Morning Call about Crude Oil

Karachi, June 06, 2012 (PPI-OT): Fall in price is overplayed

Arab Light falls to 18 months low
Crude prices (Arab Light) have plummeted by 19% to USD 96.6/bbl since start of May 2012 and have been on a downward trajectory after touching a high of USD 126/bbl in March 2012.

According to Arif Habib Limited, the prices are currently hovering at almost 18months low, these level were last witnessed in Jan-Feb 2011. The primary reasons for this significant drop are weak economic data from the US and below-average growth rates of the Chinese and Indian economies. Moreover, economic turmoil in Europe resulting in growing concerns for EURO and Greeks debt crises further adds to the jitteriness. On the supply side, pickup in output from Iraq, which is up by 20%, recovery in flows from Libya to its pre-conflict levels and statement from OPEC suggesting prices acceptable at USD 100/bbl also compounded the growing concerns. According to estimates, Iraq’s output is likely to further enhance by 0.4mn bbl(16%) from current levels of 2.5mn bbl.

Crude prices will be reacting to the OPEC meeting which is scheduled for June 14, 2012. It is expected that Iran and Iraq (second and third largest oil producers in OPEC) will push for maintaining 30mn output cap on production. According to reports, May-12 OPEC production reached 31.7mn, the highest level since 2008, mainly because of Saudi Arabia pumping above its quota. Arif Habib Limited expects prices to stabilize in the range of USD 90-100/bbl post this meeting.

Impact of lower crude prices on E and P Companies
E and P companies have witnessed across the board decline in prices in reaction to the plunge in crude prices. In FY12TD, prices have averaged around USD 122.5/bbl compared to USD 93.42/bbl, a rise of 20% YoY, which has resulted in E and P companies’ oil revenues to augment by approximately 36% YoY as production has augmented by mere 2%. For the purposes of Arif Habib Limited’s estimates, Arif Habib Limited has assumed crude at USD 90/bbl for FY13 and long term rate at USD 85/bbl. Arif Habib Limited believes market has over reacted to this decline as POL and PPL are currently trading FY13 P/E of 6.7x and 5.9x, even if Arif Habib Limited incorporates oil at USD 80/bbl

Wellhead prices and falling crude prices
As per petroleum policies, well head gas prices are benchmarked against crude price (Arab light) and are determine on semi-annual basis. However, in order to calculate the wellhead price, crude price under the latest policy is capped at USD 100/bbl, while under the previous policies the cap was at lower levels. Hence the impact of the decline in crude will have a diluted impact on wellhead prices. Cushion will also be provided by falling PKR, which on average lost its vigor by 4.5% during the benchmark revision period for well head gas price.

Consequently, prices for 1HFY13 are expected to be revised upwards by approximately 4%, as July prices are based on average of Dec-May crude prices.

Recommendation
The major beneficiary under the circumstances remains PPL, as approximately 70% of its revenues a from gas production. Arif Habib Limited’s coverage of PPL is restricted as Arif Habib Limited is part of the consortium which is responsible for its secondary public offering. The major casualty to this decline would have been POL, however, the discovery at Makori East 2, which Arif Habib Limited believes well come online in FY14, would substantially mitigate this decline. POL’s 46% revenues are oil based. Arif Habib Limited’s top pick in the sector is POL with Dec-12 target price of PKR 460/share. The scrip is currently trading at a PER of 6.3x and offering healthy dividend yield of 11%.

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