Balancing act between growth and discipline

3 January 2018Oil & Gas2018 APAC Energy OutlookEnergyOil & GasInitiation of CoverageAsiaAustralasiaJapanIndustry2018 APAC EnergyOutlookDate3 January 2018Deutsche BankMarkets ResearchBalancing act between growth anddisciplineThe return of E&P and capex names. R&C prolonged peak cycleWe enter 2018 cautiously optimistic that there will be outperformance inEnergy equities following three years of underperformance since the oil pricecollapse. APAC energy companies have had their fair share of pain but webelieve the worst is behind us and businesses have been reconfigured to workeven in a c.USD40-50/bbl oil price environment. As the forward curve nowmarches convincingly into backwardation, there are increasing upside risks to oil,underpinned by strong demand growth from emerging APAC countries and theglobal rebalancing of crude markets. Under rising oil, there is pressure on Chinaand India to revive their declining oil production which is positive for both E&Pand, particularly, capex-related companies. Widespread adoption of gas throughaggressive coal to gas switching programs has led to a winter gas crisis in China.We note the timing could not have come any better for Australian LNG exportersas the market turns to a seller's market from a buyer's market in 2018.Operating efficiencies and capital discipline leading to higher returnsBetween 2009 and 2014, oil prices went from USD57/bbl to USD100/bbl but ROEsfor the sector actually fell from 14% to 11%. We believe the days of bloated costsand expensive M&A are now over. There is increasing evidence that a balancebetween growth and capital discipline can actually be achieved, which wouldconvince investors to return to the energy space. For starters, over the next fewyears cash returns to investors are set to return to those seen at the time of thepeak oil price levels in 2013 and 2014. FCF generation should also be in the bestshape it has been in its history, more than double the levels seen in 2009. Thisis all using the DB oil deck of USD53.4/54.5/56/bbl from 2017-2019, which isconservative compared with the Street and the current oil price of USD66/bbl. Onthe other hand, capex/DD&A essentially peaked in 2009 at 2.9x, falling to only1.0x in 2017, further proof of capital discipline in the sector in the years to come,and hence rising returns to shareholders.In this outlook report, we address seven investment themes and our regional picksacross sectors and countries.■In China, CNOOC is our top pick (highest oil leverage balanced by c.5%div yield) followed by Sinopec-H (defensive cash cow with 13%/7% FCF/Johnson Wan+852-2203 6163Vitus Leung+852-2203 6158John Hirjee+61-3-9270-4318Harshad Katkar+91-22-7180-4029Wattana PunyawattanakulDeutsche TISCO Investment Advisory Co. Ltd+66-2-633 6464Ari SaludDeutsche Regis Partners, Inc.+63-2-894 6679Hanyu Zhang+852-2203 6207Grant SwanepoelCraigs Investment Partners+64-9-926-2243Joshua Lee, CFA+65-6423 5723Craig Wong-Pan+61-2-8258-2848William KhoPT Deutsche Verdhana Sekuritas Indonesia+62-21-2964 4517Deutsche Bank AG/Hong KongThis research has been prepared in association with Deutsche TISCO Investment Advisory Co. Ltd. The opinions containedin this report are those of Deutsche TISCO Investment Advisory Co. Ltd.Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should beaware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should considerthis report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONSARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017. THE CONTENT MAY NOT BE DISTRIBUTED IN THE PEOPLE ’ SREPUBLIC OF CHINA (“THE PRC”) (EXCEPT IN COMPLIANCE WITH THE APPLICABLE LAWS AND REGULATIONS OFPRC), EXCLUDING SPECIAL ADMINISTRATIVE REGIONS OF HONG KONG AND MACAU.Distributed on: 02/01/2018 23:18:16 GMT7T2se3r0Ot6kwoPa 3 January 2018Oil & Gas2018 APAC Energy Outlookdiv yield, strong gas production growth and potential marketing spin-off).Further, we like COSL-H and SEG (beneficiaries of +15-20% yoy capexincrease by parent group), Kantons (beneficiaries of crude oil imports,and gas demand surge), Kunlun (largest LNG producer and distributor).Our least preferred stocks are PetroChina-H (widening import losses,low returns and rich valuation) and SSC-H (less upstream and moredownstreamed focus by parent, levered balance sheet). We also initiate A-share coverage with PetroChina-A (Sell), Sinopec-A (Buy), COSL-A (Sell),and SSC-A (Sell).■In Australia, our top pick is Oil Search (most levered to increases in spotLNG price, +USD2/mmbtu->+8% change to FY18E). We also like Santosfor its leverage to rising oil prices, cost-cut story and corporate appeal. Ourleast preferred name is Caltex Australia (lower retail margins on heavycompetition and lowering premium petrol mix). In New Zealand, our toppick is Meridian Energy (increasing ret