Oil & Gas : Positive signs of recovery

Low oil prices severely hit exploration sector and oil services

The upstream Oil & Gas (O&G) segment finds and produces crude oil and natural gas (NG). As a price taker, upstream O&G, also known as exploration and production (E&P), has direct exposure to oil price volatility and, to a certain extent, gas price volatility. During a downturn, E&P companies will look for ways to cut costs. After the steep decline in oil prices from the recent peak in Jun 14, we have seen an average capex cut of 15% by oil majors (ie BP, Chevron, ConocoPhillips, ENI, ExxonMobil, Shell, Statoil and Total SA) and an average cut of 16% by national oil companies (eg CNOOC, Pertamina, Petrobas, Petronas, Petrochina) in 2015. Instead of spending on new oilfields, E&P companies are focusing on maintaining or increasing oil production from producing assets. Oilfield service providers such as Schlumberger, Baker Hughes, Wintermar, Logindo and Halliburton have also been hit by the recent industry downturn. Many oilfield services companies have reduced their manpower, given fewer activities such asexploration and drilling

Some positive factors remain in U.S.

Nevertheless, we saw that there is a positive sign of oil production cut from US. According to the data provided by the EIA, domestic output for the week came out to 8.825 mbpd, a decline of 113k bpd from the prior week's output of 8.938 mn. This is the largest weekly decline seen in quite some time and is a positive indication of the long-term trend in output.Further, according to Baker Hughes, horizontal oil rigs in the U.S. declined by 6 units during the week to 318. This represents a decline of 54% from the 692 units seen in operation the same period last year and is an indicator that future production should be lower than it is today by a large margin if rig counts don't begin to rise soon.

Oil prices to start improving this year

At this moment, the picture for oil price is somewhat mixed. On the one hand, U.S. inventories continue to rise but, on the other, U.S. production falling at a nice clip and demand coming in strong in terms of motor gasoline and starting to improve in the distillate fuel category. All of this suggests oil prices still have room for recovery in next couple of years. However, with the energy market rebalancing in the U.S., we still see high uncertainty in the oil price outlook for the longer-term. We expect crude oil Brent price to average USD45/bbl in 2016, after hitting its bottom of USD27.8/bbl in Jan-16, and continue to rise to USD55/bbl in 2017. Global oil inventories are expected to grow by 0.4 mbbl/d in 2017, as the global oil market is expected be relatively balanced late in 2017, with the potential for significant inventory draws beyond the forecast period.

Indonesia beats oil production target in 1Q16

Nevertheless, Indonesia's crude oil output was strong in the first quarter of 2016 on the back of higher-than-expected oil production of several oil companies in Indonesia. According to Indonesia's oil & gas regulator SKK Migas the nation's oil production totaled 833,000 barrels per day (bpd) in the January-March 2016 period, exceeding the oil lifting target that was set in the 2016 State Budget (830,000 bpd).

Recommendation: For the sector

At this stage, we retain our rating for oil & gas sector, as we remain cautious about the outlooks for oil and gas industry in 2016. Nevertheless, we believe that the sector will gain momentum in  2017 and onwards. We continue to like Medco as our top pick in the sector due to additional gas production from Senoro and Lematang Block. Risks to our call include worse-than-expected global economic prospects, and lower oil price.