Decline in Oil Prices Inevitable for a While
The authors are analysts of Shinhan Investment Corp. They can be reached at hiroo79@shinhan.com and jinmyung.lee93@shinhan.com, respectively. -- Ed.
OPEC+ fails to agree on output cut, Saudi Arabia announces output increase after April →Oil price drop
Talks between OPEC members and non-OPEC producers, referred to as OPEC+, collapsed last Friday, unable to reach an agreement on even rolling over their existing deal on output restraint (2.1mn b/d). Russia refused to support deeper cuts (1.5mn b/d) to offset demand lost to the COVID-19, expecting it to be only temporary. It also stressed that the existing deal will expire in March, which hints at the possibility of an increase from April. Saudi Arabia announced on Sunday that it will increase output from 9.7mn to 10mn b/d from April. It seems to be a strategy to lure Russia to the bargaining table as soon as possible. Oil supply glut is deepening due to increased supply from Norway and Guyana and weak demand exacerbated by the COVID-19 outbreak. The decline in oil prices is inevitable for a while with concerns over output growth from April adding to downward pressure.
An agreement before June meeting and reduction of additional output cut target remain a possibility
OPEC’s game of chicken with the US shale oil industry in 2H14-1H16 turned out to be a failure. The production cost of Permian shale is down to USD44/bbl based on WTI. The bankruptcy of small shale companies carrying higher production costs is a boon to global oil majors like Exxon Mobil and Chevron that are actively seeking M&A opportunities. As such, the oil producers’ move to increase output should not be seen as another long-term game of chicken targeting shale producers.
We believe it may be a short-term hegemonic war within OPEC+. Russia has recently increased its share in global oil production to 11.4%, further widening the gap with Saudi Arabia’s 9.9%. Both countries can weather further oil price declines for the time being, given Russia’s solid fiscal revenue (GDP ratio up to 2.7%) and Saudi Arabia’s low production cost (USD3/bbl excluding cost of capital). However, a steep drop in oil prices is negative for all oil producers. There is a possibility that OPEC+ will reach a deal before their next meeting in June. The additional output cut target may also be reduced. With slowing crude demand amid stricter environmental rules, the disagreement within OPEC+ and rising geopolitical risks in the Middle East (Iran, etc.) could increase uncertainty on the supply side, leading to higher volatility in oil prices in the longer term.
Top pick: KEPCO, earnings likely to be revised up on lower oil prices
The drop in oil prices should help boost KEPCO’s earnings from 2H20 (oil prices reflected with a five-month lag). Despite liquidity uncertainty caused by global asset management firms integrating ESG (environmental, social and governance) factors into their strategies, KEPCO’s earnings forecasts will likely be revised up on lower oil prices. Valuations are attractive at a PBR of 0.2x. Korea Gas is expected to see a reduction in accounts receivable in 2H20, but E&P earnings slowdown is a concern. Posco International should be able to offset the effect of oil price declines with gas discovery momentum in late March or early April.