30/bbl for Tiger.
We maintain OVERWEIGHT on the aviation sector as we believe the industry will benefit from still-strong global economic growth for several more years. Potential rerating catalysts include benefits to Asian airlines from robust GDP growth in the region and rising spending power. Traffic for both economy and premium class is well correlated to the business cycle and we expect continued growth in passenger numbers. In particular, while economy class traffic is 2% above its pre-recession peak, premium traffic is still 12% below, leaving plenty of room left for a continued recovery. This should help airlines improve average yields on a better passenger mix. Finally, air freight traffic and yields are expected to benefit from rising OECD composite leading indicators and purchasing managers’ indices. On balance, airlines should see continued topline expansion in 2011 though cost headwinds could affect earnings.
We have cut our earnings forecasts across our universe because we have raised our oil price assumptions, with MAS suffering the greatest core EPS cuts of 13-49%, followed by Tiger Airways of 15-28% (FY12-14), SIA of 14-26% (FY12-14), and finally AirAsia with the least cuts of 3-12%. Our target prices have been cut 3% for Tiger and 8% for MAS, while we leave our target price unchanged for SIA. We make an exception for AirAsia whose target price is raised from RM3 to RM3.40 as we now apply a higher P/E multiple of 9x instead of 7x, as a likely move by MAS to raise domestic surcharges will allow it to follow suit.
We recommend lower-risk stock picks for 2011, with SIA as our top regional airline pick followed by AirAsia. SIA provides the best mix of risk and reward as its share price of S$13.46 is at only a small premium to its S$11.70 book value per share. Its fuel price sensitivity is also the second-lowest in our universe, while dividends may surprise on the upside should its Virgin Atlantic stake be sold. SIA is expected to have net cash per share of around S$4 this financial year. Such balance sheet strength is important in an environment where high oil prices continue to pose risks. At the same time, SIA can also benefit from the continued recovery of business-class travel demand that will help it to increase its weighted-average yields. It has executed well and had never reported a full-year loss during past crises like the Asian financial crisis of 1997-98, 9/11, SARS crisis in 2003, the mega oil price surge in 2008 and the most recent great financial crisis of 2008-09. SIA has also been very responsive to the current challenges, quickly raising fuel surcharges three times in succession over the past three months and pulling one of its four daily flights to Tokyo effective yesterday due to weak demand.
Meanwhile, AirAsia has built a very robust business model at a very low unit cost that should help buffer it from unexpected fuel cost increases. If it successfully lists Thai AirAsia and Indonesia AirAsia by the end of this year, it may be able to benefit from better liquidity at its associates to speed up the repayment of intercompany balances owed to it. This could reduce net gearing to below our current expectations. AirAsia also has the lowest fuel price sensitivity in our universe.
Shipping
Raising bunker price assumptions. In conjunction with the hike in our Brent crude oil price forecasts by US$10/bbl today, we increase our Singapore bunker price assumptions by a similar percentage rise, and now forecast bunker prices of US$641/tonne in 2011, and US$673/tonne for 2012-13. Bunker fuel averaged only US$475/tonne in 2010 and is now expected to average US$641/tonne in 2011, 35% higher yoy. The price of bunker fuel is currently US$664/tonne and averages US$605/tonne YTD.
The factors that determine effective pass-through. The varying impact of rising bunker on shipping companies largely depends on the contractual arrangements that have been put in place to pass on the bunker costs. Under time charter arrangements, the charterer bears the cost of fuel, not the ship owner. Under spot/voyage charter arrangements, the cost of bunker is usually added on to the base freight rate, and therefore also indirectly borne by the charterer. Under contracts of affreightment, effective bunker pass through will depend on whether there are bunker adjustment factors that are continually revised to reflect the prevailing cost of fuel.
BLTA the most affected; MISC and SITC the least. Within our tanker and container shipping universe, BLTA bears the greatest brunt of the higher oil prices because of its high operating and financial leverage, hence we have cut EPS for BLTA by 18-22% for 2011-12. CSCL is also very sensitive, as most if not all of CSCL’s contracts do not have BAF clauses and successful pass-through may be difficult under current weak spot market conditions. Meanwhile, MISC and SITC are relatively insensitive due to time-charter contracts for MISC’s LNG shipping and offshore vessels, and SITC’s logistics contributions. NOL is moderately sensitive, and we cut EPS by 6-20%. Although NOL either hedges or adopts floating BAF clauses for its contracts, the onequarter adjustment lag could still hurt in a rising oil price environment. We have cut target prices across the board except for BLTA.
We maintain NEUTRAL on the overall shipping sector, with an Overweight rating on container shipping and Underweight ratings for both tanker and dry bulk sectors.
Higher oil prices are negative for tanker and container shipping, and we have cut earnings forecasts across the board. On the other hand, the dry bulk sector is resilient to higher fuel costs. The two stocks most greatly affected by higher oil prices are BLTA (TP: Rp495), due to its low profitability, and CSCL (TP: HK$3.80) due to its lack of formal cost pass-through formula. Our top pick remains NOL (TP: S$2.45) as it has floating bunker pass-through formulas for most of its contracts, while it will also benefit from structural cost reductions over the next 2-3 years when it takes deliveries of its newbuildings.
Source/转贴/Extract/: CIMB Research
Publish date:28/03/11
