SPC @ 4.66 ( Oil / Singapore ) 12 comments
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1.Medium-term refining margin outlook is weak; demand is plateauing
I believe my latest choice will shock quite a few given the much vaunted tightness of capacity of the oil refining industry since Hurricane Katrina, which has prompted much investment attention on the stock.
Indeed, I have expressed my positive views on SPC previously on one or two forums, on the premise that SPC is well-positioned as the de facto national oil company in a resource-rich region brimming with opportunities; buying of SPC shares by its parent Keppel at prices above $5 further supported my viewpoint.
I sold off my holdings of SPC a few days ago (at a profit given my lower purchase price ~ 9 months ago); readers better take note because I may be writing with seller's bias right now. The key trigger that caused a sea change in my optimism on the stock was the latest Monthly Oil Market Report by the International Energy Agency (IEA) and its revelations on the Singapore refining margins.
Interested fundamentalists can read the details in the reference link below but suffice to say that although I had been expecting the 4Q refining margins to be poorer than 2004's exceptional margins, I had not been prepared for the collapse in refining margins since the late Sep-early Oct upsurge following Katrina. Complex refineries typically make most of their money from hydrocracking (as opposed to the simpler hydroskimming); the Dubai hydrocracking margin for the Singapore refining centre collapsed from an October average of US$6.60/barrel to a shocking November average of US$0.79/barrel. The downtrend for this figure actually continued into the early weeks of December where it became negative ie. it became unprofitable to refine. One may note that on a year-on-year comparison, the corresponding Nov 2004 figure was US$8/barrel while remaining above US$3.50 for Dec 2004.
None of the brokerages are projecting such poor refining margins. As it is, some of the US and Asian Nov 05 refining margins are among the lowest monthly levels for the past two years. That must start to ring some alarm bells. The reasons for the margin collapse were seen to be the warmer than expected weather (hence lower demand for heating), as well as general soft demand for oil products even as oil prices remained relatively firm. For the record, SPC's prices have tended to be positively correlated with oil prices because the latter have tended to be indicative of demand; as long as demand drove oil prices up, the prices of oil products must be pulled up correspondingly. However, fundamentally, high oil prices were actually a negative for refinery operation because they implied high input costs. If demand sags while oil prices remain high, then one must start to worry. That is how I view the collapse in refinery margins in November.
A couple of other recent news have also highlighted a growing possibility of slowing demand for oil products. Indonesia undertook a highly unpopular withdrawal of subsidies for petrol due to high oil prices, which must ultimately dampen demand considerably. China announced that they would not increase domestic refinery capacity significantly for the next few years, preferring to import oil products instead; compare that to their aggressive global push in upstream exploration and one must conclude that the refinery situation may not be as critical as many might think in the hysterics post-Katrina. Oil trading in the Singapore oil trading centre has also reportedly slowed down significantly; that is another bad sign. All these corroborate the drop in refining margins in November.
I continue to believe that SPC could well outperform the market over the long-term if it plays its cards right in the booming Asean region and capitalises on its government links. However, that is long-term; I view the medium term as more important given my style of investing/trading on (fundamentals) trends. I'm not going to assume execution risks which are immense if we look at the long-term. In terms of business segments, refining contributes the bulk of SPC's profits and it has been shown to be sagging more than expected despite the much-reported supply crunch (which I now believe is on the US side but there are many barriers against arbitrage from Asia, such as high transport costs). Upstream exploration is promising but is expected to contribute only ~10% of SPC's profits in FY06 even when the Ooyong fields start producing. Sentiment might well have peaked. Not a good time to buy, or even hold. My, my opinion has really changed on this counter.
(PS: Don't even think about using P/E to judge the valuation of this one. It is essentially a commodity/basic materials stock, like HG Metal for example. We all know what happened to that one).
(1) International Energy Agency - Monthly Oil Market Report for December